Zuora (ZUO) - Any thoughts?

I’m currently conducting my research on billing/recurring SaaS leader - Zuora.

From what I’ve read and heard, the business metrics look solid with strong recurring revenue, billings and net retention revenue growth.

The Founder/CEO is an ex-Oracle employee and prior to founding Zuora, he worked as Chief Marketing Officer and later, as Chief Strategy Officer at Salesforce. Apparently, he was the 11th employee hired by Marc Benioff at Salesforce and worked there for 8-9 years.

Interesting to note that Marc Benioff was one of the earliest investors in Zuora and the Founder/CEO still owns around 10% of the company (skin in the game).

During the Q3 2018 earnings call, the Founder/CEO stated that Zuora can keep growing at 25-30% CAGR for many years, if not decades! He also asserted that Zuora has a 10-year headstart in the billing and revenue recognition space; that at this stage, the company doesn’t face any viable competition.

Zuora is poised to benefit immensely from the transition towards a subscription based economy (think video and music streaming, ride sharing, digital media subscriptions etc.) and before investing my funds, I’m trying to figure out if Zuora truly doesn’t have any competition or if the company is talking its own book?

Not sure if anybody on this board knows a thing or two about this space but if you do, I’ll appreciate your thoughts.

Thank you,

GM

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Thanks for bringing this to the board. We’ve glanced at ZUO a few times but I feel like either we’re missing something or there’s not much there. Maybe you can help.

Why would anyone need ZUO? Is it that hard to bill monthly? The subscription model seems kind of self explanatory, right? What do they actually do?

Who are their customers? Have any big names signed on? What’s the net expansion rate (ie, are customers spending more each year)? What’s the customer count and how fast is it growing?

Thanks again,
Bear

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Most of what you need to know is covered in these two posts:

https://discussion.fool.com/zuo-dreamer-at-al-33114559.aspx?sort…

https://discussion.fool.com/zuo-it-loves-me-it-loves-me-not-3315…

Bert likes it here:

https://seekingalpha.com/article/4230753-zuora-will-holiday-…

Now on the buyer beware side…read this bizzare earnings call from 2 ago:

https://seekingalpha.com/article/4203326-zuora-inc-zuo-ceo-t…

I think they cleaned their “act” up on the last earnings call, but this one really freaked a few people out IMO…doubt they will ever do that again.

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Bear,

Zuora is a leader in the billing/revenue recognition software space. It sells software (as a service) to those enterprises which are moving towards the ‘subscription economy’ and its solutions help these companies to recognise ongoing subscription revenues and properly bill their customers.

Zuora sells two main products - Zuora RevPro (revenue recognition) and Zuora Billing (billing)

In addition, Zuora also sells some ancillary solutions - Zuora CPQ and Zuora Collect

Zuora’s software helps businesses to launch and manage their subscription based services in a fully automated manner.

Approximately, 50% of Zuora’s revenue is generated from the cloud/SaaS sector; media (magazines and newspapers) account for 13% of revenue and the automotive sector is also growing in size.

In terms of customers, Zuora deals with prominent companies in each vertical i.e. TECH - New Relic, Nutanix, NVidia, Box, Zendesk, Symantec and Netapp; MEDIA - HBO, Financial Times, Wall Street Journal, News Corp UK etc; CONSUMER/BUSINESS SERVICES - FedEx, Zillow, Tripadvisor; TRANSPORTATION - GM, Ford, Renault, Peugeot, Toyota and Kia etc.

According to MGI Research, the ‘billing and revenue recognition products’ market is projected to grow by 35% CAGR from 2017 until 2022 ($1.8 billion to $9.1 billion) and Zuora is the clear cut leader in this field.

As far as I’m aware, a few smaller firms offer piece meal solutions but Zuora is 10 years ahead of the pack and nobody comes close.

The company has now bagged 504 enterprise customers (+30% yoy) and each of these are spending more that $100,000 in Annual Contract Value. In addition to the base fees, these customers also pay Zuora based on the volume of invoices issued or revenue recognised on its platform.

I’ve corresponded with Bert Hochfeld and he has confirmed that Zuora doesn’t have any viable competitors and the company is indeed capable of growing revenue at 25-30% CAGR for at least the next decade (or more). He also thinks that it is possible that a big firm may acquire Zuora.

The stock was cut in half during the recent stock market pullback and it is currently trading at ‘just’ 9 times sales. IF Zuora can succeed in compounding its revenue at 25% per annum for 10 years and assuming its Price/Sales multiple eventually contracts to 6; this should translate into a 7 bagger by 2029. Remember, Zuora’s CEO is expecting 25-30% CAGR top line growth for years; if not decades - so a 10-12 bagger within 10-12 years isn’t outside the realms of possibility.

To top it all, Marc Benioff, Paul Allen’s fund (Vulcan Capital) and Benchmark Capital are/were investors and the CEO (Tien Tzuo) still owns 10% of the company.

Given all of the above, I’ve decided to invest 5% of my portfolio in this high-growth business.

Hope this has been helpful; please let me know your if you have questions/comments.

GM.

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The net retention rate has been rising and is now 115%.

In Q3 2018, Zuora’s subscription revenue increased 43% yoy

and

Zuora Billing processed $8.6 billion in transaction volume (+37% yoy)

Short 2 minute videos on Zuora RevPro (revenue recognition) and Zuora Billing (billing).

RevPro ---- https://www.youtube.com/watch?v=gXKrFloQ5xE

Billing ---- https://www.youtube.com/watch?v=EGIIubeFD0U

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I use to have to deal with these kind of Billings years ago for service contracts, it certainly would have been a nice solution then. As they mentioned in the RevPro video, we used elaborate Excel sheets to track the beginning and end dates of all active contracts that were then used to post accounting entries on how much revenue to recognise in the ERP system. Though I believe our current system handles it much better now.

I checked their webpage briefly but couldn’t find, do they partner with SAP and Oracle so that all the accounting entries can be synced back to the main financial system?

It seems a nice solution for a company that is purely on subscription revenue but not sure how it integrates for one that is on a mixed model as you would already be invoices other products and having a CPQ tool integrated with SFDC or using SFDC CPQ.

But from their customer list, they have managed to sign up some large, tradition companies they would have subscription and non-subscription revenue, just not sure what part of their products they are using in their implementation.

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Great write up, GM. Got me interested. Unfortunately, I found a pretty big problem:

28% of total revenue (professional services) is negative gross margin revenue. This isn’t unprecedented, but the amount is huge. For comparison, MDB’s services revenue was only 7.5% of their total revenue, and it wasn’t negative margin, just very low margin. Okta’s was 7.5% as well, and was negative margin. But 28%…that’s several times as much as I would think acceptable.

I am certain this is the reason they trade at a PS of 9. Square backs out revenue that they just pass through to the CC companies, because their gross margin on this revenue is $0. ZUO’s is worse than that, because ZUO is actually negative on this 28% of their revenue. If you back out ZUO’s services revenue, mkt cap divided by TTM subscription revenue is more like 14 (instead of their PS of 9). Not terrible, but not bargain territory. But I don’t know how to account for the fact that they’re also negative to the tune of several million dollars. To say the least, it is going to make profitability a rough uphill climb.

I wish you the best with your investment, but I urge you to take this issue seriously.

Bear

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Unfortunately, I found a pretty big problem:28% of total revenue (professional services) is negative gross margin revenue. This isn’t unprecedented, but the amount is huge.

Bear:

This was affected by a one time massive infusion of professional services revenue from the RevPro acquisition.

Beginning Q1 2020 (2 quarters from now), you will see that % contribution represent a much lower % of total revenue…and the total revenue growth will more closely track with subscription growth.

In Q3, we grew subscription revenue by 43% year-over-year, to $44.5 million. We grew total revenue by 33%, to $61.6 million. As a quick reminder, which we highlighted previously, the reason that total revenue grew slower than subscription revenue is that we had a big one-time uptick in professional services revenue last year related to our RevPro business. We’ll have this year-over-year anomaly in Q4 as well, but we believe it should normalize in Q1.

Best:
Duma

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Bear,

The services revenue will drop off quite rapidly in a year and become a much smaller proportion of total revenue.

Although Zuora’s published revenue growth rate is in the mid 30s due to the slow services growth, its subscription (or real) growth rate is 43%.

Just like Nutanix’s (zero margin hardware revenue), Zuora’s high real growth rate is also being masked by its artificially elevated professional services revenue (which is tapering off).

Does the above change your view?

Best,

GM

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Bear asks,

Is it that hard to bill monthly?

As a former Internet Service Provider owner (changing “monthly” to the more general “recurring”), yes it is, especially when you offer prepaid contracts. Once you do that, your CPA tells you you have to recognize the revenue monthly over the life of the contract, even if the contract is non-refundable. Even though we wrote our own billing system, this was a total mess. I’m not sure we ever got it 100% right. I would have jumped on Zuora in an instant.

Bruce
Long ZUO

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I checked their webpage briefly but couldn’t find, do they partner with SAP and Oracle so that all the accounting entries can be synced back to the main financial system?

I just watch this video that shows an overview of the Zuora Ecosystem:
https://youtu.be/zQ7XlLZSpeA

It describes interfaces to legacy CRM, ERP, and provisioning/tax systems, and specifically mentions Quickbooks, NetSuite, Oracle, and SAP.

Enjoy,
Brian

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GM and Duma,

You’re regurgitating management’s story, but you need to look closer. Yes, they say year-on-year comparisons also include the financial impact of a RevPro product which we began to offer following our acquisition of Leeyo on May 31st 2017. But look at the quarter before that (ended April 30 2017). Services already made up almost 20% of total revenue! (they had $6.3m services revenue and $32.3m total revenue)

And even if services does taper off, that will slow total revenue growth rate! This is a mess – simply too complicated. This is a business that’s really priced at 14x (subscription) sales, where total revenue growth rate is expected to slow to 25-30%, and profit is a long way away. No thanks. There’s going to be some confusion the next couple quarters, and frankly as I looked back at the conference calls, they haven’t been very clear about it. Hard pass.

Bear

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Hey Bear:

For record, I am not evangelizing ZUO. I am only giving deference to Bert who seems to like this stock…although I am not a subscriber to his service…the article was very favorable.

But since you brought up the very good point about the low margin professional revenue…and this no doubt gives some a little nausea after the recent PVTL parallel, perhaps you could run this concern by Bert?

Note also that the subscription revenue growth for 4th quarter appears to be 32%.

Quite honestly, despite the links I referenced in my original posts and the diligence performed at that time, ZUO lost me at the second quarter earnings call that was bizarre beyond words…as commented on at the NPI.

I only posted on ZUO again because BERT liked them…otherwise, they were in the penalty box.

So again, not evangelizing ZUO as compared to TTD, MDB, NTNX where I did evangelize.

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Bear & Duma,

I did express the same concerns about the services revenue to Bert and his response is pasted below:

“Part of the reason for the negative gross margin on services has to do with the impact of the RevPro acquisition a year ago and the deferred revenue write down that is required. RevPro had lots of services revenue as proportion of the total and you are seeing that impact. That will normalize in fiscal year 2020-that is to say after one more quarter. The company will not run at a negative professional services gm.”

Hope this helps.

GM

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I learned from Pivotal not to separate service revenue from subscription revenue, and look at total revenue and margin.

For Pivotal, the Pivotal Labs revenue (lower margin part of the business) was REQUIRED to get subscription customers, so it makes no sense to separate it out. You can’t have one without the other.

For SaaS companies, the service revenue is required to support subscription customers. I would also argue the best products have a lower service revenue to subscription component. A product that works better will have lower service needs.

It sounds like ZUO has a temporary spike, but service revenue and costs will always be there.

NTNX is completely different, pass thru hardware can be eliminated. (Yet to be determined if NTNX will lose customers because of it).

Jim

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Jim,
I think what you said here is worth repeating,

I learned from Pivotal not to separate service revenue from subscription revenue, and look at total revenue and margin.

For Pivotal, the Pivotal Labs revenue (lower margin part of the business) was REQUIRED to get subscription customers, so it makes no sense to separate it out. You can’t have one without the other.

For SaaS companies, the service revenue is required to support subscription customers. I would also argue the best products have a lower service revenue to subscription component. A product that works better will have lower service needs.

A wise person, off the boards, recently made this point to me. Thank you for bringing this up. I think it is a lesson that we should all take to heart.

best,
Ethan

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