Domo’s $2 Billion Valuation Looks Steep Given Its Operating Metrics, Intensely Competitive Industry

by Trefis Team
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Domo Technologies became the latest tech unicorn to reveal its plans to go public over recent months, as the business intelligence company filed for an IPO with the SEC last week. The news hardly comes as a surprise, given that upbeat equity market conditions coupled with increased investor optimism towards technology firms have resulted in a string of multi-billion dollar tech firms going public in 2018 – including Dropbox (DBX), Spotify (SPOT) and DocuSign (DOCU).

But what comes as a surprise in Domo’s IPO filing is the relatively weak financial position the company is currently in. Notably, the company incurred expenses of $284.3 million in 2017, compared to revenues of $108.5 million – ending the year with an operating loss of $175.8 million (the company reports results for a fiscal year ending Jan 31). And with just $72 million in cash on hand, Domo cannot sustain its operations at this rate of cash burn for more than a few months unless it raises more money. This is a fairly precarious situation to be in for a company seeking to go public.

Domo has carved a niche for itself in the extremely competitive business intelligence industry, but its market share gains have come at the cost of burning a disproportionately large amount of cash. While profits remain elusive for many disruptive multi-billion dollar startups (including Uber), the cash burn rate is seldom this high as a proportion of revenues. This would explain why the company is headed into an IPO at an expected valuation of $2 billion – down from its $2.3 billion valuation at its last round of funding in April 2017. But as we detail in our interactive model for Domo, the $2 billion valuation implies a rather aggressive revenue multiple for the company.

Domo’s Business Model At A Glance

Domo is a business intelligence company that allows customers to access real-time data and analytics from their smartphones. The platform pulls in data from different departments of a company, which is typically stored in different formats (and different locations), and makes it easy to interpret. Domo’s cloud-based platform is primarily targeted at CEOs, and generates most of its revenues in the form of annual subscription fees (including an annual platform fee under its Professional and Enterprise plans). Besides this, the company also generates one-time revenues from professional services associated with deploying and customizing its platform based on customer requirements.

Understanding The Key Drivers Of Domo’s Value

Our interactive model for Domo values the company based on our forecasts for 3 core value drivers:

  • Number of Customers: This is the total number of paying customers for Domo at the end of a given year. Domo’s aggressive sales push has helped its customer base increase from 1,199 in 2016 to 1,521 in 2017, and we expect this figure to reach 1,800 by the end of 2018.
  • Subscription Revenue per Customer: We arrive at this metric by dividing Domo’s subscription revenues for a year by the number of paying customers at the end of that year. The company’s average subscription revenue per customer has increased from around $49k in 2016 to about $57.5k in 2017, thanks to its targeted focus on large enterprises. As Domo bills customers annually based on the number of users accessing its platform, this strategy has yielded higher revenues per customer. We expect the company to stick to this growth policy going forward – allowing it to report sequential growth in subscription revenues per customer despite its recent decision to cut per user fees in response to competitive pressure.

  • Other Revenues as % of Subscription Revenues: As Domo’s revenues from professional services and other sources are directly related to its subscription revenues, we use this metric to forecast all non-subscription revenues for the company. Non-subscription revenues have fallen from 27% of subscription revenues in 2016 to 24% in 2017, and we expect this to decline further to 21% in 2018.

Based on our forecast for the three key metrics above, we forecast Domo’s subscription revenues to be $112 million in 2018, while its Professional Services & Other Revenues are expected to be around $23 million. Taken together, this represents an estimate of $135 million for Domo’s total revenues in 2018. Now, an IPO valuation of $2 billion indicates a 15x revenue multiple based on our estimate for 2018 revenues.

There are several factors that support using 15 as an appropriate multiple, including:

  • Domo raised funding in early 2016 and early 2017 which valued the company at $2 billion and $2.3 billion, respectively. This represented revenue multiples of about 27x for 2016 and 21x in 2017. As the revenue growth rate declines to a sustainable, long term value, the multiple should ideally be adjusted lower with time. A figure of 15x, therefore, appears fairly reasonable.
  • The business intelligence industry is growing at a rapid pace and is poised to become a $26.9 billion market by 2021 from $17 billion in 2016. As a prominent player in this industry, Domo has significant growth potential.
  • Domo has several high-profile companies on its customer list, including DHL, MasterCard, eBay and National Geographic, among others. The company has benefited from positive word-of-mouth from existing customers, and has been able to retain its largest clients over the years. This will play a key role in increasing adoption among large enterprises in the long run.
  • A sizable chunk of Domo’s expenses are directed towards research and development – which includes the company’s efforts in artificial intelligence and machine learning. While these expenses were 102% and 72% of revenues in 2016 and 2017, respectively, it makes the business more future-ready, given increasing integration of AI into business analytics.

Valuation Risks

However, Domo also faces significant operational and competitive headwinds which call to question a revenue multiple as high as 15.

  • As we pointed out earlier, the company’s biggest issue is its extremely high operating expenses. Domo’s sales and marketing expenses stand out in particular – with the company spending an average of $125 million in sales and marketing annually. To put things in perspective, Domo’s sales and marketing expenses in Q1 2018 were $39.6 million which helped them add 73 new customers (assuming 100% retention rate). This works out to a customer acquisition cost (CAC) north of half a million dollars per customer. Given that annual subscription revenues on average are less than $60,000 per customer, the company may need to retain a customer for as much as 9 years just to break even on the customer acquisition. It should be noted, however, that Domo’s expenses include the company’s annual conference, Domopalooza, which plays an important role in spreading brand awareness. At the same time, the fierce competition in the industry may require a steady increase in these costs going forward – something that does not bode well in terms of long-term value given revenue pressure.
  • Unlike most software and business intelligence firms, which generally enjoy gross profit margins in the 80-90% range, Domo has a gross margin figure in the 50-60% range. While these margins should grow rapidly as cost of revenues should grow at a fraction of the rate at which revenues improve in the long run, the unusually low gross margin may hint at some operating inefficiencies.
  • The business intelligence industry has several of the largest tech giants in the world competing to grab a sizable market share – including Microsoft, Oracle, SAP and IBM. Besides these deep-pocketed companies, the industry also has a long list of specialized players who have established a name for themselves over recent years, like Tableau and Qlik. Additionally, many of these competitors have the added benefit of cross-selling their services to customers (Microsoft in particular), all of which could weigh on Domo’s growth in the long run. These factors explain Domo’s huge sales and marketing expenditures in order to gain market share – a situation that could be exacerbated in the near term, before the industry matures and shows signs of consolidation.
  • Domo had to revise some of its subscription fees lower earlier this year to keep them competitive with the rates of competitors. We expect this pricing pressure to continue going forward as incumbents engage in price-based competition to draw customers from rivals. Making things even more difficult for the smaller players, switching costs for customers are fairly low – making it even more difficult for the companies to keep churn low.

In subsequent research notes, we will highlight when (and if) Domo can turn profitable – provided it is able to tide over its current cash crunch.

However, if you disagree with any part of our analysis, you can create your own model by making changes on our dashboard.

List of Interactive Valuation Dashboards For Other Multi-Billion Dollar Startups Including Uber, Airbnb And Xiaomi

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