Domo Looks More Convincing Now

Summary

• Domo saw a strong Q1. Revenue grew by 19% despite 9% opex cut, highlighting a solid go-to-market execution and a proven offering.
• The better-than-expected renewal rates despite the $35 million cost-cutting plan mean there is room for more margin expansion.
• Domo is fairly priced. We will upgrade the stock to overweight with a price target of $37.

Overview

Domo (NASDAQ:DOMO) looks much more convincing today than last August when we covered the stock the first time. Since then, shares price has been up ~36% as fundamentals have improved. The solid growth despite the decrease in cash burn in Q1 is a sign that the company has fully overcome the go-to-market issue. Given the potential upsides this year driven by the margin expansion and the seemingly successful go-to-market revamping, we will upgrade Domo from neutral to overweight.

Catalyst

Expense cut and higher renewal rates should expand margin in the near term. The company will realize over $35 million in expense cuts in 2020, which primarily happens in Q2 and Q4. The company based its $35 million expense cut on the assumption of an 80% renewal rate. Yet, the better-than-expected 85% renewal rate in Q1 indicates that there is room for more cost reductions as the company sees fits going forward. Moreover, the Q1's 79% gross margin that represented an increase from 77% last year was already close to the 80% target, which opens a possibility for a target model upgrade as margin continues to expand.

The solid growth despite the expense cuts demonstrates a strong go-to-market turnaround and proven offering. Having experienced the offering ourselves and seen the overall reviews in Gartner, we have got the impression that the sales execution issue last year was more of a go-to-market problem as opposed to the lack of demand for the offering. The strong execution in Q1 has further validated our thesis. Despite the 9% expense cuts, subscription revenue grew by 23% in Q1, followed by the 13% increase in billings. With that in mind, we believe that the company should not have any issue sustaining this level of growth.

(source: domo.com)

The highlight for the quarter, however, was the visible increase in demand for BI tools by the COVID-19 crisis command centers. In our view, the trend will likely continue for the rest of this year and, as such, will create an ongoing tailwind. Since the pandemic, the company has seen a +60% increase in usage volume so far.

Risk

Given the past underperformance despite the strong offering, Domo's bullish case has revolved around the speculation of a takeover by the larger enterprise players. Considering the current +$860 million Enterprise Value and strengthening fundamentals, this looks less and less likely to happen as CEO Josh James may choose to keep growing the business. James is already a successful entrepreneur who sold Omniture to Adobe (ADBE) in 2009 for $1.8 billion, which, in our view, means that he will be in no rush to sell Domo at a lower valuation.

(source: company's proxy statement)

James also holds an ~84% voting rights in the company, which will potentially add some uncertainty to the takeover narrative.

Valuation

Domo now looks like a convincing opportunity. Having learned of the management's strong execution and commitment to achieving cash flow positive, it should be a strong contender for a profitable growth story in BI space. Gross margin has improved by ~1,200 bps over the last three years, and given the catalyst, we feel that it can see a further improvement this year.

(source: seeking alpha)

At ~4.5x P/S, Domo is priced similar to Upwork (UPWK), a service marketplace company in the freelance gig economy with similar growth and go-to-market. Both stocks have recently been in the ~20% zone and will also guide ~15% growth for the full year. Given the consistent execution in the next few quarters and a bit of a surprise in profitability, the stock can potentially trade higher than 5.5x at the end of the year. Therefore, the price is fair in our view, and we will subsequently upgrade the stock to overweight with a price target of ~$37 per share.

Analyst’s Disclosure: I am/we are long DOMO. 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.