Description

Zuora is a software provider powering the Subscription Economy trading at a severe discount to other SaaS companies with similar financial profiles.  On an Enterprise Value to Revenue basis, the company trades at about 3.7x calendar 2022E revenue.  This is a discount to most SaaS companies with similar revenue growth rates which trade at 6x – 12x revenue multiples.  Zuora is two years into a turnaround with a new head of sales and a revamped sales strategy and team.  Zuora’s current subscription revenue growth is about 15% - we think this can accelerate over time to a 25% clip.  The company is currently close to breakeven – we feel there is operating leverage in the business with 80% subscription gross margins and flattening operating expenses.  If revenue can accelerate, there is a tremendous amount of upside to the stock.  Revenue growth has decelerated the past couple of years and the market is pricing in continued slowing in Zuora’s current valuation.  Completion of a successful turnaround would be a positive surprise to the market and ZUO stock would sharply appreciate in that scenario.

Zuora sells billing and revenue recognition software to companies that are starting subscription businesses or switching to a subscription revenue model.  The software industry has moved from primarily a perpetual license model 20 years ago to a subscription model today.  Now other industries are beginning to make this move (think Netflix, Disney+, Spotify, ADT, Caterpillar, etc.) as they shift from selling products to selling usage-as-a-service.  Zuora calls this the Subscription Economy and it is the macro driver for the business.  Zuora Billing allows companies to charge their customers any type of subscription rate they desire, from billing by time to billing by applications used to billing by consumption.  Zuora Billing allows for 50 charging models and 180 currencies, and supports 20 payment methods and 30 payment gateways, including a new partnership with Stripe.  Zuora’s billing engine can handle the most complicated billing strategies and can also scale up to massive usage.  Zoom Video Communications (ZM) is a Zuora marquis customer and demonstrates the scale of Zuora’s billing capability.  Zuora Revenue, its revenue recognition product, allows customers to properly recognize revenue even with complicated revenue recognition rules.  Zuora recently added an analytics product that allows customers to better understand their billing patterns and use this knowledge to more effectively bill their customers.

Zuora’s revenue growth rate has been decelerating over the past few years.  In 2018, overall revenue growth was 40%, declining to 17.5% in 2019 and forecast to be 9.5% in 2020.  One obvious reason for this slowing is the decline in services revenue, which declined 1% in 2019 and 10% in 2020.  These declines were planned by the company as it transitions much of its lower margin service work to systems integrators such as Accenture and Cap Gemini.  While lowering overall revenue growth in the short term, this move has the effect of increasing blended gross margins and allowing these systems integrators to form practices around Zuora which will lead to a growing pipeline and higher revenue in the future. 

The bigger issue for Zuora has been the deceleration in revenue growth in the company’s subscription line.  Subscription revenue growth has decelerated from 37% in 2018 to 25% in 2019 to 16% in 2020.  Many of the company’s customers are small businesses and suffered in Q2 2020 because of the pandemic.  This caused a decline in the company’s dollar-based retention rate from 107% the prior year Q2 to 99% in 2020.  This also hit the subscription revenue line which grew 15% in Q2 2020 versus 24% in the prior year.  Zuora is shifting its focus to larger customers now as part of its new sales initiative and these customers will be hardier in economic downturns.  Zuora’s is a very sticky product in general because it is used to run its customers’ businesses and bill for their revenue.  The issues Zuora has had have not been customers leaving its product but rather smaller customers failing because of the pandemic.

Tien Tzuo, co-founder and CEO of Zuora brought in a new Chief Revenue Officer in October of 2019.  This CRO, Robbie Traube, has an excellent resume, last serving as Vice President, Strategic and Vertical Accounts, North America at Adobe.  He spent 10 years at Adobe, mostly driving sales of the company’s Adobe Experience Cloud.  Prior to Adobe, Robbie was Vice President of Global Business Development at ClickSoftware, and prior to that he was the Senior Vice President of Worldwide Sales and Alliances at Mercado Software.  Upon joining Zuora, Robbie put in place a disciplined sales process with clear goals and objectives and accountability for each salesperson.  He structured a team selling approach versus the hunter-farmer model the company used previously.  This enables deeper and more consistent engagement with the customers and is more fitting for larger enterprise accounts.  Usually changes in sales take 12 – 18 months to filter down to the P&L, so we are just about entering that zone with Zuora.  Over the next year the P&L will tell if our thesis is correct or not.                  

In addition to adding Robbie as Chief Revenue Officer, Tien also strengthened the management team at other positions.  He added Chris Battles as Chief Product Officer.  Chris previously served as Senior Vice President & General Manager of Communications & Collaboration and Chief Product Officer at LogMeIn.  Paul Heard was added as Chief Information Officer with prior experience at Micro Focus, HPE, and DaimlerChrysler.  This infusion of management talent leads me to believe that the company will be making positive changes which will benefit shareholders. 

Zuora currently trades at about a $1.7 billion market cap with $170 million in net cash on the balance sheet.  It was free cash flow positive in Q2, an achievement many of its similarly sized SaaS peers cannot claim.  On an enterprise value to revenue basis, it trades at 3.7x calendar 2022E revenue of $400 million.  If subscription revenue returns to a 25% growth rate, I think it can trade more in line with its SaaS peers at an 8x revenue multiple on calendar 2022E sales.  This would translate to a $25.50 stock price or about 80% upside from current levels.

Risks of a Zuora investment at these levels are as follows.  The company does business in a very competitive space and could possibly lose market share to new or existing players.  A bear could say that they have already been losing market share the past two years which I would counter and say it has been a poor sales process that has hurt them, and we will find out who is right shortly.  The company’s CEO is also its co-founder, which often is not a good combination as it takes a different skill set to run a large organization.  I think that Tien has brought in quality talent to surround him and now he can focus on evangelizing the subscription economy as the broader theme to drive adoption of Zuora’s software.  Turnarounds often take time and can be a two-steps-forward, one-step-back process so it may take longer than I think for the sales improvements at the company to hit the top-line.      

Catalyst

I think revenue growth will accelerate causing a rerating of the stock.