Hubspot Inc (NYSE:HUBS) is a good long-term investment choice due to its strong revenue growth from the company’s land-and-expand model. Successful product launches have helped grow the company’s number of customers and their spending levels over the years. Hubspot is entering the downturn in a position of strength due to its strong balance sheet and positive free cash flow generation. At an 11.8 price-to-sales multiple, the stock is not cheap but it is not trading above historical highs.
Hubspot had a strong quarterly result
Hubspot delivered a strong quarter where the company’s revenue increased to $199M, representing a 13% year-on-year growth. Subscription revenue makes up $191M, which is 96% of Hubspot’s total revenue for the quarter. This high level of predictability means that the company can expect consistent cash flows compared to software companies that take in a one-time large license fee.
The company has also been successful with its land-and-expand model. Hubspot grew total customers to 78,776 as at March 2020, up 30% year-on-year. Existing customers have also been spending more each year, with total average subscription revenue per customer 2% higher year-on-year.
Hubspot’s revenue has also been powered by its international growth, which now makes up 42% of Q1 2020 revenue compared to 22% in Q3 2014. This is an important metric as it shows the scalability of Hubspot’s platform on a global level. From this growth, it is likely that Hubspot’s value proposition is attractive all over the world.
(Source: Investor Presentation)
Our view is that the smaller companies are being underserved by enterprise software providers, as the smaller deal sizes make it difficult to serve them efficiently. As such, Hubspot’s focus has been serving this niche in a meaningful manner. We think the company has a long runway for growth as it gains new customers while increasing their usage of Hubspot services gradually through multiple hubs that the company provides.
Hubspot is entering the downturn from a position of strength
As some companies had to layoff employees, Hubspot has actually hired more people. Its employee count is at 3,578, which is 30% higher year-over-year. The company also adapted quickly due to their remote presence before the pandemic:
In mid-March, we moved quickly to shift our entire workforce to a remote working environment to protect our employees and our communities. Prior to the pandemic, remote was already our third largest office, and I believe our systems and employees have adapted well. As a reminder, we plan for higher headcount growth in the first half of 2020 as a result of our strong hiring last fall.
Hubspot has also been helping its customers and prospects by giving its team a lot of flexibility in offering discounts and flexible payment terms. The company also lifted e-mail and calling limits and added a collection of features, including meetings, bots and 1:1 video into their free CRM. They have also reduced the price of their starter growth suite by over 50% late in the quarter. This helps to reduce the financial strain on companies that are facing difficulties during this period. For those companies that are transitioning online with cash flow difficulties, the concessions make it easy to start using Hubspot as well.
Hubspot has also introduced its CMS hub, which helps make managing websites at scale easier. It provides features like dynamic content, adaptive testing and 24/7 security monitoring, which adds value for growing companies. The creation of more hubs helps Hubspot continue its land-and-expand model and we should expect higher average revenue per customer increasing in the future.
These moves might result in some short term volatility in Hubspot’s financials, but it creates a long-term tailwind for the company as customers continue to stick with Hubspot after they transition online. Hubspot also has the financial capability to support these concessions as it has $968M of cash and cash equivalents and only $346M of long term debt. The company also generated $60M of free cash flow in the latest fiscal year, which reduces the need for Hubspot to raise more capital to support these initiatives.
Long term prospects look good for Hubspot
We expect a 20-25% compound annual growth rate over the next five years, driven largely by subscription growth. Given Hubspot’s recent growth rates of over 30% and the launch of more hubs, we believe this growth is achievable. Hubspot also expects its operating margin in the long term to be roughly 20-25%. We expect HubSpot’s non-GAAP operating margin to rise from its current 10.3% to around 20% in the next 5 years. This is mostly driven by operating leverage in expense items such as research and development, and sales and marketing.
With the recent spike in stock price, Hubspot is now up 22% year-to-date. This is reflected in a higher price-to-sales ratio at 11.82 currently. This is trading near the top in the past 6 months. Hubspot is not the steal that it was in the middle of March 2020 but its strong fundamentals might make this a buy in the long run. The highest price-to-sales ratio over the past 5 years for Hubspot was in the high 13s. Hence, there is a case that the stock is fairly priced for investors willing to hold through the volatility.
(Source: Seeking Alpha)
While Hubspot has customers of all sizes, the bulk of them falls in the smaller or mid-market segment. These customers typically have a higher churn rate due their failure rate and lower cash flows. During the downturn, it is likely that the company would face a higher churn rate compared to previous years as companies go out of business.
For Hubspot to continue its strong performance, it has to continue innovating and serving its customers well. This will improve the odds that customers will stay on its platform for the long term. Up till now, Hubspot appears to be executing well on all fronts.
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.