With the risk of standing in front of a running “high-growth SaaS” train, I recommend shorting the shares of Domo which have now rallied 122%since the beginning of the year. Domo has one of the worst unit economics I’ve ever seen on the public markets, having raised ~$730m of equity capital since 2010 only to reach around $106.7m of run-rate ARR before going public at a 85% discount to its latest private funding round. Nonetheless it seems that investors in this market are quick to forgive a growing SaaS name, and a couple of solid quarters combined with some pump from a highly promotional CEO and a general melt-up in some SaaS names in early 2019 have pushed the shares to a ~3X increase since the lows recorded in November of 2018, just five months after the company went public.
Quick technical note before I proceed: Domo’s financial year ends in January, so FY19 has basically just ended and when discussing current financial year I’ll be using FY20.
Domo is a BI/Data Insights/Data visualization/Marketing Management/all-in-one tool, built mainly for the use of executives in large enterprises. The company was founded in 2010 by Joshua James, a veteran entrepreneur who founded and sold Omniture to Adobe for $1.7B in 2009. Domo describes its product as an “Operating System for Businesses” and touts the breadth of its platform as the main reason for its mounting losses over the years and the elevated (unprecedented) customer acquisition costs. Despite Domo’s description of its platform as “seven startups in one”, or “the Ferrari of dashboards”, the offering isn’t much different than other BI startups like Looker and Birst, and for most use cases still falls short of industry leaders Tableau, PowerBI (Microsoft) and Qlik. This is not the crux of the thesis but I would point out that building a very broad, multi-segment SaaS offering from the get-go is usually not the best road to commercial success in the software world. Most if not all SaaS success stories have started with doing one thing exceptionally well and then widening the offering, initially organically by adding more features and modules, and ultimately with some acquisitions as well. Domo has gone completely the other way and two clients we spoke to described a very long (and costly) implementation period, and an actual use of limited number of the available features in their day-to-day work (although admittedly both of them liked the product and are happy with the decision to implement).
Gartner’s BI Magic Quadrant for 2018 and 2019 shows Domo made little progress in both market positioning and product offering. I’m not a fan of these rankings but just wanted to show that nothing in their positioning within the industry has really changed despite the stock’s run-up and the CEO’s upbeat comments during recent earnings calls.
Note that Looker, a well-funded startup that just raised its series E round, improved its positioning pretty significantly when compared to Domo (Looker has also reportedly grew 2018 revenues at 70% compared with 30% for Domo while starting from a similar base). Our research indicates that Lookers is the solution of choice for many tech-savvy/innovative companies, while Domo targets enterprises from more traditional industries and concentrate its sales pitches on high-ranked executives who have limited ability to understand what's under the hood.
Not all SaaS Are Created Equal
After failing to raise more money from its VC investors, and after taking on $100m of expensive debt (we calculate 11% effective interest rate) in early 2018, Domo tried, and surprisingly succeeded, in going public in June of 2018. The company raised $200m at a painful ~85% discount to its latest private funding round ($330m pre-money valuation vs. reported $2.2b valuation in its last private round in early 2017). The IPO took place in an extremely lucrative market for growing SaaS companies, immediately after high-flying names like Docusign, Dropbox, Zuora and Avalara. But there are different kinds of SaaS - there are great ones, good ones, and bad ones. And then there’s Domo, which I believe is in a league of its own. I’ll discuss Domo’s specific KPIs and future prospects a little later, but before that I wanted to just give a statistical overview of where Domo stands within the 2018 batch of SaaS IPOs.
A total of 16 SaaS IPOs took place in 2018, among them the median ARR run-rate at the IPO quarter was $202.5m. Domo was ranked #15 with $106.7m.
In terms of new ARR added in the most recent quarter Domo was ranked last with $8m (annual rate) vs. a median of $18m.
Median gross margin was 73%, Domo was #14 at 59.8%.
Operating margins are where Domo really excels, and its negative 147% margin (not a typo!) was a distant last among the group (2nd worst of the group had a negative 49.6% margin). The median margin was negative 29.3%, which is also a sign of our times I guess but this belongs in a different discussion.
Median dollar retention rate rate was 117%, and Domo is #13 with 105%.
Domo has a relatively high average ARR per customer with ($66.9k), which was enough for #4.
#15 in revenue per employee with $146k vs median of $190k.
#15 in sales efficiency.
#1 in cash burn since company was founded. In fact, Domo is so successful in burning cash that in the 8 years until its IPO it burnt $658m, more than Dropbox, Zuora and Elastic combined.
I saved the best for the last - Domo spends so much to acquire new customers that it needs 98 months to pay it back, and even this is with eliminating all OPEX and simply using incremental gross profit divided by S&M spend in the previous quarter. In a more realistic scenario Domo needs 15 years to achieve positive ROI on a newly acquired customer. As I said before, there’s bad SaaS and then there’s Domo.
Before you think the market has completely lost its mind by letting Domo go public, I would point that the IPO took place at the underwhelming valuation of 2.6x NTM revenues, well below your median/average SaaS business.
Why shares went vertical
After bottoming at $14 and change in November, shares have started to climb back after a decent Q3, but only went ballistic after the Q4 earnings release and conference call. There was nothing particularly spectacular about Q4 earnings though. Revenues were 4% better than expected (mainly on non-subscription revenues) and operating loss was better than expected but still only marginally better than Q3. q/q growth in ARR actually slowed to 5%, the lowest it’s ever been, and total cash burn was $29.4m, about $3m better than Q3 and $6m better than last year. Guidance was also in-line with expectation at around 20% top-line growth next year. So why have the shares rallied more than 40% in the week since earnings? I think it boils down to three main points highlighted throughout the earnings call:
A “fully-funded business-plan” comment made by the CFO (= no equity raise).
The CEO talking about accelerating revenue growth in FY21 (“to 40% maybe 50% at some point in the future”) after guiding to a slowdown from 30% in FY19 to 20% this year.
Subscription gross margins inflecting from 64% in the year ago quarter to 74% in Q4-19, which was admittedly impressive (though they were already at 73% in Q3).
There’s some inherent contrast between #1 and #2. Management’s optimism about accelerating FY21 growth is based on a recent decision to increase the enterprise sales team by 30% in the first half of the current year. The story is that there’s a new leadership to the sales team that really knows what it's doing this time around, and James was so thrilled that he decided to ramp up the team. This burst of optimism may have fueled the stock and pushed some internal hiring decision, but is not reflected in the quarterly number thus far, with the latest Q being the slowest in terms of q/q subscription revenue growth (5%), and among the weakest quarters even in $ terms of net ARR added (and remember that more than 50% of that growth actually came from existing customers).
q/q growth in sub. revs.
q/q USD change in sub. revs.
During the call the CEO said more than once that they’ll be rushing the hiring of the new additions to the sales team since they are hoping to see some contribution late in FY20 and the sales cycle is quite long. With these comments I just don’t see how burn comes down in Q1 and Q2 given the slower growth and aggressive hiring (and what looks like a pretty expensive Domopalooza which took place this week). It also makes me think they must be worried even about the 20% they’ve guided to this year, although James made it sound like they can reach the 20% by only selling to their existing base (a claim which isn't supported by their current net retention numbers).
Just to put some numbers where it's due, net cash used in operating activities was $144.1m in FY17, $148.7m in FY18 and $131.4m in FY19. Guidance provided on the call was for a use of only $76.5m in FY20 and a “fully-funded business-plan” as the CFO put it. In Q4 they just burnt $29.5m (including Capex), and if they front-load the hiring I just can’t see how they burn less than $50m in H1, even if I give them credit for some more gross margin efficiencies and a slight reduction in R&D and G&A. This leaves very little room for error for H2 and a dwindling net cash position of $27m by mid-year, which I don’t think will fly with their creditors (or with common sense) if they have the chance to raise more equity at that point.
Change in deferred revs
Cash used in Ops.
[Not necessarily important for this writeup but I found the difference between the CFO and the CEO's answers to the question below pretty amusing.]