Wall St. Leaves Money on Table for Subscription Companies

Look, we know the old truism that if you don’t have customers and profits youdon’t have a business, you have a hobby. But could we please get a little balanceon the profit idea?

Emerging companies typically don’t declare profits because they use excesscash to fuel growth. Anything left over is plowed back into the business.

If the company is public, its stock price rises not because of some magical ratioof earnings or dividends to share price, but because the money the companyinvests in its people, processes, technologies, research and development, andproducts make it a more valuable entity to anyone looking at its future. Themini-computer makers were famous for this. I recall Digital rising to US$199.50 pershare with never a dividend. It’s a good model.

This is the basis for my argument that subscription companies are being givenshort shrift by Wall Street analysts because they apply metrics more in tune withthe manufacturing era than the information age. You might disagree, becausecompanies like Salesforce, NetSuite and many others not yet public get plenty ofattention — but that misses the mark.

Unconventional Wisdom

Because the analysts don’t track things like unbilled deferred revenue — a measureof how much money is under contract but not yet on the books — they don’t geta realistic view of a subscription company’s health. Since the analystsinfluence who buys what stocks and at what price, the market-pricing mechanismin the stock markets may not be giving subscription companies — or investors –a fair shake.

I caught up with Tien Tzuo last week to discuss this. Tzuo, you may recallwas CMO and chief strategy officer at Salesforce before cofounding Zuora,the subscription billing and finance company.

Say what you want about Tzuo, but he isn’t shy when it comes to expressing his ideas about subscriptions.Last week he was seen speaking on CNBC and wrote an article for All Things D on subscriptions with NetFlix’s recent stunning 40 percent appreciation in thebackground.

Some companies’ meteoric growth spurts are directlyattributable to eschewing conventional Wall Street wisdom regarding profits andearnings, Tzuo believes. The examples he gave me say a lot.

Let It Flow

“Salesforce vs. WebEx. For years, WebEx was on a growth path that wassix months ahead of Salesforce’s. Then they went public and listened toWall Street’s insistence on earnings. Wrong move. Salesforce ignored it,overtook WebEx within six months after WebEx went public, and went on tosoar to much greater heights.

“Successfactors vs. Taleo. Same thing — Taleo cared about earnings, SFSFwent contrarian and said, ‘Hey not only are we not going to show earnings,we’re going to spend all our IPO money on growth and show losses foryears.’ SFSF started off a fraction of Taleo’s size, overtook them, andwound up with a $3.4 billion exit (SAP bought SFSF in 2012), which wasalmost two times greater than Taleo’s (Oracle bought Taleo for $1.9 billionin 2012).

“Finally, to bring it back to current events, Netflix. They didn’t listento Wall Street — they never have. They knew their strategy was focusing oncustomers, and customers more and more want movies anywhere, on anydevices, not just on DVDs, and they followed their customers’ lead. Thisweek when the stock soared 40 percent higher, it was a big vindication for them.”

Tzuo has a point, and writing essays like his and speaking out are ways that theestablishment eventually changes. Of course, this isn’t a statistically valid study –though I am sure such things exist — but it does raise some important questions. IfWall Street is not valuing subscription companies correctly, it is causing a lot ofmoney to be left on the table.

This affects CRM because the financial analysts have a great deal of influence.Yet too much influence can inhibit companies developing the next greatapplication by preventing capital formation where it’s needed. Given howmuch of CRM and social are delivered as subscription applications by emergingcompanies today, it’s a concern. So Wall Street really does need to kick it up anotch or two.

Denis Pombriant

Denis Pombriant is the managing principal of the Beagle Research Group, a CRM market research firm and consultancy. Pombriant's research concentrates on evolving product ideas and emerging companies in the sales, marketing and call center disciplines. His research is freely distributed through a blog and Web site. He is the author of Hello, Ladies! Dispatches from the Social CRM Frontier and can be reached at [email protected].

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