For some high-growth tech stock investors, it’s been two years (in some cases a little more) of suffering. Some early pandemic winners may suffer Zoom video communication (ZM -0.74%) reached their records way back in late 2020. Others like it PubMatic (PUBM -1.97%) have been mostly down since their 2021 initial public offerings (IPOs).
What’s frustrating now is that a bull market seems to be trying to find some footing, especially led by tech infrastructure stocks like semiconductors and energy. Not only are Zoom and PubMatic being left behind, but they both gave a weak outlook for calendar year 2023. Is it time to sell these two struggling tech stocks?
1. Zoom Video: Growth is done, now it’s a question of “how cheap is cheap enough?”
A high-growth and promising stock before the pandemic, Zoom Video Communications became an economic lockdown darling as the world rapidly shifted to remote work. But since then Zoom has boomed. It’s starting to look like 2020 broke this software communications company, turning it into more of a sluggish utility stock than a nimble software outfit.
The final financial report for the 2023 financial year (the 12 months ending January 2023) painted a less than perfect picture. Fourth-quarter revenue beat management’s guidance, coming in at $1.12 billion, or up 4% year over year (or up 6% when excluding the negative impact of a strong US dollar). Net loss was $104 million and free cash flow was positive $183 million – the discrepancy between the two is primarily employee stock-based compensation of $518 million. Stock-based compensation for the full fiscal year was $1.29 billion, which Zoom mostly offset with share repurchases (funded by free cash flow) of $1 billion.
But it was the outlook for the 2024 financial year that really disappointed. Revenue is expected to be in a range of $4.435 billion to $4.455 billion, broadly flat with the just-ended fiscal year (although the US dollar has another negative impact on this outlook).
By some metrics, Zoom is cheap. The stock trades for less than 17 times free cash flow after 12 months. Even if revenue continues to explode, the company took steps to increase its profit margin going forward. Zoom also has a fortress balance sheet with $5.4 billion in cash and short-term investments and no debt.
But being a value investor requires a completely different competence than being a growth investor. Patience can be tested to a much greater degree with a “value” stock, as shareholders are often required to wait for the market to recognize slow but steady progress by management to improve profitability. Meanwhile, other areas of the economy are already back in growth mode and getting investors’ attention.
I still own my small position in Zoom and have no plans to sell anytime soon. But be aware that it may still be a bumpy road ahead for this once-magnificent growth company. Zoom looks more like a boring old telecom stock than ever before.
2. PubMatic: The promise of higher profit margins isn’t coming true … yet
PubMatic’s transition from fresh IPO growth stock to value stock happened in a completely different way. With economic uncertainty emerging in the second half of 2022 and lingering so far in 2023, digital advertising has slowed dramatically. When economic conditions tighten, marketing activity is often the first part of a company’s budget to take a hit. Small companies like PubMatic, which offers software for media outlets that want to list and manage ad space available for sale, suffered.
Q4 2022 revenue was $74.3 million, down slightly from $75.6 million a year earlier. While PubMatic’s small connected TV segment (think streaming video services) continued to grow at a robust pace, display ads (banner-style ads with text, images and links), about two-thirds of PubMatic’s sales, dragged down results.
But most frustratingly, the company’s promised expansion of profit margins may take longer to deliver than expected. Management launched cost-cutting plans towards the end of 2022, but it says they will take time to bear fruit in 2023. Adjusted earnings before interest, tax, depreciation and amortization (EBITDA) margin is expected to be more than 30% for 2023, compared by 38% in 2022. Free cash flow is expected to be “equivalent to 2022”, implying about $38 million (or about 15% free cash flow profit margin).
At least management gave a vote of confidence by introducing a $75 million share buyback plan that can be executed through the end of 2024. PubMatic ended the year with $174 million in cash and short-term investments and no debt, so the company is well positioned to return excess cash to shareholders via share buybacks.
Like Zoom, PubMatic could be seen as cheap by some metrics. Shares trade for less than 20 times trailing 12-month free cash flow at the time of writing. But this is another potential “value story” that will take time to unfold. Patience could ultimately be rewarded for shareholders in this company, so I’m not inclined to sell — and especially not if the digital advertising industry starts to pick up again later this year. But if you stand by PubMatic, be prepared to brace yourself for a bumpy ride for quite some time.
Nicholas Rossolillo and his clients hold positions in PubMatic and Zoom Video Communications. The Motley Fool has positions in and recommends PubMatic and Zoom Video Communications. The Motley Fool has a non-disclosure policy.