What a brutal six months it’s been for Zeta. The stock has dropped 49.8% and now trades at $14.54, rattling many shareholders. This might have investors contemplating their next move.
Is there a buying opportunity in Zeta, or does it present a risk to your portfolio? Check out our in-depth research report to see what our analysts have to say, it’s free.
Even though the stock has become cheaper, we're swiping left on Zeta for now. Here are three reasons why we avoid ZETA and a stock we'd rather own.
Why Is Zeta Not Exciting?
Co-founded by former Apple CEO John Sculley, Zeta Global (NYSE: ZETA) provides software and data analytics tools that help companies market their products to billions of customers.
1. Customer Churn Hurts Long-Term Outlook
One of the best parts about the software-as-a-service business model (and a reason why they trade at high valuation multiples) is that customers typically spend more on a company’s products and services over time.
Zeta’s net revenue retention rate, a key performance metric measuring how much money existing customers from a year ago are spending today, was 97% in Q4. This means Zeta’s revenue would’ve decreased by 3% over the last 12 months if it didn’t win any new customers.
Zeta has a weak net retention rate, signaling that some customers aren’t satisfied with its products, leading to lost contracts and revenue streams.
2. Low Gross Margin Reveals Weak Structural Profitability
For software companies like Zeta, gross profit tells us how much money remains after paying for the base cost of products and services (typically servers, licenses, and certain personnel). These costs are usually low as a percentage of revenue, explaining why software is more lucrative than other sectors.
Zeta’s gross margin is substantially worse than most software businesses, signaling it has relatively high infrastructure costs compared to asset-lite businesses like ServiceNow. As you can see below, it averaged a 60.3% gross margin over the last year. That means Zeta paid its providers a lot of money ($39.73 for every $100 in revenue) to run its business. 
3. Operating Losses Sound the Alarms
Many software businesses adjust their profits for stock-based compensation (SBC), but we prioritize GAAP operating margin because SBC is a real expense used to attract and retain engineering and sales talent. This is one of the best measures of profitability because it shows how much money a company takes home after developing, marketing, and selling its products.
Although Zeta was profitable this quarter from an operational perspective, it’s generally struggled over a longer time period. Its expensive cost structure has contributed to an average operating margin of negative 6.8% over the last year. Unprofitable, high-growth software companies require extra attention because they spend heaps of money to capture market share. As seen in its fast historical revenue growth, this strategy seems to have worked so far, but it’s unclear what would happen if Zeta reeled back its investments. Wall Street seems to be optimistic about its growth, but we have some doubts.
Final Judgment
Zeta isn’t a terrible business, but it doesn’t pass our quality test. After the recent drawdown, the stock trades at 2.9× forward price-to-sales (or $14.54 per share). While this valuation is fair, the upside isn’t great compared to the potential downside. We're fairly confident there are better stocks to buy right now. We’d recommend looking at the Amazon and PayPal of Latin America.
Stocks We Like More Than Zeta
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