Updated Deal Bullets

• The HubSpot IPO is experiencing strong demand with the price range lifted from $19-$21 to $22-$24, and at that level is said to be “multiple times oversubscribed.”
• Caution is warranted for two reasons 1) recently, deals that come with raised prices and high openings have traded down and 2) HUBS is a long way from profitability and may not be able to deliver their “target model.”
• HubSpot has strong mindshare and a decent solution for inbound marketing, but the picture painted in the roadshow about a perfectly integrated solution is rosier than reality. (As is often the case when it comes to feature-rich software.)
• As we noted in our recent “S1 Teardown” (included below), HubSpot has been capitalizing some software development, which is at least a mildly questionable accounting practice. It can be argued that it’s appropriate for a SaaS business model, but it has the effect of making margins and returns look more attractive than they are.
• At the high end of the range, the market cap of HUBS will be $744M or a bit over 7x sales. Based on the high multiple of the most direct comparable, Marketo (MKTO) at 14x, this does indeed seem “cheap”, but there is more than one way to see this gap shrink. As we note below, investors should have a $40 “top.”

Long-term Targets?

Management is probably aware that they don’t have a precise idea where their long-term financial model will settle out. As shown here, at least they kept all the numbers nice and round so they look like the swag that they are.

The two line items that look most suspect are gross margin (at 80%) and sales and marketing (at 30%). For comparison, consider that MKTO has improved GM steadily by about 4% per year but is still just at 64%. Even the mighty Salesforce (CRM) only has a 76% GM.

In terms of sales and marketing, it’s a bit surprising that a company with such a superior “inbound” marketing method is still spending 60 cents on the dollar to capture sales. We know that the “CAC to LTV” has been presented as 4.6x, but this is still a high figure.

S&M has been improving by about 3% per year as a portion of revenues. To get from the current 61% to the target model 30% will take a decade.

A number of investors have pointed out that it’s “inevitable” that one of the industry heavyweights, like Salesforce or SAP, will acquire HUBS long before the target model will ever play out. Perhaps that’s what will happen here. We’re reminded of Netezza that offered a similar set of conditions and was bought out by IBM before their target model (which we found very aggressive) would ever be gleaned.

Short of a real IV model, some investors may simply apply a 1x PEG ratio to “normalized” earnings at a 25% operating margin to get a price on the stock of $40/share. If it gets there, take your money and run.

From the S1 "Teardown" published September 18, 2014: 

HubSpot is an enterprise class online marketing and sales platform that leans toward inbound rather than outbound interactions. It does more than a typical email marketing system and is more interactive than a CRM system like Salesforce.com. HubSpot integrates website pages with email, analytics, SEO, CRM, and calls-to-action to create more business from online content. Subscriptions to the HubSpot service start in the hundreds and run to the thousands of dollars per month.

The company is growing slightly north of 50% and just crossed the $100M revenue run rate. Even though gross margins are strong at 67%, hefty expenses on sales and marketing contribute to losses that have been running at $34M per year.

The number of customers is about 12,000 and has been growing close to 30%, while the average subscription fee per customer ($8,823) has been increasing to drive overall revenue growth. Customer acquisition costs have also been increasing – they stood at $11,334 in June of 2014 versus $10,895 in March. It’s a little odd that a firm like HubSpot has to spend more to attract new customers given that their solution is designed to address this.

Shares to be offered and a proposed range have not been set, but the bankers are expected to be Morgan Stanley, JP Morgan, UBS, Pacific Crest, Canaccord, and Raymond James.

Market & Competition

HubSpot competes in a large, fragmented, and challenging market. At one end, they compete with large companies like Salesforce.com (CRM), IBM, and Oracle (ORCL), and more focused providers like Marketo (MKTO), Marin Software (MRIN), and Constant Contact (CTCT), to name a few. There are also niche providers of services like SEO, like MOZ. This helps explain why they have to spend so much to acquire new customers. It’s confusing, and myriad alternative approaches exist in solving the same or similar problems.

Strategy & Management

As far as the S-1 is concerned, HubSpot will be following the same approach they have been using the past few years – emphasize their “all-in-one” approach over other solutions and get more customers on board. At the same time, they’ll continue to increase their average revenue per client with additional usage and contacts stored in the system.

HubSpot was founded and is based in Cambridge, MA, with a management team that springs from MIT and local startups like Endeca (acquired by Oracle), Pyramid Digital (acquired by SunGuard), Akamai (AKAM), and SolidWorks (acquired by Dassault). The company is venture funded by Sequoia, Matrix, General Catalyst, Scale Venture Partners, and Charles River. None are scheduled to be selling in the offering, but investors can expect 51 million shares to be free to trade once the share lockup expires.

Interesting Footnotes

HubSpot capitalizes some software development costs, which is a little surprising in a space where technology moves so quickly. And the rate of capitalization has increased recently to $2.5M for the six-month period ended June 2014, versus $1.6M for the same period one year ago.

In 2011, HubSpot bought Performable for $3.4M in cash, 3.7M shares of preferred stock, some stock options, and milestone payments that total $3.1M or less depending on performance. The total purchase price based on the accounting in the S-1 is $9.8M.

Open Questions

The biggest question for investors in HubSpot is going to be valuation and the nature of the business model – specifically, when does CAC begin to decline so that margins can materially move higher? Or will the company be introducing higher priced features of their core offering?

The most direct compare will be Marketo (MKTO), which has fewer customers (3,359) but higher revenues ($145M estimated for 2014). Marketo has the same money-losing business model, but looks like it will become profitable more quickly than HUBS thanks to their higher pricing.