Investors have plenty of reasons to believe in Zuora (ZUO), the subscription software company dedicated to other subscription-based companies, again. It should come as no surprise to anyone that of all the types of business rocked by the global coronavirus pandemic, subscription-based companies (which Zuora labels as operating in the “subscription economy”) have held up strong.
Zuora’s chief data scientist recently put out a research report (no doubt self-serving, but containing interesting data anyway) showing that while revenue of S&P 500 companies contracted by -1.9% in Q1, subscription-based companies actually still grew at 9.5% y/y. Zuora’s exclusive exposure to this “subscription economy” – which will continue to define the way we consume goods and services – makes the company well-positioned to grow.
I recommended Zuora close to the March nadir when shares were trading around $7-8; even though Zuora has leaped ~60% from those levels, I still think investors have a fantastic opportunity to buy into a strong growth story with a strong thematic tie to the subscription economy. The key pieces of the bullish thesis for Zuora, for me, are as follows:
- Recovering growth. We’ll dive into Zuora’s Q1 results shortly, but note that after a sales execution problem last year, Zuora has recovered to stable mid-teens revenue growth
- Growing profitability. Zuora is already roughly cash flow neutral, while gross margins are on the rise.
- Unique niche. There are plenty of ERP companies, but Zuora’s focus on subscription-only companies is unique. Some of the most well-known subscription companies are Zuora users, including Box.com (BOX) and Symantec (SYMC), as well as some other surprising customers like Caterpillar (CAT).
- Value-oriented. Even after the strong April/March rally that outperformed the S&P 500 by roughly thirty points, Zuora still retains good value relative to other similarly-growing peers.
Let’s touch on that last point in further detail. At current share prices near $12, Zuora has a market cap of just $1.39 billion. After we net out the $172.6 million of cash and $9.4 million of debt on Zuora’s balance sheet, its enterprise value stands at $1.23 billion.
Wall Street analysts have a consensus revenue estimate of $299.1 million this year, representing just 8% y/y growth for the year (Zuora has withdrawn full-year guidance, but has guided to ~5-8% growth in Q2). Considering Zuora just grew Q1 revenues at a blistering +15% y/y pace (and the fact that Zuora has never seen below a 10% y/y growth pace in any quarter) this consensus estimate and Zuora’s own Q2 forecast is likely several points light. Nevertheless, even if we use this conservative forecast, we find that Zuora is trading at a valuation of just 4.1x EV/FY20 revenues. For a company that is growing margins and cash flow while recovering its growth footing, I’d say this still gives investors an opportunity to buy Zuora on the ground floor.
Stay long here and use any near-term dips to buy.
We can now parse through the details of Zuora’s latest earnings results. Take a look at the earnings summary below:
There are a couple points of strength to call out. Zuora’s revenues grew 15% y/y to $73.9 million, far surpassing Wall Street’s consensus of $70.6 million (+10% y/y) – and possibly also hinting that the full-year forecast has opportunity to it as well. We note that Zuora actually accelerated revenue growth by four points relative to 11% y/y growth in Q4 despite a flagging macroeconomy, which actually underscores Zuora’s point that subscription companies are much more resilient in these types of macro shocks.
Zuora also posted billings growth of 10% y/y in Q1. There are two observations that we can make from Zuora’s billings rate here: one, if Zuora billed 10% y/y in the first quarter, it suggests that 8% y/y full-year growth is light, and two, Zuora noted that this 10% y/y growth was after the impact of many deals pushing into May. Understandably, many customers have delayed their new purchase decisions in the wake of the coronavirus, but Zuora has noted that it has been able to close a large percentage of deals that have pushed. Per CEO Tien Tzuo’s prepared remarks on the Q1 earnings call:
Many companies are still in a state of change. They’re all sorting through their internal priorities and processes leading to a lot more noise in the system. The result is, it can take longer to finalize some deals, causing them to slip out of the quarter. The good news is, of those Q1 deals that slipped, 75% of them closed in May. We have also been helping some of our long-standing customers in industries like sports and travel with volume credits and payment deferrals. In certain situations, we are intentionally targeting lighter deals leading to faster deployments. And we know that once we get operational with real revenue flowing through our system, we’ll have the ability to expand. Now all this means that in the short term, there will be some impact on billings for the next quarter, but we expect to see the long-term growth trends to stay intact.”
While Zuora’s guidance still incorporates billings slowing down in Q2 (despite May catching up to many pushed Q1 deals), we would expect that the back half of FY21 will show better revenue and Billings trends especially if Zuora can continue to close the delayed deals in its pipeline at such a high rate.
Another point of strength is Zuora’s revenue mix this quarter. Subscription revenues made up 77% of overall revenues this quarter, up from 74% last quarter. Because Zuora’s professional services/implementation is actually performed below cost (aka, has a negative gross margin), the greater mix of subscription revenues this quarter (which we would expect to continue as Zuora grows into a larger scale, and has the ability to push more of this implementation work to third-party partners) had a superb impact on gross margins. Zuora’s overall pro forma gross margins ticked up to 60% this quarter, up six points from 54% in the year-ago quarter, while subscription gross margins on a standalone basis rose one point from 78% to 79%. Zuora’s high mix of professional services revenue and lower margins relative to other SaaS peers has long been a point of contention with investors, and the company is showing positive trends in this regard.
Equally impressive is the fact that, thanks to reduced travel and marketing expenses, Zuora’s pro forma operating losses shrunk to -$7.7 million or a -10.4% pro forma operating margin, a 910bps improvement relative to -19.5% in the year-ago quarter.
These strong profitability results also trickled into cash flow, where Zuora’s operating cash flow turned to positive $3.0 million, from a loss of -$2.0 million in the year-ago quarter. And if you exclude $3.2 million of capex this quarter that is related to Zuora’s one-time headquarters move, Zuora’s free cash flow would also have been positive $1.0 million, versus a loss of -$3.8 million in the year-ago quarter.
In my view, amid continued market turmoil, investors will be willing to excuse Zuora’s unexciting mid-teens revenue growth in exchange for the fact that the company is finally showing a credible path to profitability.
There’s a lot to like about Zuora. Think of this company as an all-encompassing bet on the future of the subscription economy. Aside from stabilizing growth and robust margin improvements, I also believe Zuora would be an ideal M&A candidate for a larger ERP company like Workday (WDAY) or SAP (SAP) to acquire into their portfolio of applications down the road. With shares trading at just over ~4x forward revenues, there’s not much to lose.
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Disclosure: I am/we are long ZUO. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.