Zuora: The drought may be over and this stock is ready for a rally (NYSE:ZUO)

Current market sentiment is undoubtedly cautious. Amid higher interest rates and an uncertain macroeconomic recovery, the best strategy is to focus more on “growth at a reasonable price” stocks, allocating a larger share of your portfolio to value-driven technology.

And while these names are far from exciting, companies like Zuora (NYSE:ZUO) constitute a perfect long-term holding which will have little correlation with the evolution of the markets in the broad sense. After years of lagging its tech sector peers, Zuora shares have soared nearly 20% this year, buoyed by particularly strong first-quarter results that defied expectations.

The fact remains that Zuora is one of the cheapest small- and mid-cap software companies on the market, with a low single-digit revenue multiple. And while it’s certainly a niche product, it’s of little interest. direct competitors that exactly address its use case of powering billing solutions for other subscription companies. It recently doubled its niche in make a complementary acquisition of a company called Togai, which helps businesses create metered, usage-based pricing configurations and perfectly complements Zuora’s existing suite of billing management tools.

I last wrote a very bullish opinion on Zuora back in March, when the stock was still trading in the ~$8 range. After a 20%+ rally and strong first quarter results, I remain bullish on Zuora’s prospects for the rest of the year and encourage investors to stay long. In my opinion, Zuora’s gathering has only just begun.

As a reminder to investors who are new to this stock, here is my updated long-term bull case on the company:

• Zuora caters to subscription-based business models and is the category leader in this niche. As more and more companies adopt this type of model, Zuora’s potential customer base has expanded significantly. It’s also important to highlight Zuora’s uniqueness in this regard: businesses can choose a traditional ERP, but Zuora’s subscription-based solutions help solve common problems. Its recent acquisition of Togai, a billing tool for metered and usage-based pricing, further extends its reach.
• Improve net retention rates above 100% as Zuora grows with its customers. Zuora’s net revenue retention rates are consistently above 100%, indicating net upsell. As Zuora’s customers increase their subscriber base, so does the opportunity for Zuora to monetize and grow alongside its customers. The company noted that upsells had reached a “record pace” and highlighted several key milestones, such as GoPro’s subscription storage and insurance program (a key part of the company’s planned turnaround) which reached a million subscribers.
• Gross margin leverage. A better mix of subscription and professional services revenue has helped Zuora elevate its gross margin profile to record highs to date, reversing a common investor concern about the stock at the time of its IPO.
• Ripe for a takeover, especially when valuations are low. While I never like to base an investment decision on high hopes that the company will be acquired, Zuora checks a lot of boxes to be acquired: It’s small with only a market cap of around $1.5 billion ; it offers a very unique product that many large software companies may want to get their hands on, especially at a time when organic growth is losing steam; and its pro forma operating margins are positive.
• Strong cash position. The company has over $0.5 billion in cash and just under $0.2 billion in net cash (after debt offset) on its books, giving it significant financial flexibility to pursue its own acquisitions and other growth opportunities.

In my opinion, Zuora’s Q1 rise is a harbinger of a much longer rally. Stay here for a long time and continue riding the recent upward wave.

First trimester download

Now let’s take a closer look at Zuora’s latest quarterly results. The summary of first quarter results is presented below:

Zuora’s revenue increased 6% on a year-over-year basis to $109.8 million in the quarter, beating Wall Street’s expectations of $108.8 million (+5% YoY) . Subscription revenue grew at a stronger 10% year-over-year, decelerating just one point from the fourth quarter’s 11% year-over-year growth rate.

One of the key drivers of outperformance is better install base expansion. Net revenue retention rates reached 104%, although they were lower than 108% in the first quarter of last year. According to CEO Tien Tzuo’s remarks on customer expansion during the first quarter earnings call:

One of the highlights of the first quarter, I would say, is the expansion of our install base. Our stable of large corporate clients continues to guarantee the sustainability of our business. Our customer satisfaction levels continue to increase, as measured by Net Promoter Score. Customers continue to appreciate our new innovations, which generates strong opportunities for expansion. In fact, in the first quarter, we saw an increase in cross-selling year-over-year as customers added another Zuora product or adopted our technology in new business units. Some examples. Our customers are adopting additional products like Zephr (…)

Our Zuora Revenue to Zuora Billing cross-sell works. Last quarter we talked about Toast, as a great example. This quarter we saw another customer from Zuora, a global leader in customer experience and contact center solutions with over $1.2 billion in annual revenue. They added Zuora Billing with advanced consumption to help them analyze millions of customer usage data to monetize their AI-powered support offerings.

We help our clients expand into new countries or regions. »

And yet, from a sales execution perspective, the company has also prioritized achieving smaller, faster wins. These proofs of concept can be a great way for Zuora to get in the door, while expanding usage and cross-selling over time.

ARR growth, meanwhile, stood at 8% year-over-year during the quarter, which the company says continues to be held back by macro-driven customer loss and longer sales cycles – two factors already factored into the company’s guidance for the first quarter and second quarter. the year.

And from a profitability point of view, we should also note that Zuora’s pro forma operating margins jumped 11 points year-on-year to 17%:

Pro forma EPS of $0.11 also dashed Wall Street’s expectations of $0.07.

Assessment and key takeaways

Note that, at least in my opinion, there is a lot of conservatism in Zuora’s outlook for the current year. The company updated its FY25 outlook to include the absorption of Togai’s operating expenses (and yet pro forma operating profit expectations rose by $1 million at the midpoint, thanks to better trends in the first quarter), while maintaining its turnover outlook for the whole year. Togai is to be sold as a standalone offering as well as bundled within Zuora’s existing suite for existing customers. So while we don’t have any financial details behind the transaction, it should contribute to growth.

At the current stock price near $10, Zuora trades at a market cap of $1.54 billion; and after offsetting the $547.1 million in cash and $362.3 million in debt on the company’s most recent balance sheet, it results the company’s value is $1.36 billion. This places Zuora in a situation 3.0x EV/FY24 revenue multiple, and one 17x multiple of FCF.

Given the rally that has already occurred over the past few months, I believe Zuora has already achieved some of its value-based upside, and so my rating is watered down slightly (from a Strong Buy to just a Buy NOW). I am confident that Zuora can achieve a revenue multiple of 4x EV/FY24, which implies a $13 price target and approximately 25% additional upside from current levels.