Coupa Software: A smart buy

Coupa is a business spend SAAS (Software-as-a-Service) company which benefits from network effects, high switching costs and could be a beneficiary of a normalizing economy during 2021.

I’m involved in procurement during my day job so I was impressed by Coupa’s cloud software. Business spend can be a slow and manual process. Before buying something, employees may have to review different electronic or paper files for pricing. Tendering for a product can be a painful process if you are relying on email or a paper process. Evaluating suppliers is tough if the supplier is privately owned and discloses limited information on performance and financial results. Lastly, benchmarking prices is a pain because pricing may not be transparent for certain products.  

Enter Coupa! Coupa’s business spend platform connects its more than 1,400 clients with more than 5 million suppliers globally. Coupa’s business spend software is easy to use, and helps companies spend smarter together. Coupa makes procurement as easy as shopping as Amazon. Take a look at the following snapshot of Coupa’s procurement software.

Source: Coupa Software website

Employees searching for goods can see existing inventory in the search results, which removes redundant spending. Matched invoices are paid and billed to the correct expense accounts. Coupa also allows customers to manage payments and early pay discounts from their payment platform

Coupa’s platform has benefited from rapid supplier growth which has allowed clients to enjoy 5-20% cost savings from Coupa Advantage, a system of pre-negotiated rates and favourable contract terms from major suppliers. Clients can even combine their purchases with other Coupa clients to achieve even better rates. In 2019, five Coupa clients combined their IT hardware and peripherals purchases negotiating USD1 million savings in three weeks.

Coupa is a sticky product because companies rarely change purchasing software while there are usually tough learning curve issues related to a new spend platform. Coupa’s gross renewal rates averaged 95% in 2019 and net retention which includes upsells and higher prices has averaged 110% in recent years. Revenue per client has increased for four consecutive years but none of Coupa’s clients made up more than 10% of revenue. Clients typically subscribe for at least three years and pay one year in advance.

Coupa flywheel

Coupa has three layers of defence against competitors. First, Coupa should benefit from network effects as the company grows. More spend under management grows attracts more suppliers which in turn attracts customers who wish to tap on to the wider variety of goods and services. Coupa’s cumulative spend under management since its inception has grown to more than USD2 trillion from USD257 billion since its Oct 2016 IPO while the number of suppliers on the platform has more than doubled from 2 million suppliers at its 2016 IPO. Coupa’s willingness to accept lower fees in the short term also strengthens Coupa’s network effects. Unlike its competitors such as SAP Ariba, Coupa does not charge an upfront or ongoing fee to suppliers to be part of the Coupa network so suppliers of all sizes benefit from being on the platform. This pro-supplier policy strengthens Coupa’s flywheel and accelerates supplier growth.

Source: Coupa December 2020 investor presentation

Second, Coupa is able to achieve cost savings of up to 20% for clients with its platform using the collective buying power of its clients to secure favourable prices, contract terms or early payment discounts. These cost savings alone are sometimes enough to justify or subsidize the price of a subscription to Coupa. As Coupa grows its client base and spend under management, supplier discounts and contract terms should become increasingly attractive. This focus on quantifying customer success is enshrined within the company’s culture with client success stories stating the cost savings achieved from using the company’s platform. Robert Bernshteyn, the CEO has published a book called “Value as a Service” which describes Coupa’s focus on delivering quantifiable results.

Lastly, switching costs would be high with the unique insights provided by its platform. By aggregating data within the client’s departments and across peers, Coupa allows clients to easily collect, analyse and benchmark spend data. For example, Coupa can benchmark spend on a certain product to see if they are paying too much or being overly restrictive. As the number of employees and amount of spend through the platform grows, Coupa gains more data which allows insights including Coupa’s Spend Guard function which alerts audit departments to suspicious transactions.

Management

Robert Bernshteyn, 47, the CEO has been instrumental to the company’s growth since he joined the company in 2009. While Robert was not the founder of Coupa, his personal story is a tale of hard work and innovation. Robert and his family left communist Russia when he was seven to emigrate to United States with only a thousand dollars. During his childhood, Robert recalls spending nights in New York searching for unwanted furniture to sell with his dad and focusing on his newspaper routes. With his newspaper route earnings, Robert started a successful baseball card trading business despite not understanding the game and using his card trading proceeds to fund his university education.   Before joining Coupa, Robert was the VP of product marketing at SuccessFactors, a SAAS human resources company where he contributed to a 15x increase in revenues and a 20x increase in company valuation in the three years leading up to the company’s IPO.

There is decent alignment of interests between shareholders and management. First, Robert Bernshteyn, the CEO owns 2% or 1.55 million shares which are worth more than USD430 million so he clearly has skin in the game. Second, 60-70% of total compensation for Coupa’s management team in the latest fiscal year is based on long term incentives such as restricted stock units and stock options. Glassdoor provides hints on Coupa’s excellent culture. Coupa has 4.4 out of 5 stars on Glassdoor while Bernshteyn has a 95% approval rating based on 574 reviews. 89% of Coupa employees would also recommend the company to a friend, another telling statistic on the company’s superior culture.

Valuation

USDmSub revenueRevenueNet profitOCFFree cash flowNet cash
Jan-20167684-46-22-2692
Jan-2017118134-38-21-25201
Jan-2018165187-442015249
Jan-2019233260-563730147
Jan-2020345389-91685618

With the company trading at 41x trailing revenue and 211x free cash flow, Coupa is expensive but I think it’s worth paying up for a company compounding revenue at 43% every year since its IPO and its growing moat. Coupa should be able to continue growing at these rates for the next five years given its large addressable market and the cost savings offered by its platform.

Changing business spend software was not a priority for most companies during a global pandemic. As a result, revenue growth decelerated to 30% in the latest quarter compared to 40-50% in 2019.  With economic growth and activities normalizing in 2021, more companies may be open to Coupa’s business spend software which could lead to accelerating revenue growth. Coupa operates in a huge USD56 billion market compared to its USD490 million of revenue in the trailing twelve months so there should be plenty of room for growth.  

Coupa isn’t profitable yet but there are signs of scalability. The company turned free cash flow positive in fiscal 2018 and free cash flow margin was 15% as of fiscal 2020 and 20% as of the first nine months of the fiscal year ending January 2021. Coupa is targeting 30% free cash flow margins in the “long term” but I think this goal should be achievable by end-2022 based on its current growth rates and operating leverage. There’s at least 100% upside from the current USD277 share price if Coupa can compound revenue at 35% over the next 10 years while free cash flow margins reach 30% in 2023.

Risks

Overpaying for acquisitions is a key risk as Coupa regularly purchases smaller companies to provide a wider offering of business spend modules to clients. In 2020, Coupa made its largest ever acquisition after paying USD1.5 billion for LLamasoft, a supply chain design company. While LLamasoft offers promising synergies with the company’s core procurement software, this acquisition has resulted in Coupa having USD1.5 billion of gross debt or USD125 million net debt. Coupa produced USD95 million of free cash flow in the last 12 months so these borrowings are still manageable. Furthermore, the company’s debt consists of convertible bonds which are mostly due in 2025-26 so the company still has a long payment runway.

Coupa is a smaller player compared to SAP and Oracle who controls underlying enterprise resource planning systems and more R&D resources. SAP is the market leader in the cloud business spend space. I’ll argue that using Coupa’s software is easier to use, implement and is better placed to deliver cost savings and insights because of the company’s focus on business spend management. SAP and Oracle are currently distracted with their transition to cloud solutions from their legacy on-premise databases. Management frequently compares Coupa with Salesforce in describing their competitive situation. Salesforce’s ability to grow and thrive despite fierce competition from ERP providers such as Oracle and SAP is a good analogy for Coupa’s competitive situation.  Oracle and SAP mostly control the underlying databases for sales and account receivables but Salesforce has succeeded in growing its core CRM business because of their focus on ease-of-use and implementation. 

Summary

In short, Coupa is a high growth company with a decent moat trading at a high valuation. However, I expect Coupa’s business to continue compounding at 30% per year the next 10 years with the share price growing at similar rates. I bought a small starter position and I’ll be waiting to see if organic revenue growth accelerates in 2021 before buying again.

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