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Domo's IPO Could Doom Eager Investors

Leo Sun, The Motley Fool

Domo (NASDAQ: DOMO) went public on June 29, and the cloud analytics software firm got off to a bumpy start. After debuting at $21 per share, the stock opened at $23.80, dipped to $22, then finished the first trading day at $27.30 for a 30% gain.

However, Domo subsequently stumbled back below $22, as ongoing concerns about trade tensions pummeled the broader market. Does this pullback represent a buying opportunity? Or does it indicate that Domo could face tough headwinds in the near future?

A person holds a tablet with a computer generated image of a cloud hovering above it.

Image source: Getty Images.

What does Domo do?

Domo's cloud-based OS lets CEOs manage their entire companies from their smartphones with access to real-time data and business management tools. It also provides employees with real-time analytics tools for business decisions. Domo's founder and CEO Josh James previously founded Omniture, an online marketing and analytics firm that Adobe acquired for $1.8 billion.

Domo claims that its platform "digitally connects all the people, data and systems in an organization." It also states that its cloud-powered technology helps "customers in the aggregate" query "between 100 to 200 trillion rows" of uncached queries per day.

Its expanding ecosystem includes its Mr. Roboto AI platform, its Buzz collaboration and productivity suite, its Adrenaline data warehouse, and various data visualization tools. Its DomoBots "connectors," Fusion data transformation engine, and Domo Appstore let developers integrate other apps into its platform.

Domo serves over 1,500 organizations, including 385 larger "enterprise" customers, which account for nearly half of Domo's revenue. Domo claims that by the end of last year, its 20 largest customers had "increased their investment in our platform by approximately nine times compared to their initial subscription" -- indicating that it has plenty of room for cross-selling services.

A graphical representation of cloud connections.

Image source: Getty Images.

Domo's competitors include Microsoft (NASDAQ: MSFT), which integrates collaboration and productivity software into its cloud services, Tableau (NYSE: DATA), which offers data visualization and business analytics tools, and salesforce.com (NYSE: CRM), which provides a wide range of cloud services for businesses.

Spotting Domo's problems

Domo's revenue rose 46% to $108.5 million last year. However, its revenue only grew 32% to $31.9 million during the first quarter of fiscal year 2019, indicating that its sales growth was decelerating.

Between the first quarter's of 2018 and 2019, Domo's gross margin expanded from 59% to 64%. That figure sounds impressive, but it's significantly lower than Tableau or Salesforce's margins. Domo's margins are actually closer to Microsoft's margins, which aren't directly comparable since much of Microsoft's revenue still comes from non-cloud businesses.

DATA Gross Profit Margin (Quarterly) Chart

Source: YCharts

Domo's operating expenses also gobbled up 199% of its revenues last quarter. That was an improvement from 257% a year earlier, but it still kept its bottom line deep in the red. Its net loss narrowed from $183.1 million in 2017 to $176.6 million in 2018, but it still posted a net loss of $45.5 million during the first quarter.

In its S-1 filing, Domo warns that it will "incur losses for the foreseeable future." Decelerating sales growth, tough competition from tech giants, and widening losses indicate that it will quickly burn through the $193 million it raised from its IPO. The company even warns that it could hit a cash crunch by August. Therefore, investors should brace for an inevitable secondary offering.

Domo investors should also realize that they can only buy Class B shares. The Class A shares are completely owned by Josh James, which gives the CEO an 86% voting stake in the company. This dual class system, which is becoming increasingly common in tech IPOs, prevents investors from gaining any control over the company's future. Moreover, there are unanswered questions about James directing business from other companies he owns back to Domo, which may have obfuscated the company's "real" revenue growth.

The stock isn't as cheap as it looks

As of this writing, Domo has a market cap of about $593 million. This means that it trades at just over five times last year's sales. Assuming that its sales rise 30% this year, it would be trading at four times this year's sales.

That makes it "cheaper" than Tableau, Salesforce, and Microsoft, which all trade at about seven to eight times this year's sales. However, Domo trades at discounts to those three companies because investors noticed some major problems with its business.

The cloud software market is tough for smaller players due to high expenses related to infrastructure and marketing, as well as tough price competition from bigger rivals. Domo's core business sounds interesting, but it's something we've seen Tableau, Salesforce, and Microsoft already do. Therefore, I'd steer clear of Domo unless it can present meaningful ways to counter those rivals and narrow its losses.

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Teresa Kersten is an employee of LinkedIn and is a member of The Motley Fool's board of directors. LinkedIn is owned by Microsoft. Leo Sun has no position in any of the stocks mentioned. The Motley Fool owns shares of and recommends Adobe Systems and Salesforce.com. The Motley Fool recommends Tableau Software. The Motley Fool has a disclosure policy.