Is Zuora’s IPO another unicorn in the making?


IPO VC

By Rohit Kulkarni, SharesPost

Zuora is hoping to raise $88.8 million by selling 10 million shares at $10 per share. Given the strength of current IPO market and Zuora’s value proposition, the company may well become the next unicorn.

The San Mateo, California-based software developer is perhaps the biggest proponent of the subscription economy, the idea that consumers will pay for regular access to products and services and not just the individual items themselves. Zuora creates cloud-based software that enables companies in any industry to successfully to transform themselves into a subscription business. Zuora even trademarked the phrase and created a widely followed economic index to track the growth of the industry.

In many ways, the market has already proved Zuora’s theory. Media companies such as Netflix and Spotify already offer monthly subscriptions to stream movies, television shows and music directly to desktop and mobile devices. Retail ecommerce firms like Dollar Shaving Club, Blue Apron and StitchFix have sprouted up in recent years based on the same concept.

Rohit Kulkarni, SharesPost
Rohit Kulkarni, SharesPost

The subscription economy has completely transformed the software industry and consumer preferences alike. Traditional players like Microsoft and Adobe have had to fundamentally change their business models from individual box sales of Office and Photoshop. Today, consumers and businesses pay monthly subscription fees to access their software over the internet.

Media businesses have adopted subscriptions at a much more rapid clip. Netflix is valued at almost $130 billion. Recently, Spotify went public with a valuation approaching $30 billion. MoviePass, a subscription-based movie ticketing service with a business model pivot in 2017, has reported more than 2 million subscribers.

The question is whether Wall Street will reward Zuora for not only its technology, but also its leadership in this space.

Private Valuations Holding Up & Moving Higher: Zuora is going public at a pretty good time for software unicorns this year. Cybersecurity company Zscaler priced its IPO at $16 per share after revising its expected range up to $13 to $15 per share. The company closed its first day of trading at $27.50, about 72 percent higher than its opening price.

Despite some doubt about Dropbox’s prospects, the cloud storage company also exceeded expectations. The company raised its IPO price to between $18 to $20 per share compared to its earlier range of $16 to $18 per share. Dropbox closed its Wall Street debut at $28.50 per share, about 36 percent higher than its opening day price (Nasdaq: ZS).

If Zuora shares are valued at the high-end of its IPO range, the company will be worth up to $1.16 billion compared to its most recent private valuation of $740 million. Since tech IPOs can serve as a key indicator of investor sentiment, Zuora’s 55 percent private-to-public markup can be a promising sign for other small-cap private tech companies.

We’ve tracked 23 VC-backed tech IPOs over the past 24 months in the chart below. According to our data, 15 companies enjoyed IPOs that exceeded recent private valuations, while eight companies suffered down-round IPOs.

Companies with IPO valuations that exceeded private market valuations. Source: SharesPost
Companies with IPO valuations that exceeded private market valuations. Source: SharesPost

Background: Founded in 2007, Zuora makes software that helps companies offering subscription-based services with pricing, billing, and insights into consumer behavior. The company employs 933 people. Zuora’s largest investors include Redpoint Ventures, Wellington Capital Management and Benchmark. Its largest institutional shareholder has an 11.1 percent stake in the company. Zuora serves about 950 customers, including the companies HBO, Box, Zoom, DocuSign, Ford Motor Co and Delta Airlines.

The Upside Scenario

Room to grow, especially in retail: Zuora surprisingly has few retailers as customers, even though subscription retailers like Dollar Shave Club, Blue Apron and StitchFix have been disrupting the industry. In addition, traditional retailers such as Target, Walmart, Gap and Ann Taylor have launched their own subscription services.

The market for subscription ecommerce has been doubling each year for the past five years, according to consulting firm McKinsey & Co. Sales from the largest subscription retailers jumped to $2.6 billion in 2016 from just $57 million in 2011.

Subscription retail has also fueled a lot of merger and acquisition activity. In 2016, Unilever paid $1 billion for Dollar Shave Club, while Albertson’s shelled out $200 million for meal kit company Plated.

Another vote of confidence: Indian tycoon investor Azim Premji, who has previously backed Zuora, indicated that he might purchase another 12 million shares.

Not too expensive: At 5x revenue in 2018, Zuora’s $1.16 billion valuation seems perfectly reasonable.

The Downside Risk

Still losing money: It’s not clear when Zuora will ever turn a profit. In fact, the company seems to be going backwards. In 2016, the company reported an operating loss of $39 million, a big improvement over the previous year, when its operating losses totaled $48 million. But last year, Zuora’s operating loss soared back to $46.3 million.

Low gross margins: In 2017, Zuora generated a gross profit margin of just 52.4 percent. That’s pretty low when you consider software-as-a-service firms can generate gross margins between 80 to 90 percent.

Cash burn: Zuora burned about $25 million in operating cash last year, even though the company is a dominant force in the subscription economy.

Rohit Kulkarni is managing director and head of research of SharesPost Inc.

Photo of IPO AHEAD sign courtesy of hanibaram/iStock/Getty Images.

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