GitLab Finally Looks Priced To Win

When not researching and writing about stocks, yours truly is a software engineer with close to 30 years of experience at large organizations.

So, today's review hits near and dear to my daily routine - the development, integration, deployment, and monitoring of software projects.

For those that are not familiar, software development is an involved process. First, business or technical requirements must be defined in a "issue story" for any change to a piece of software. Then, the code must be developed to fulfill the requirement, a peer review is conducted, and then the code is added to the project's code repository. This change is then integrated into the project, security scans are conducted, and automated tests are run to make sure the new change didn't break anything. If all of these pass, the change can be "deployed" to be either further tested or used by consumers of the software.

Even at this point, though, there's more to it! Developers need to observe the operational metrics of the application post-change. Are there unexpected errors happening? Are performance levels within an acceptable range? And so forth.

Today's Green Screen stock review covers one of the few firms offering a completely integrated solution to this entire involved process: GitLab (GTLB). Let's take a closer look at the business.

GitLab's Offering

Traditionally, many of the above tasks are handled through "point tools" from different vendors. For example, issue story tickets might be managed through Atlassian's (TEAM) JIRA product, and source code might live in that same company's Bitbucket offering. Integration and deployments, however, might be done through the open source Jenkins software. Security scans might be conducted through SonarQube's SonarScanner, and automated testing through a hodgepodge of apps (Cucumber, Selenium, Mocha, et. Al.). Finally, observability would likely be handed through an application performance management (APM) tool like Datadog or Dynatrace.

Managing such an unwieldy portfolio of tools has its downsides. Juggling multiple vendor contracts is a headache. Integrating these various tools from different providers costs developer time and money. There is little ability to track the lifecycle of a change at a high level.

This is where GitLab comes in.

GitLab sells an entire DevSecOps (development, security, operations) platform that covers ALL of the above tasks. It offers a project management/ticketing system, a documentation platform, a source code management tool, tools for doing continuous integration and delivery (CI/CD), static code analysis offerings, and an artifact storage system. After deployment, operations offerings include solutions for service desk, incident management, and analytics.

Essentially, GitLab sells a full software development pipeline "in a box". All backed by AI-powered features, *of course*!

The upside for customers is simplicity. By cutting complexity and standardizing, clients are seeing as much as a 427% return on investment in GitLab in six months or less. That has led to some impressive metrics, including 1,025 customers spending over $100k a year (growing nearly 40% annually), and over 50% of the Fortune 100 deploying GitLab in some form.

The Revenue Picture

GitLab is offered as a "software-as-a-service" (SaaS) package. Most customers utilize a cloud-based subscription, where GitLab securely hosts all of the software and data, automatically upgrading its platform with new features and bug fixes over time. Some clients with sensitive data may deploy GitLab "on-premises" in their own data centers. Either way, pricing is standardized on a per-year, per-user rate. This subscription model makes GitLab a true recurring revenue play, with nearly all customers renewing on an annual basis.

That's just what we are looking for!

The growth outlook is also attractive. GitLab's 3 year compound annual revenue growth rate (CAGR) is 35%, and forward guidance implies 25-30% growth this year. Today, 75% of organizations rely on "point-tool" solutions held together by custom integrations, but this is rapidly changing. By 2027, GitLab expects that number to reverse, with 75% of firms moving to integrated platforms like their own.

Management estimates that trend will lead to an addressable market over $40 billion in the next 5 years. Considering GitLab only has a revenue run rate of $750 million, that's big time growth potential going forward!

With both recurring revenue and solid growth potential, GitLab passes both of our tests here. Moving on...

Is There A Moat?

As any software engineer will tell you, DevSecOps platforms are absolutely critical to the day-to-day operations of not only software companies, but any firm that relies on internally developed software to conduct business.

Switching point tools is disruptive enough, as it requires new integrations to be developed and maintained. Believe me, migrating source code management systems, or project management platforms, is a tremendous pain that can take months to years.

Given that, migrating a full DevSecOps platform is even more of an effort. I believe it is very unlikely that a larger firm that has adopted and deployed GitLab will be switching away from it anytime in a 5+ year time period. The costs in time and money would be immense. That gives this company quite high SWITCHING COSTS to defend against competitors. This can be seen in the firm's nearly 130% net revenue retention, meaning not only does it not lose customers, it tends to grow within them by 30% annually!

Speaking of competitors, there are really just two notable ones that compete in full-pipeline platforms like this. GitHub is a very similar solution to GitLab, owned by Microsoft, which has the advantage of a bigger, richer parent company and the ability to strategically price it as part of a wider array of business solutions (not monopolistic at all!). GitHub is a strong competitor here and MSFT-based firms are very likely to lean towards it over GitLab.

The other notable competitor is Atlassian (TEAM), which has decent-to-good offerings in almost all of the DevSecOps tasks. However, Atlassian lags behind GitLab and GitHub in a few key areas. First, its offerings are not as tightly integrated. And second, there are some gaps in what it provides (for example, no good static code analysis tool, and inferior CI/CD offerings to competitors).

Management and Finances

GitLab is a founder-led company. Sid Sijbrandij founded the company as an open source concern in 2012, and soon commercialized it through Y Combinator (the famous Silicon Valley incubator). Sijbrandij took GitLab public through an IPO in 2021, and today remains as CEO with over 55% of the total voting power. At just 44 years old, he looks to have a long future at the helm, if he wants it.

The firm is on solid financial footing. There is over a billion in cash on the balance sheet, and no debt. Free cash flow turned positive last year and has strengthened even more into the first quarter of this year. I believe the days of running a cash deficit business are in the past. GitLab has been measured with its acquisitions, and as a result its cash returns on capital are outstanding, an impressive 140% over the trailing 12 months.

No concerns with leadership or the underlying financial picture.

Risks

GitLab would fall into the "medium-low" risk category in my opinion. Switching costs are high and competition is limited, at least at present.

That said, there are some clear risk factors. Microsoft is a VERY strong competitor here - I wonder if GitLab might not become a target acquisition for a larger software player (which may not be a bad thing for investors). Atlassian, too, is much bigger and more established. Winning new deals will require marketing spend and pricing will always be subject to competition.

Valuation has historically been a problem with GTLB stock as well. The company went public in the exuberance of 2021 at a clearly inflated $77/share. It trades at just above half that today. That creates some bad sentiment on the market around the stock which can limit near-term gains (the whole "fool me once" trope).

At large, though, given its stickiness and subscription revenue model, I don't see GitLab being torpedoed by a singular event (aside from a massive data leak or something similar). Any decline here should be rather obvious and drawn-out over time.

Conclusion

GitLab is a "green dot" stock. It has all the markers we love: good growth potential, a nearly 100% recurring revenue base, an economic moat in the form of stickiness with large customers, founder-led leadership, and impeccable financial statements. It will go into the Watch List today, but at what price?

Using our always conservative modeling estimates, I target about 23% annual growth over the next 5 years, offset by 4% annual share dilution. The target free cash margin is 30%, which is well above its current 13%, but in line with that of similar competitors. This optimistic assumption is offset by a quite high 12% discount rate (I usually discount at 10.5%, which itself is high). Anyway, the outcome of all this is a fair value target of $44 per share. With GitLab trading right about that number now, we will wait a bit for a margin of safety that's more comfortable for adding the stock.