Coupa’s evolution – a story of growth and competitive success
It has been more than 2 years since I took a serious look at Coupa (COUP). I looked at it in October 2016 after its IPO, concluded it was expensive and that I couldn’t see its differentiators and diverted my attention to what I thought would be other, more attractive opportunities. Back then, I was concerned about the falling trend in reported percentage revenue growth and in bookings. For a time, that concern proved to be a reasonable judgement – but, in the last year, the shares have doubled, and that is far better than the average for the enterprise software index. So, I thought it’s reasonable to revisit the company – well, so to speak, and see what might have changed and if there is anything unique or enticing for investors to consider.
One of the first things to discover about Coupa after not looking at the name for a while is that this leopard has grown quite a bit larger than expected and acquired a lot more spots. That is, it has acquired a bunch of companies and now offers a set of solutions which significantly enhance its offering beyond just e-procurement. I am not going to try to add together all of the acquisitions and describe all the expanded capabilities -but this company goes far beyond the traditional e-procurement functionality, and that explains why, in part, its growth percentage has remained at elevated levels and how it has managed to jump over industry pioneer Ariba (now a part of SAP (SAP) in terms of how industry consultants view its positioning.
Over the past couple of years, Coupa has augmented its potential growth and has built a rather substantial competitive moat. Both of these are major factors in my current belief that Coupa, despite what appears to be its generous valuation, is an investment that is likely to produce above-average returns over an extended period. I confess to being somewhat surprised as to just how far this company has gone in building a suite of integrated solutions – all of them related to e-procurement, but in reality, going far beyond the definition of that solution. I would have to credit a significant component of this successful strategy to the company CEO, Rob Bernshteyn. Mr. Bernshteyn was the Global Product and Marketing VP that created a very successful business that was sold to SAP for a healthy valuation. Prior to that, Mr. Bernshteyn was the Director of Product Management at Siebel. So, he has the background to find acquisitions that have led to a successful business strategy for this company.
Should readers buy the shares? As mentioned, they have doubled over the past year, and the EV/S ratio is quite high (greater than 10X based on my forward sales estimates as of this writing). And the estimates of analysts as compiled by First Call show slowing growth. I think the estimates are likely to prove quite wrong, and I expect Coupa to continue to sustain hyper-growth both this calendar year and on in the future. The company is seeing a well-demarcated path to profitability. It has built a substantial competitive moat. The shares will not be immune to any market downturn – despite reporting a huge upside in its last reported quarter, and raising guidance as well, the shares fell by nearly 1/3rd in less than 2 months this past autumn. While that kind of contraction seems unlikely from the current level of $64/share, anyone investing in Coupa needs to be prepared for a bumpy ride. But I think looking out beyond the day to day volatility, investing in Coupa shares makes sense for technology investors.
One of the results of broadening the product set is that the dollar based net retention rate has been rising noticeably. When Coupa went public, the rate was in the range of $1.05, and now, it has reached $1.12. Clearly, that kind of increase is one of the factors that has driven the growth rate and in time will have a positive input in terms of operating margins. Further, the ARPU is also continuing to rise, and that is another factor behind the strong growth rate the company has been able to sustain.
As mentioned, one thing that hasn’t changed since my last evaluation – Coupa shares are still very expensive with an EV/S significantly greater than that of the average name with its growth rate. The real question is: what is the longer-term growth rate? – and just how long is longer-term? Coupa shares screen a bit better in terms of the metric of cash flow margin to growth – they are just about average from that standpoint.
One of many reasons for the company’s valuation is that the company has seen a growth re-acceleration. It reported growth of 42% last quarter, and that is up from 38% the prior quarter and 40% for the year. The company has a history of beating its own estimates and the consensus by substantial amounts. It started the current fiscal year forecasting its growth would be 23%. The year is likely to see growth at or above 40%.
Most lately, the company provided a revenue growth estimate of 25% for the current quarter along with an expectation for break-even non-GAAP EPS. These estimates were significantly greater than the prior consensus, but they are based on essentially no sequential growth in revenues. That won’t happen, at least in my opinion, and the cycle will start over again when the company reports its results for its 4th fiscal quarter in early March. I expect to see another relatively large beat along with some escalation of current estimates for FY 2020.
After last quarter, essentially, all of the estimates from the analysts who supply their “forecasts” to First Call were increased – something that has happened like clock-work every quarter. One might wonder as to either the denouement or the purpose of this game – it is certainly not intended to enlighten investors or to provide an estimate that is a useful tool in evaluating Coupa’s valuation. In my own screening process, I use an estimate of 29% for 3-year forward growth – a substantial deceleration from current levels, but a bit above the current First Call consensus growth forecast of 23.6% for Fiscal 2020 which starts on February 1st. Based on my current expectations, I think that it would be reasonable to expect Q4 top line and bottom line to beat the consensus by around the same amount or more when compared to the results reported for Q3. I think given recent history, it is fair to say that Coupa’s valuation is lower than meets the eye although the shares will not be looked as a bargain by most observers. From my perspective, and accepting the fact that the future of this company is not totally clear, the company’s shares really turn out not to be an outlier in terms of evaluating top-line growth to valuation.
Why and how is Coupa doing it
Coupa operates in what is described by Gartner as the procure to pay market (P2P). This is a rapidly growing business segment, with an overall CAGR of 10% and a CAGR of the cloud segment (where Coupa operates) approaching 20% according to Gartner over the next several years. Gartner forecasts that by its definition, the P2P market is $4 billion overall, but Coupa and the other participants in the space claim the TAM is quite a bit larger, and that is probably the case if all of the ancillary capabilities, including workforce tracing, inventory management and T&E management are included. Coupa’s latest estimate of its TAM was $37 billion – readers do not necessarily have to believe that number in order to expect that the company will be able to maintain hyper-growth for several years into the future.
Gartner describes the market as in its “Choice” phase in which demand growth is highest and in which the market is consolidating quite rapidly. Over the past year, one quarter of the vendors in the Gartner MQ disappeared because they were acquired. I have linked to the Gartner review of the space for readers who want to read the source material.
Not terribly surprisingly, successful vendors are extending their product footprint by what Gartner describes as supporting workflows for direct materials procurement. There are a number of additional innovations that are becoming common including analytics, enhanced dashboards, mobile access and virtual assists. Further, some kind of AI is becoming mainstream, and something called robotic process automation is enhancing the productivity of employees engaged in the purchasing process.
At the moment, the market has two distinct leaders who are clearly favorites to be the market share leaders as the procure to pay business segment matures. Coupa is judged by Gartner as the leader, while SAP, which owns two entrants, Ariba and Fieldglass, occupies 2nd place a bit behind Coupa when it comes to “completeness of vision” or put another way it trails Coupa in terms of functional capability.
As some readers may recollect, Ariba essentially invented this space and was the market share leader for many years. The fact that Gartner now ranks Ariba in 2nd position in its MQ behind Coupa, suggests that Coupa has been able to displace Ariba in many accounts and that Coupa is winning a disproportionate share of new opportunities.
Needless to say, there are many other vendors of varying sizes and capabilities in the space. Oracle (NYSE:ORCL) has an offering that is well accepted by its users. Sadly, for Oracle, its current capabilities lack invoice archiving and its mobile and chatbot capabilities are rated substandard by Gartner.
SAP has yet to completely integrate its offerings from Fieldglass and Ariba. This has led to a certain level of customer confusion. Ariba itself, by far the larger of the two offerings, has some functional gaps such as its tax engine and overall reference customers give the offering a below-average rating.
Gartner says that Coupa is the most discussed vendor in the space – it has for a variety of reasons developed a strong reputation as the leader in terms of innovation and ease of use. It scores best in the MQ because of innovation that meets evolving customer needs. Coupa’s M&A activity in the couple of years or so, in which it has acquired AI capabilities, supplier risk data aggregation solutions, advanced sourcing optimization, a fraud detection engine and a cross-catalog search capability has given the company a breadth of capabilities that is substantially greater than what is available from anyone else in the space.
Last quarter, the company saw significant acceptance of what is called “community intelligence risk aware solutions.” This is a rather unique prescriptive offering in which users can compare their results with what a community of Coupa users experience to determine where there are outliers and if these outliers might be a signal of fraud. Overall, at this point, more than 50% of new subscription revenue is coming from solutions beyond the core Procure module and this is driving average deal sizes.
Not all of this capability is completely integrated into a single offering – but in handicapping growth potential for Coupa, one reason that the company has over-attained its forecast is that it has been successful in leveraging its new capabilities and securing new name accounts. That is one of the trends that is likely to continue this year and beyond, and which is creating a competitive moat and hyper-growth. I missed the potential of that strategy when I last wrote about Coupa, and it is one of the basic reasons for the company’s ability to enjoy hyper-growth.
To sum up, Coupa’s market is in its highest growth phase at the moment as users choose their vendors and P2P software becomes ubiquitous. This is leading to a CAGR for Cloud P2P of near 20% over the next few years. Coupa has been able to innovate and acquire its way to a leadership position in the space. At this point, the company is the most talked about vendor. The company has made a substantial number of strategic acquisitions, which has broadened its footprint to the point where it appears to have the most far-reaching solution in the space. And the company has been able to achieve a broad footprint while maintaining ease of use. Given the growth of the segment viewed holistically, and beyond just P2P, as well as the tailwinds that Coupa is likely to enjoy going forward from its platform of a variety of procurement related capabilities, it is not terribly surprising that the company has been able to maintain 40% growth over the recent past. Just how fast it can grow in fiscal 2020 is not yet really determinable. But I certainly would be surprised if Coupa does not reach at least 30% growth in fiscal 2020, and it seems entirely feasible, given the strength of the IT spending environment, that 35% growth isn’t a realistic possibility – or even a probability.
Where does Coupa go next?
I imagine that Coupa’s strategy is going to be more of the same. Coupa’s competitive moat is that it has built an interconnected set of solutions that surround its basic procurement function. That is pretty much why it has been successful and is growing its market share. While there is a certain level of fungibility in procurement solutions, what Coupa has done is to create a series of interrelated solutions that many users typically will want to use as part of E-procurement functionality.
Basically, while I have tried to illuminate the company’s strategy that has gotten it to the “top of the greasy pole” to borrow a phrase from Disraeli, Coupa remains focused on selling more solutions to larger customers and that means finding more and more solutions that allow it to augment its touch points in B2B e-commerce. The company’s two latest acquisitions were DCR and Aquiire. And perhaps, its most significant new offering is that of Coupa Pay.
Coupa Pay is a major initiative for the company and involves a series of integrated solutions on a single platform that facilitate users paying for what they buy on as part of the overall Coupa solution. The company has just begun offering what it describes as a virtual card for PO. That particular solution is designed to accelerate the processing of low-value, high-volume payments. The payment solution is designed to be secure and compliant, it can be used to optimize working capital, and it ensures that users can take advantage of early payment discounts. The advent of Coupa Pay, with its substantial revenue potential, is one of the reasons why the company’s TAM has gotten so large and why the company has the potential to maintain hyper-growth for an extended period.
Last October, Coupa bought a company called Aquiire. Aquiire, whose name really does have 2 ‘i’s, is a leader in a category called supplier catalog search. It is part of Coupa’s strategy to build a large competitive moat between what it does and what other more basic “spend” solutions can provide. Aquiire apparently delivers what is described as a more “consumerized” version of a shopping experience to the B2B world. The Aquiire technology is patented and will be integrated into the company’s real-time search and price comparison engine. This will create an industry-unique shopping model, according to Spend Matters, a leading industry consultant.
Coupa acquired DCR last September. DCR is a vendor of what is called contingent workforce solutions. For those interested in what that means – it has to do with managing the procurement of services. And to go further, it has to do with managing the procurement of services as part of the gig economy with the concomitant reliance on temporary labor and what is called Statement of Work (SOW) services. It is another brick in building a total suite of e-procurement solutions.
Neither DCR or Aquiire by themselves is a major acquisition. Coupa paid about $48 million for the two businesses together and they had a combined revenue run rate of perhaps $12 million when they were acquired. Both of them were loss-making. But I think their value is they help solidify Coupa’s position as the thought leader in the e-procurement space. Further, I expect that the acquisitions will have huge revenue synergies as time passes. Coupa will be able to substantially leverage the technology by presenting it to its own user base. While Coupa’s core e-procurement business continues to grow and attract users and build the amount of spend under management, more and more of the growth will be coming from areas outside of the core. In my opinion, this is what is driving the dollar based net retention rate higher and leading to the growing revenue per user metric. And the ability to sell more solutions to a single buyer will ultimately lead to an improvement in the company’s sales and marketing expense ratio.
Looking at Coupa’s financials and wrapping up the analysis
To a certain extent, one can readily become jaded in writing about companies that grow 40% or more consistently and lose a sense of just how rare that is for a company at some scale. Last quarter, Coupa reported sales growth of 42%, and that included no material contribution from its latest acquisitions. Billings growth was up by 39% year over year, a slight acceleration from the billings growth results in prior periods. Subscription revenues also grew by 42%, while subscription gross margins rose by about 80 bps on a GAAP basis. The company is generating small GAAP loses from its services revenue; that number, given its small size, has a relatively minor impact on total company margins.
The company improved its operating expense ratio, although operating expense grew on an absolute basis. Perhaps surprisingly, most of the improvement was on the sales and marketing line, where the GAAP expense ratio for that metric went from 47% to 37%. Overall, the operating expense ratio fell from 92% to 82%. These results were actually negatively influenced by the two acquisitions the company just completed which basically added to costs and did not contribute materially to revenues.
I think it would be reasonable to anticipate that sales and marketing expense will take a major step upward in the current quarter. On the other hand, the very rapid growth in the other operating expense categories is likely to abate to some degree, at least in percentage terms.
Coupa has swung to positive cash flow generation. Part of this has to do with the rise in stock-based compensation. Some of it also is the impact of the amortization of the debt discount which is an expense in the GAAP P&L. The company’s core e-procurement business, by its nature, does not generate deferred revenues. On the other hand, some of the company’s newer acquisitions, where the revenue stream is based on subscriptions and not based on transactions, can generate deferred revenue. So far, that contribution has not been material.
The company’s free cash flow margin has been 9% for the past 12 months. The company has forecast break-even cash flow for this quarter – but then, again, it is forecasting break-even operating income for the period without material sequential revenue growth. I expect that the company will over-attain on all of the metrics it has forecasts as has been the case this last year and before.
The company, with a cash balance of more than $400 million, gross, has more than enough liquidity to finance the kind of acquisitions it has been consummating. I think it is very likely that Coupa will continue to find tuck-in acquisitions of small scale that it will use to strengthen its competitive positioning and to create a larger moat.
In the analysis I use to compare companies on an EV/S and a cash flow basis, I have forecast that Coupa will achieve 29.5% growth, and that is a minimum expectation. I am inclined to believe growth will be faster and that the company will continue to grow non-GAAP profits. But in the absence of credible guidance, estimates turn out to be more guesses than real forecasts.
I would suggest that the company is highly likely to experience material sequential growth in this quarter, its fiscal Q4. It should be noted that a substantial component of revenue is transaction based, and that revenue will grow as the spend under management expands. Spend under management grew last quarter grew to $940 billion up from $840 billion in the prior quarter. Last quarter, revenues grew about 10% sequentially, or around $6 million. It would be difficult for this writer to conceive the circumstances of that growth – at least in dollars – declining in the current quarter. With that in mind, the current consensus forecast for revenues next year is one that makes little sense and should not be used in evaluating Coupa shares.
I do not currently own any Coupa shares, and I have no immediate plans to add them to the portfolio I recommend to the subscribers of my Ticker Target service. There are simply too many attractive investment opportunities out there for me to own all of them. But should the shares pull back, or should I have room in the portfolio for an additional name, this company is one I will consider. I expect, despite what appears to be lofty valuation, that the shares will be able to generate positive alpha over the next year and beyond.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
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