The tech IPO market is revving up its engines. After earlier successes by other IPOs over the past few weeks, Zuoro (NYSE:ZUO) had an impressive debut on Thursday. As Yahoo Finance reported, the stock easily surpassed its initial value of $14, trading above $20 for much of the day before finishing at that exact value. At a share price of $20, Zuoro looks to have a valuation of over $2 billion.
There is no denying that Zuoro has plenty of room to grow and has carved a unique niche catering to the growing subscription market. But $20 is towards the higher end of Zuoro’s current potential as the company does face major challenges going forward. Bolder investors may consider buying Zuoro’s stock with the aim of holding on for the long term, like insurance groups, but it is probably better to wait for a bit to see if the stock drops closer towards its initial IPO value.
The Subscription Market
From newer players like Harry’s and the struggling Blue Apron (NYSE:APRN) to established businesses like Albertson’s, companies are growing heavily interested in the subscription model for their online business for good reason. Subscriptions ensure a reliable clientele, consistent income, and can come in a wide variety of products. According to McKinsey, “the subscription e-commerce market has grown by more than 100 percent a year over the past five years.”
Amidst the subscription e-commerce gold rush, Zuoro aims to be the man selling shovels. It is an enterprise resource planning tech company that aims to provide tools, billing analysis, and let subscription-based businesses respond quicker to challenges, get payments faster, and generally become more efficient. Unsurprisingly, Zuoro is a subscription-based business itself. In its SEC report, Zuoro states that it has more than 950 customers as of January 31, 2018. These includes major businesses such as HBO, General Motors, and Caterpillar.
As a result, Zuoro’s revenue has risen over the past three years, going from $92 million in the 2016 fiscal year to $113 million in 2017 and $167 million in 2018. The fact that the rate of revenue growth improved significantly in 2018 appears to be a very good sign.
It should be noted that much of the revenue growth in 2018 did come from growth in “professional services” as opposed to the subscription business which will make or break Zuoro. But even if we look at just the subscription revenue, the rate of revenue growth still increased from 32 percent to 34 percent. In summation, Zuoro is a company in an important, rising market which should be able to count on solid growth going forward.
If things go right for Zuoro and the subscription-based model continues to grow more popular, there is no denying that this is a company with significant potential. But there are a few problems.
The first problem is that Zuoro is not profitable. While this is hardly unusual for a rapidly growing tech company going public, what is striking is that net losses increased from $39 million in 2017 to $47 million in 2018, while they had decreased from 2016 to 2017. Furthermore, cash and cash equivalents also fell from $72 million in 2017 to $48 million in 2018, and Zuoro also accumulated $14 million in debt.
Zuoro can brush the lack of profitability aside by pointing to its current growth, but there are a few concerns. First is that while Zuoro may have found itself a unique niche, it faces heavy competition from other larger companies such as Microsoft (NASDAQ:MSFT) and Oracle (NYSE:ORCL) which also help enterprising online businesses. They are not as dependent on the subscription market which some analysts worry could be reaching a tipping point instead of growing further. And at the valuation of $2 billion, you are looking at a price to sales ratio of 12, which is higher than its competitors.
Potential, but not enough
Zuoro had initially indicated that its share price would be around $10, and this company at $10 is a steal and at $14 is a solid buy.
But the situation starts to change at $20. Zuoro could still work out at that price level, given its potential in a subscription market which should likely continue to grow for the foreseeable future. But it faces significant competition and real challenges towards becoming profitable, and the stock is no longer as cheap compared to its peers.
There is nothing wrong with buying Zuoro now and betting on its long term potential. But I suspect the stock will fall in value once the inevitable IPO hype wears off, especially as buyers are salivating for practically any tech IPO given recent successes. Wait for the stock to fall, and you could be getting a great value buy which could pay off well over the long run.