Two trades today: One short (HUBS) and one sell (FFIV), as I’m removing yet another one of our long positions.
I’ve got a new short position I want to start scaling into today — $HUBS. I’ll give you the upshot of the longer form analysis below that I worked with Liam Garrity-Rokus on.
Hubspot helps company manage their email lists and online presence. Growth is strong, but it’s far from profitable and doesn’t plan to be for at least another couple years. The valuation is high, trading at 6x this year’s topline estimates. This is a stock market that will likely punish unprofitable companies, even high growth ones, as we’ve seen it do with the likes of FireEye and Twitter for example. There’s a lot of red flags about the company’s culture, work force and long-term vision, raised in part in this expose by Dan Lyons, who full disclosure, I’ve been interviewed and quoted many years ago.
I’m personally adding a small 1/5-sized tranche of a short position in this stock today and I’m also adding a tiny bit of HUBS puts with the $40 strikes with expiration dates out in September and December. The company reports earnings after the close tomorrow and I’d likely look to add more if it spikes after the report.
Hubspot is currently focused on finding companies in the “midmarket,” which is generally made up of companies with “between 20 and 2,000 employees.” While the company is currently not profitable, the company’s loss per share is expected to decline over the next two years (from -$1.39 in 2015 to -$0.43 in 2017). But the company likes to often reiterate that they are still on track to achieve sustained free cash flow in early 2017.
The company is increasing its international exposure and seeing a lot of growth from international markets: international sales was 25% of total sales in 2015 and grew at 77% (y/y). Hubspot’s products are now available in 6 languages. That said, Hubspot is still very dependent on U.S. markets for growth and this market is seeing rising competition. The sales cycle in international markets could also be a hindrance for profitable growth if it takes Hubspot longer to gain new international customers.
HUBS has a strong balance sheet with $145.5 million in total cash and investments (both short-term and long-term investments) and only $0.8 million in capital lease obligations. HUBS has “over 2,200 partners who use HubSpot to deliver marketing services to their midmarket clients” at the end of 2014, but that’s the kind of metric that raises more questions than it answers. Why do they need all those partners to deliver marketing services and how do you keep quality control?
HUBS also has a lot of competitors and some might even offer better products/services. Marketo, salesforce.com, and Oracle are potential competitors in the space.
As I said earlier, one of the biggest bearish points here is that company is not profitable and is not expected to be in the next two years. A falloff in gross new customer additions, combined with poor customer renewal levels, could cause a falloff in revenue growth. HUBS has had difficulty keeping its renewal rates high in the past and keeping them high is extremely important for the company because the cost of customer acquisition for HUBS is relatively high.
And here’s a kicker, that you have to read between the lies to understand how the company is actually trying to hype a big negative from their Q4 2015 earnings call: “We achieved just over 100% revenue retention for the first quarter ever. Back in 2013, just two years ago, our total Company revenue retention rate was in the mid-80s, with the customer renewal rate in the high 70s, and only 8 or 9 points of upsell offsetting that. Now we’re seeing customer revenue renewal rates in the low 80s and we’re getting 20 points of upsell.”
Let me break that down for you guys a little bit — the company is losing 20% of its customer base every quarter. Meaning that they have to replace 80% of its customer base every year just to keep even.
Finally, the valuation isn’t cheap either, as the company is trading at an enterprise value to sales ratio of more than 8. EV/Sales is almost 6x 2016’s estimates and and almost 5x 2017’s revenue estimates. And this for an unprofitable company. Twitter, for comparison purposes by the way, is trading at less than 4x 2016’s estimates and 3x 2017’s estimates.
So I’m getting started small like usual and giving myself some space to add to the position on Thursday or next week or later. Using my scale in tranche approach as usual.
I think it’s time to move on from my F5 FFIV long position. I see some indications that the company’s running to a technological roadmap trouble and I’m not liking the way they’re managing our money. The company’s a leader in making applications inside of corporate IT networks run smoothly. But that’s becoming increasingly threatened by the Cloud Revolution, as companies just use cloud-based networks instead of maintaining their own IT networks. The company is spending hundreds of millions of dollars buying back their stock and I’d rather see that money go to building or acquiring a cloud-presence. I will keep the stock on my Long Watch List but for now I am selling my FFIV position entirely as I want to free up that cash and remove one more long position.