HubSpot Is A Nice Business, But Is It A Buy?

If you run a small-to-medium sized business (SMB) - or any business really - developing and maintaining the core products or services you provide is really just one part of the challenge (the "operational" side).

Just as important - some would argue more important - is marketing those products and services to drive sales.

Traditionally, this meant advertising. Creative marketing teams would develop ads for print, radio, television, and eventually internet banner and search ads. They would pay to have these ads displayed by content providers, which then drove consumers of that content to their product or service.

As the internet grew, new ways to draw in customers started to evolve. One of those methods was referred to as "inbound marketing", a term coined by the founders of today's Green Screen stock in review: HubSpot (HUBS).

In 2009, Brian Halligan and Dharmesh Shah wrote the book Inbound Marketing: Get Found Using Google, Social Media, and Blogs. The premise was that, instead of paying content creators to show your ads, you became the content creator yourself! By creating valuable informational or educational content in the form of blogs, social media posts, short-form videos, and so forth, you built a following that could be converted to your paid product or service more easily and inexpensively.

Following their own advice, Halligan and Shah wrote that book to promote their new business, HubSpot. What does HubSpot do, and does it make the cut as a "Green Dot" stock? Let's have a look.

HubSpot's Business

As you probably surmised, HubSpot was built to help companies build out their inbound marketing operations. Over time, it has evolved into something quite a bit more.

Underpinning all of HubSpot's products is a free-to-use customer relationship management (CRM) platform. Through it, businesses can store lead and customer contact information, keep records of all interactions with them, manage their activities, and report on sales and pipeline conversion status.

This allows clients to get immediate value from HubSpot. Later, once their business reaches scale, they can upgrade to one or more of HubSpot's paid "Hubs" to get additional tools and functionality. Those are:

Marketing Hub: The original Hub, this provides tools for clients to attract new customers, engage them, and lead them through the sales pipeline. Features include things like marketing automation, email distribution lists, social media management, SEO for search engines, etc.

Sales Hub: Consists of tools focused on closing and tracking sales, including chat tools, meeting/call scheduling, lead tracking, quoting estimates, sales forecasting, reporting, and more.

Service Hub: For managing client's interactions with their customers after the sale has been made. Tools include live chat, automated help desks, incident ticket management, knowledge base tools, feedback facilitation, etc.

CMS Hub: A set of creation tools to develop the content that is the core of the "inbound marketing" idea. HubSpot provides website builders, blogs, form creation, web analytics, landing page and call-to-action (CTA) templates, and more to help clients build out their marketing materials.

Operations Hub: One of its newer offerings, Operations Hub provides functionalities for SMBs to run day-to-day tasks, such as data cleanup/organization/querying, task automation, etc.

The vast majority of the company's sales (98%) come from subscription revenues to one or more of these Hubs. A small 2% comes from professional services like training, education, and customer support.

Many readers probably look at this and think "yeah, but a lot of companies do this". And that's true. What really sets HubSpot apart is its laser focus on the small-to-medium business client set. Competitors like Salesforce are mostly concentrated on large, enterprise customers, leaving the SMB space less competitive.

Revenue Characteristics - Growth and Recurrence

First of all, we can check off recurring revenues. As we just saw, nearly all of the firm's revenues come from SaaS subscriptions, making them wholly recurring. Clients continue to pay the firm indefinitely until they decide to switch solutions or cease doing business altogether.

That leaves the question of growth. This hasn't been much of a problem to date. HubSpot's 3-year revenue CAGR is spicy at 37%. Sales grew 33% in 2022 and are forecast to grow over 20% in 2023. Customer count has increased 27% annually since 2019, and revenue per customer 8% annually over that same period.

Where does that leave us going forward? HubSpot still has a lot of growth potential ahead of it. The SMB market is truly enormous - about 315 million SMBs worldwide. That's quite a green field of growth from the company's current 177,000 clients. With over half of revenue coming from international clients, and its tools applicable to nearly every kind of business, in theory all of those SMBs are "in play" as potential customers. There's no reason to think HubSpot shouldn't be able to continue its 20% annual growth trajectory in adding new customers for some time.

On the revenue-per-customer side, HubSpot has been diligent about building out its suite of tools. It started with just Marketing Hub, and has added the others over the years. This provides a way to "up-sell" existing clients to new offerings, increasing revenue per client. I expect this to add on another 5%+ or more to revenue growth annually.

In total, management estimates a very large addressable market close to $90 billion. To put that in perspective, the company did less than $2 billion in sales in 2022. I believe 20%+ annual sales growth should be achievable for many years going forward. There's plenty of growth left in HubSpot.

What About The Moat?

The key economic moat factor for HubSpot are HIGH SWITCHING COSTS. CRMs are notoriously difficult to migrate, as the data is human-generated and often acts as the underpinning for multiple business integrations (it's like switching a database). As marketing, sales, and eventually operational tasks come to rely on HubSpot tools, it becomes even harder to move away from. Clients are unlikely to switch vendors unless there are strong cost or functionality reasons to do so.

This stickiness can be seen in HubSpot's net revenue retention rate, which was over 110% in 2022 (and has been well over 100% for years). That's impressive for a SMB customer base. The firm does very well holding on to and upselling its existing customers.

The focus on SMBs is a mixed blessing for the company. On the downside, SMBs are much more likely to go out of business, get acquired, or be willing to undertake a core sales platform switch. On the other hand, most of HubSpot's competitors (Microsoft, Salesforce, Adobe, etc.) focus mainly on large enterprise customers. While these companies offer some tools for small companies, they are far less integrated or functional than HubSpot's. I don't see a major push into SMB being a likely strategy for these competitors - it is just a very different market.

Overall, I believe HubSpot has a solid economic moat. While it will always have higher churn and likely be more impacted by economic downturns, this is not a firm that's going to lose a significant amount of its revenue in a short period of time.

Management and Finances

For most of its history, HubSpot was run by Halligan and Shah, who literally "wrote the book" on inbound marketing.

In 2021, Halligan stepped down and the CEO spot was given to Yamini Rangan. She has a strong background in the industry, holding high-level management positions at Dropbox, Workday, and SAP. While she's only been at the helm for 2 years, HubSpot has continued to chug along with solid growth and cash profitability metrics.

Halligan remains as executive chairperson, and Dharmesh Shah is still in a very influential position as CTO. So there is still significant founder influence here, something we like to see. I'm pretty comfortable that HubSpot remains well led and mission focused.

Insider ownership is a little disappointing. Despite being founders, Halligan and Shah together own only about 5% of the company. Rangan's ownership is quite small at present, about 25k shares. While this is on the low end of what I like to see, it isn't a major concern.

Financially, HubSpot is a strong company. While the income statement shows an unprofitable operation, frankly I don't pay a lot of attention to it other than the revenue and gross margin lines. From a cash flow perspective, HubSpot has generated positive free cash flows for many years now, at a margin of 12-15%. It is also a firm that has driven most all of its growth organically, instead of relying on acquisitions. That has allowed very efficient cash returns on invested capital, averaging over 30% annually since 2018.

We've got substantial founder influence and a strong, efficient, cash-generating financial model here. That's a solid look for any investment candidate.

Risks

From a business perspective, I would consider HubSpot a "medium-low" risk firm in the context of our other picks.

There are always going to be the standard business risks: recessions, socioeconomic troubles, etc. But those are going to affect all stocks. HubSpot looks like a firm that should weather those reasonably well given its critical functions and subscription model. Certainly the company will suffer diminished growth in these scenarios, and its focus on SMBs will certainly lead to more customer loss than competitors that are geared toward enterprise sales.

The biggest risk investing in the stock, in my opinion, is paying too much and getting hurt by valuation changes. At close to $500/share, the stock trades at 13 times sales and 116 times free cash flow, both of those quite expensive figures. HubSpot is one of the few SaaS stocks that did not undergo a major revaluation during the 2022-23 period. No matter how well the company does, if you buy at a poor price, your returns are going to be poor as well.

It is also somewhat difficult to put a confident fair value price on. Management has consistently targeted 20-25% long-term operating margins, but the firm has been GAAP unprofitable on an operating basis pretty much throughout its history. Free cash margins, while solidly positive, have not reached levels I would expect from a SaaS provider. These facts make it difficult to predict a believable level of long-term profitability for the firm - a huge factor in valuing it.

Conclusion

HubSpot provides key business-critical, "sticky", applications for its SMB clients, has excellent past and future growth metrics, boasts almost 100% recurring revenue, and still has significant founder influence in its executive suite. That's pretty much everything we are looking for from a business perspective. It makes the cut as a "Green Dot" stock and will be added to the Watch List today.

One thing we will have to keep an eye on is price. I don't think the stock is a buy at current prices. It has, however, been a volatile stock in the past and we are likely to see a good entry point at some point in the future.