SaaS Day Of Reckoning

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Includes: AYX, NEWR, PAYS, ROKU, TTD, YEXT, ZUO
by: Shareholders Unite
Summary

There seems to be a mass rotation out of high valued growth companies, in particular those which largely depend on SaaS business models.

These rotations usually last longer than just a day so we would not jump in with all guns blazing just yet.

However, we do think there are at least three or four names that one could buy at present levels already.

The most admired business models on Wall Street are companies which manage to earn recurring revenues and earnings from offering SaaS (software as a service).

There are good reasons for the often sky-high valuations for SaaS businesses as it is a business model with many avenues to add revenue streams, here is a little summing up of a framework we have been using:

  1. Get a foot into the door with a killer app, something at which the company is good at that fulfills a real business need.
  2. Convert license clients into recurring revenues via SaaS in the cloud.
  3. Expand users (seats) at existing customers and grow with their growth.
  4. Expand geographically.
  5. Earn additional revenue with services (helping customers understand the product, showing what it can do for them, and train them and help in installation, configuration, etc.)
  6. Open a partner channel, that is, build a community or ecosystem.
  7. Use the recurring (subscription) revenues to build out sales and R&D.
  8. Use R&D to build additional functionality and/or verticals, modules that can be used to up-sell ('land and expand').
  9. M&A might be used for the same purpose as R&D, to acquire new capabilities to up-sell.
  10. Open up the platform for third-party/customer apps and take a share of the cut or use it to solidify the platform's position ("stickiness") and value.
  11. Grow revenues in order to achieve operational leverage.
  12. Ultimately, earn enough free cash flow to deleverage (where applicable) or allowing the company to buy back the shares that are issued as stock-based compensation and/or pay dividends.

This is by no means a complete list and not all of these items apply to each SaaS company either. The main elements that characterize these companies is that they have a SaaS platform which started with a basic service (the "killer app") which new services are added, either through company R&D, M&A or partnering through API's (creating an "ecosystem").

This generally increases the number of revenue streams (cross- and up-selling) and increases the value and stickiness of the platform. Quite a number of the SaaS companies are category leaders as well.

There are additional tailwinds for SaaS business models like:

  • The digitalization of enterprise.
  • The move towards the cloud.

Largely as a result of the favorable business model and these tailwinds, valuations have kept on rising and reaching, well, astronomical heights:

Chart Data by YCharts

And here:

Chart Data by YCharts

This is not anywhere near a complete list, but it is remarkable that there seems to be a collective sell-off on Monday (September 9), at the end of the day:

  • AYX is down 15%
  • TWLO is down 9.5% (recovering a bit at the end)
  • WORK is down 9%
  • WDAY is down 1%
  • YEXT is down 4.9%
  • LVGO is down 10%
  • FIVN is down 4.5%
  • NEWR is up 0.6%
  • SHOP is down 5.7%
  • ESTC is down 4.2%
  • PAYS is down 21.3%
  • TLND is down 3.9%
  • ZEN is down 3.4%
  • DOCU is up 4.1% (on earnings)
  • NOW is down 3.35%
  • TEAM is down 4.5%
  • ZUO is up 1%

But other growth stocks were also down, for instance SHU portfolio star performers Roku (ROKU) and Trade Desk (TTD) were down 5.2% and 8.3% respectively.

Buying opportunity?

In general we actually don't think this is a general buying opportunity. These kind of rotations are usually not done in a single day, but we think there are a few exceptions.

Yext (YEXT)

We have already flagged Yext recently as a good buying opportunity and now you get another one. Basically the company offers a unique service and the valuation is one of the most reasonable in the sector.

Yes, the company is still making losses but they are not burning lots of cash and sit on nearly $275M of cash which, on present cash burn, would last them several decades. We can't really see the shares going much lower, which is something we can't say for most names mentioned above.

Zuora (ZUO)

Equally reasonably valued as Yext is Zuora, but we like it slightly less as the revenue growth is a little slower and the cash burn considerably higher:

Chart Data by YCharts

They also have somewhat less of it ($174.6M), but that should still last them for years so there are no real worries here.

While Yext sold off heavily after their recent earnings, Zuora had an opposite experience with the shares rallying after a beat and raise. We will have a more in-depth article on Zuora soon.

PaySign (PAYS)

We had an in-depth look at the company in June, and on Monday morning (blissfully unaware of the sector rotation that was about to start) we actually picked up 500 shares at $9.76 for the SHU portfolio.

The 21% decline of the shares on Monday was clearly beyond the sector rotation, and was caused by (The Fly):

08:38 Paysign cuts FY19 revenue view to $35M-$37M from $38M-$40M, consensus $38.57M The company's adjusted EBITDA guidance remains unchanged at $10M-$12M. The revised guidance primarily reflects delays in onboarding of new plasma industry programs planned for Q1 and Q2. The resulting revenue shortfall has been partially offset to date by better than expected revenue from the company's pharmaceutical industry programs. The delayed plasma programs are now planned to be live by the end of September and are expected to materially increase the company's monthly plasma industry revenue.

What's not to like? The company is fast growing, profitable and generates lots of free cash flow. And now the shares have gone on sale because of what seems a minor and temporary issue.

Mind you, the shares are still anything but cheap at 19x EV/S, but they are a lot cheaper than a couple of months ago. And you get quality.

New Relic (NEWR)

It already experienced a 30% sell-off just after we noted the tailwinds mid-July. The culprit was near-term weakness (more than offsetting stellar Q1 results) but we see a gradual recovery here as the valuation is now really quite reasonable, in line with Yext and Zuora.

Alteryx (AYX)

We are still kicking ourselves for flagging a good entry point at Alteryx in May 2018 at $30.85(!) and then not including a position in the SHU portfolio. The rest is history, here is the last part of it:

The company is killing it, a very strong market position, 60%+ growth, profitable and generating lots of cash. But despite Monday's surprising 15% sell-off, we're not yet jumping on board even though it's very tempting.

The shares are still very expensive although given the amount of growth opportunities the company has and the 90% gross margin, we'll be buying if it comes back a little more. We simply don't believe this rotation is a one day event.

Conclusion

High growth stocks in general, and SaaS stocks in particular had a rough day on the market on Monday, there seems to be some kind of sector rotation out of these names as valuations often have ran ahead of themselves.

These rotations are usually not done after just a day, so we wouldn't jump with all guns blazing just yet, but if you want to nibble, then Yext, Zuora, PaySign and New Relic seem good choices to us.

Disclosure: I am/we are long YEXT, PAYS. 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.