In a sudden and sharp reversal, tech stocks — which have been red-hot ever since March — fell off a cliff heading into Labor Day Weekend. The selloff of Zuora (NASDAQ:ZUO) stock was intense, as the shares plunged 35% in a matter of days. The plunge came after the subscription software provider reported disappointing results amid the tech-stock carnage.
This selloff of ZUO stock — and of the tech sector — is nothing to worry about. Instead, it’s a buying opportunity,and beaten-up Zuora is especially attractive at this point.
The reality is that nothing is wrong with tech stocks besides the fact that they rallied too much. For months, these stocks could do no wrong. They kept pushing higher and higher and higher to more and more extreme valuations. Eventually, gravity kicked in, and the result was a rapid selloff of tech stocks to more reasonable valuation levels.
They’ll get to those more reasonable valuation levels soon. When they do, the selloff will end, and the longer-term rally will resume because the fundamentals underlying tech stocks remain as robust as ever. That is, technology continues to disrupt every facet of our daily and professional lives, at an accelerated pace today because of Covid-19. As a result, these companies’ influence, revenues and profits will surge over the next five to ten years.
Moreover, nothing is really wrong with ZUO stock. Unusual economic circumstances as a result of Covid-19 have hurt the company. But the company’s difficulties won’t last. When they pass, ZUO stock will skyrocket by as much 100% over the next 12 months.
So investors should use the recent weakness of Zuora stock to buy the shares.
Here’s a deeper look.
Tough Times for Zuora
Zuora has fallen on tough times amid the Covid-19 pandemic.
That may seem unusual for a software-as-a-service (SaaS) company, as many other SaaS businesses are flourishing today. But while Zuora’s customers are enterprises, its business is more closely linked to consumer spending,. That’s because the company provides tools which help enterprises create consumer-facing subscription services.
If consumers aren’t buying those services, enterprises will spend less on Zuora’s offerings.
That’s exactly what is happening this year.
Consumer spending has fallen off a cliff. Some subscription services — like Netflix (NASDAQ:NFLX), Zoom (NASDAQ:ZM) and DocuSign (NASDAQ:DOCU) — are thriving. Others are not.
The services that aren’t doing well are spending less on Zuora’s offerings or going out of business. Consequently, in the second quarter of 2020, higher-than-usual customer losses and lower per-customer spending levels caused Zuora’s dollar-based retention rate to fall below 100% for the first time. Further, its revenue growth slowed to 8% from 17% in 2019.
This slowdown has caused ZUO stock to be very weak, with its shares down 31% in 2020.
Brighter Days Ahead
It appears that last quarter will end up being rock-bottom for Zuora, and that things will only get better going forward.
Consumer spending is rebounding. That trend will persist because consumers, businesses and legislators are getting better and better at adapting to the pandemic. Changes like requiring social distancing and mask wearing, converting parking spots into outdoor dining capacity and implementing contactless omni-channel capabilities like curbside pick-up are proving to be effective. Plus, general Covid-19 hysteria is waning, and pent-up consumer demand is being unleashed by low interest rates.
As this rebound persists, those subscription businesses that struggled during the pandemic will bounce back, with The Subscription Economy megatrend coming back to life. Consequently, subscription businesses will spend more on Zuora’s products and/or come back to the platform. Additionally, a whole new host of subscription businesses which emerged during the crisis will also join Zuroa.
As a result, over the next few quarters, Zuora’s new customer growth will accelerate, and its financial results will greatly improve.
As all that happens, beaten-up Zuo will rebound.
100% Gains for Zuora?
My numbers indicate that ZUO stock could double rather quickly.
As the subscription business model is adopted by most sellers of consumer products., I think Zuora’s growth rates will recover back to 2020 levels of just shy of 20, and stay there for the next five to ten years.
Its gross margins will power higher as its higher-margin subscription business grows and its lower-margin professional services business becomes a smaller and smaller revenue contributor. Zuora’s operating spending will keep becoming a lower percentage of its revenue as it continues to control its costs.
Incorporating those assumptions, I estimate that Zuora’s revenue will reach $1 billion by 2030 with 30% operating margins. That should generate earnings per share of about $1.30, which results in a 2020 price target for ZUO stock of over $20 (My target is based on a forward earnings multiple of 35 times and a 8.5% discount rate).
The current slowdown is preventing Zuora stock from reaching $20.
Once the slowdown ends — and it will in the coming quarters — the stock will rebound to $20.
The Bottom Line on ZUO Stock
At $10 and change, ZUO stock looks like a compelling buy.
The stock is oversold and undervalued, and today’s depressed growth trends should reverse course over the next few quarters. That’s a winning combination which could cause the stock price to climb to $20 rather quickly.
Luke Lango is a Markets Analyst for InvestorPlace. He has been professionally analyzing stocks for several years, previously working at various hedge funds and currently running his own investment fund in San Diego. A Caltech graduate, Luke has consistently been rated one of the world’s top stock pickers by various other analysts and platforms, and has developed a reputation for leveraging his technology background to identify growth stocks that deliver outstanding returns. Luke is also the founder of Fantastic, a social discovery company backed by an LA-based internet venture firm. As of this writing, he did not hold a position in any of the aforementioned securities.
