Though not widely reported, Responsys (NASDAQ:MKTG) experienced a severe service outage on Cyber Monday. One of its two data centers went down, potentially impacting more than half of its customer base. From what we have gathered, the outage took several days to contain.
The ramifications, however, will likely take much longer to overcome.
The outage didn't just leave customers on temporary hold. It nullified weeks of planning to get critical marketing efforts completed on the most important day of many online retailers' year. Thus, the disruption represented a breach of trust that will threaten MKTG's position in minds of existing accounts and potential customers.
To get a sense of how devastating an outage can be, investors need to look no further than Knight Capital Group (NYSE:KCG). KCG's technology hiccup sent its shares tumbling from over $10 to a 52-week low of $2.24. It's been four months and the stock still trades at one-third of its previous value. BATS experienced an equally public calamity, which forced the company to pull the plug on its IPO.
Thus far, MKTG has escaped investors' wrath, partly because most have yet to fully assess the implications. However, even before this event, Pipeline Data had been expressing negativity toward this segment of the space. Specifically, tactical marketing tools have been losing momentum as customers seek more strategic marketing solutions. Weak Q3 results from companies like CTCT and MKTG validated this thesis.
Beyond this segment-specific headwind, MKTG has also been facing intensifying competition at the hands of ExactTarget (NYSE:ET), as well as Experian (EXPN - London) via its May 2012 acquisition of Conversen. Conversen was known for its technological acumen, but lacked execution and market credibility, both of which Experian has brought to the table. With its 9-digit war chest and $10 billion market cap, Experian has begun flexing its muscles in the space. We believe this is yet another reason why MKTG disappointed investors in Q3.
This latest fumble won't help matters. In the software market, competitors jump on situations like this to create FUD (fear, uncertainty, and doubt) in customers' minds. Such is the nature of software. In a stable IT environment, well-tested software tends to work forever. However, poorly written software tends to suffer long-term issues. Thus, MKTG's risks could extend well-beyond Q4.
In fact, from what we've gathered, we believe that MKTG may miss its Q4 numbers by a tidy amount.
MKTG charges subscription fees for a base level of usage. It also collects overage fees for usage that goes beyond the contracted limits. Obviously, Q4 is big for overage fees. In Q4 of last year, revenue was $37.2M with overage revenue of $6.2M. Third quarter revenue was $40.5M with overage revenue of $5.1M. Indeed, Q4 estimates call for $42.4M and EPS of $0.05, which likely assumes approximately $7M in overage revenue.
Much of that overage revenue would likely flow on Cyber Monday, but that was the day of MKTG's outage. Our research leads us to believe that this was lost revenue as: 1) there's no make-up date for Cyber Monday and 2) MKTG competitors -- good Samaritans that they are -- stepped in to assist. We'd be shocked if they weren't talking about making that assistance permanent.
In addition to lost overage revenue, MKTG will likely have to "issue credits, make refunds, or pay penalties". As stated in its 10-K: "If we do not complete this maintenance according to schedule or if customers are otherwise dissatisfied with the frequency and/or duration of our maintenance services and related system outages, customers could elect not to renew, or delay or withhold payment to us, or cause us to issue credits, make refunds or pay penalties."
In addition, "We offer a multi-tier support structure that provides varying levels of service level commitments depending on the customer's requirements."
In Q3, subscription dollar retention was over 100%, consistent with past quarters. Considering that this outage knocked out one of its two data centers, it would be reasonable to assume that 50% of MKTG's customer base was impacted. Accordingly, we believe investors should doubt MKTG's ability to maintain its 100% dollar retention rate, something that appears baked into next year's estimates.
Worst of all, subscription and especially overage revenue substantially drops to the bottom line. Its current operating model likely leaves just $4M of cushion to absorb overage losses, credits, refunds and penalties before they'd have to report a loss for the quarter (much less the consensus $0.05 profit). MKTG has had its issues in the past. An interview with MKTG's co-founder and former CTO, Raghu Raghavan, revealed cracks in the armor which were perhaps warning of things to come. One quote alluded to "disastrous acquisitions". In the software space, poor acquisitions generally result in subpar products and poor financial performance, as we have recently witnessed with Hewlett-Packard (NYSE:HPQ).
In the interview, Raghavan also stated that Responsys "should have had huge churn", but its data integration capabilities were helping to keep customers at bay. However, there's only so much a customer can take before starting over is less painful than living in fear of another outage at a critical juncture. Accordingly, investors should be wondering if this is the straw that breaks the camel's back.
The company is taking steps to minimize the damage. However, MKTG has not historically been known for its customer response times. According to Gartner Group, "references mention somewhat slow support turnaround times".
Nonetheless, on the day of the outage, Responsys posted a new listing on LinkedIn seeking a Director to ensure reliability of the company's production environments. A key (though oddly phrased) bullet point stated, "An ounce of preventing an outage is worth 50 pounds of response to recover the from the outage" -- a case of too little, too late.
Since MKTG's poor Q3 print, the company has reportedly been seeking buyout offers. However, in light of our latest round of information, we believe that MKTG woes are likely to continue or worsen. A poorly architected platform, customer defections, and employee defections are hardly a recipe for wooing suitors.
As word of this trickles out, we believe that suitors will step away and the shares will come under renewed pressure.
Disclosure: I am short MKTG. 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.