ZUO - Zuora stock price analysis: Transiting from growth to value

2023-09-05 20:01:00 ET

Investment thesis

Zuora ( NYSE: ZUO ) stock price has dropped by more than 26% from its highest level this year as signs that the firm slowing down emerge. The stock’s sell-off accelerated after the company’s revenue missed estimates on August 23 ^rd .  Still, I believe that Zuora is a good investment as it transitions from a growth to a value stock. It has a substantial market share in the subscription industry and more room to expand its services.

Zuora’s tailwinds remain

Zuora is a SAAS company that many people in the United States have never heard about. Together with firms like Cloudflare (NET) and Fastly (FSLY), Zuora provides services that power most of the popular products.

In Zuora’s case, the company provides the technology that powers the subscription business of leading enterprises. Some of its biggest customers are companies like ABB, Microsoft (MSFT), Zoom (ZM), Honeywell, Sony, and Caterpillar.

Zuora’s core business is helping companies onboard and manage their subscriptions in an easy manner. By serving these firms, Zuora is also able to create products to upsell to their customers. As a result, over the years, it has added other solutions like billing, quotations, customer growth, and revenue.

The subscription business has been growing for a long time as products like Netflix, Disney+, and New York Times (NYT) become popular. Analysts at WSJ believe that the industry could grow from $650 billion in 2020 to over $1.5 trillion in 2025.

Zuora has been a key beneficiary of this trend as its revenue jumped from $235 million in 2019 to over $396 million in 2022. This growth will be important because of how Zuora makes money.  Its revenue rises when more companies move into its platform and when transactions pass through its network.

In addition to this, Zuora is learning from the needs of customers and innovating along these lines as well. For example, in August 2022, the company acquired Zephr in a $44 million deal. The addition of Zephr added more products for the media and publishing industry.

Growth is still continuing

A common concern among Zuora’s investors is that the subscription industry growth is set to wane after booming during the pandemic. Besides, most companies seeking to pivot to subscription have already done that. There is also an ongoing subscription fatigue going on.

However, for Zuora, I believe that the company has more room to grow for two reasons. It is still adding more customers, and, most importantly, it is generating more revenue from them through upselling .

In the most recent quarter, the company added companies like DISH Wireless and The Atlantic. In all, its subscription revenue jumped by 18% in constant currency while the number of $500k customers rose by 26%.

Another example of this is the growth of its volume. Its system’s billing transaction, revenue, and collect volume jumped to $87 billion, $190 billion, and $40 billion in the last fiscal year. Some of this growth is happening because of Zuora’s comprehensive suite of products.

Zuora’s management expects its revenue growth to continue. In its Q4’24 results, Zuora’s revenue rose by 11% to $108 million as the non-GAAP subscription gross margin rose slightly to 81%. A key headwind for the company was foreign exchange since a third of its customers are international. These challenges could remain for a while as the US dollar strength continues.

To be clear. I suspect that the number of new customers will continue slowing in the coming years. But even if this happens, the company’s revenue will do well as existing customers buy more products.

Salesforce (CRM) has shown that this is possible. While the company started by offering simple CRM products, it has added more solutions like marketing, e-commerce, communication, and data analytics.

From growth to value

The Covid-19 pandemic helped to supercharge the growth of many companies. Think of a company like PayPal (PYPL), which recorded remarkable growth as the volume of transactions rose.

My investment case for Zuora is that the company is in a slow transition from growth to value. In this case, the company’s revenue growth will be at a moderate pace while the management will focus more on profitability.

Zuora’s annual revenue in the past financial year was $396 million, a 14% increase from the previous year. I suspect that the double-digit growth will continue in the next five years followed by higher single-digit growth. For this year, the company estimates that its revenue will grow by 10% to between $428 million and $433 million. Subscription revenue will be between $380 million to $384 million.

If it grows by 10% in 2024, its revenue will reach $480 million followed by over $500 million in the next financial year.

As it moves from growth to value, Zuora’s business will become more profitable, with analysts expecting it to break even in 2023 . Talking about profitability, the company’s CEO said :

“Based on the current environment, we believe it’s prudent to put dollars to the bottom line. We have the sales capacity to deliver on our outlook for the second half of the year, and we have the ability to ramp up as needed.”

Zuora has good characteristics as a value company. For one, it will become a highly profitable asset-light company with low churn. Its gross margins stand at 81%, which is almost the same as companies like Adobe, Salesforce, and Autodesk. Microsoft, Adobe, and Autodesk have a net profit margin of over 20%.

Therefore, if Zuora’s revenue growth stalls at ~$500 million and its net profit margin comes in at $20%, its profit will be $100 million. Big SAAS companies like Microsoft, Adobe, ADSK, and Salesforce have a PE ratio of o ver 35. As such, I believe that a conservative multiple of 30x, puts Zuora’s valuation at ~$3 billion, higher than its current $1.2 billion.

Zuora’s valuation is compelling

Zuora’s valuation seems like a bargain for now, reflecting a company that is transitioning from growth to value. The company has a market cap of $1.2 billion and ~$406 million in cash and short-term investments. Its total debt load stands at $214 million, bringing its net cash to $192 million. This means that the firm has an enterprise value of just ~$1 billion, which is a good one for a company that will soon start making over $500 million in annual revenue.

As an unprofitable company for now, the best valuation multiples to look at for Zuora are the EV to sales and EV to EBITDA. Data compiled by SeekingAlpha shows that the company has a forward EV/EBITDA of 20.32 and EV to sales of 2.62. In contrast, peer SAAS companies like Fastly, Cloudflare, and CrowdStrike have EV-to-sales and EBITDA multiples of over 20x.

Another way I look at Zuora’s valuation is to compare it with Intuit’s Mailchimp acquisition in a $12 billion deal. At the time, MailChimp’s annual revenue was about $800 million and its annual growth was ~20%. Zuora is a smaller company with slower revenue growth. But if we extrapolate these numbers, we see that its ~$1 billion enterprise value is a bit cheap.

The key challenge for Zuora’s valuation is that its rule of 40 metric is a bit weak. The rule of 40 states that a company’s revenue growth and profit margin should equal or exceed 40. In Zuora’s case, revenue growth in the recent quarter came in at 11% while its operating margin of 9%, giving it a rule of 40 figure of just 19. This figure reflects the fact that Zuora’s growth is slower than its historic standards.

In future, though, as Zuora starts to focus on profitability, I suspect that its operating margin will get to over 20%, in line with other larger SAAS companies like Microsoft and Adobe. This view is supported by Zuora’s

Risks to the thesis

There are two main risks to the bullish thesis. First, technically speaking, the shares have formed a double-top pattern at $11.86 whose neckline is at ~$9.61. Therefore, since a double-top is usually a bearish sign, there is a likelihood that it will see some short-term volatility now that it has moved below its neckline.

Worse, Zuora has already dropped below the 200-day and 50-day exponential moving averages (EMA), pointing to more downside in the near term. Technically speaking, I believe that the next key support level to watch will be at $7.25, the lowest point on May 4 ^th .

Source: TradingView

The other risk is if growth slows at a faster pace than we expect and if interest rates remain at an elevated level for longer.

Most importantly, Zuora faces major forex thesis as the US dollar strength continues. After falling to $99.5 in July, the US dollar index has jumped by almost 5% to over $104. It has been stronger against key currencies like the Japanese yen, Chinese yuan, and the Swedish krona.

Zuora is sensitive to foreign exchange in two main ways. First, a stronger dollar makes its international revenue numbers weaker in dollar terms. In its recent quarter, the strong USD had a $2 million impact on revenue. Second, it spurs inflation in its key markets, which affects its deal-making.

The final risk is that Zuora’s insiders have been selling the shares . They have sold shares without buying in the past 12 straight quarters, which is not a sign of confidence.

Source: MarketBeat

Final thoughts

Zuora is a best-in-class SAAS company that provides a service that is still seeing strong growth. It has sticky customers, which helps reduce its churn. Also, the company has more room to grow its average revenue per user (ARPU) as it unveils more services in its product suit.

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