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Elevator Pitch
I maintain a Buy rating for Rapid7, Inc. (NASDAQ:RPD) stock.
My earlier June 8, 2023 article drew attention to the potential re-rating catalysts for RPD relating to corporate actions such as M&A. With the current update, I detail Rapid7’s financial prospects for 2024.
I think that Rapid7 will deliver a good set of results this year with robust top line growth and substantial margin improvement. But the company’s favorable outlook isn’t fully reflected in RPD’s valuations, as the stock’s forward EV/EBIT multiple is below its expected EBIT growth rate. As such, I stick to a Buy rating for Rapid7.
Revenue Growth Prospects
Wall Street sees Rapid7’s top line and normalized EPS growing by +12.6% and +39.5%, respectively for full-year fiscal 2024 as per S&P Capital IQ data. I touch on RPD’s revenue growth expectations in the teens percentage range in this section of the article, while the company’s profitability improvement drivers are highlighted in the next section.
RPD shouldn’t have any issues meeting or exceeding the market’s consensus FY 2024 top line expansion forecast, taking into account both industry-specific and company-specific growth drivers.
Seeking Alpha News recently cited both Morgan Stanley’s (MS) and Susquehanna’s research reports suggesting that cybersecurity demand will be reasonably strong this year in its January 10, 2024 and December 15, 2023 articles, respectively. In specific terms, Gartner (IT) estimates that “global security and risk management spending” will increase by +14.3% to $215 billion in the current year. Rapid7’s +12.6% consensus FY 2024 revenue growth projection is realistic as compared to the overall market’s expected mid-teens percentage growth rate as outlined by Gartner.
Separately, Rapid7 has the potential to increase its revenue on a per-customer basis in a meaningful way going forward with its efforts to market or sell its solutions as a package. In its Q3 2023 earnings press release, RPD stressed that it has witnessed “strong customer traction and momentum around our consolidated offerings for risk and threat management” which are reflected in its key metrics. The company’s ARR (Annual Recurring Revenue) rose by +14% YoY in Q3 2023, as its solutions sold as a bundle contributed as much as 40% of its new ARR for the recent quarter.
The growing take-up rate of “consolidated offerings” has a positive impact on RPD’s top line prospects. Rapid7 mentioned at the company’s third quarter results briefing that its “deal sizes are getting larger as ASPs (Average Selling Prices) have steadily increased” with its integrated product offerings finding favor with more clients.
In summary, there is a reasonably high probability of RPD achieving strong revenue growth in 2024 that is at least in line with the market’s estimate.
Profitability Outlook
In the preceding section, I noted the sell side’s projection of a +39.5% growth in RPD’s bottom line for the current fiscal year, which is expected to be driven by both an increase in top line and margin expansion. Specifically, the analysts are predicting a +400 basis points improvement in Rapid7’s EBIT margin from 12.2% (estimate) in FY 2023 to 16.2% for FY 2024 based on data sourced from S&P Capital IQ.
There are two key factors supporting higher operating profit margins for Rapid7 in 2024.
One factor is integrated product offerings which I highlighted above. It is safe to assume that there are lower costs associated with serving a client that purchases multiple products as a package as compared to the expenses relating to adding new customers who only buy a single solution. As more of RPD’s clients choose to take up the company’s packaged solutions, Rapid7 is likely to enjoy positive operating leverage by spreading fixed costs (i.e. customer servicing expenses) over a larger revenue base.
Another factor is that Rapid7 should continue to benefit from its ongoing expense control efforts. RPD noted at its Q3 2023 earnings call in November last year that it has “worked to optimize our organization and underlying cost structure over the past few months.” The most recent quarterly operating metrics indicate that the company’s cost management efforts are working well. RPD’s research & development costs as a proportion of sales decreased from 20% for Q3 2022 to 16% in Q3 2023, while the company’s marketing costs as a percentage of sales dropped from 38% to 34% in the same time frame.
In a nutshell, Rapid7 is likely to deliver significant profitability improvement in 2024 thanks to positive operating leverage effects and good cost control.
Valuations
Rapid7’s shares are undervalued in my opinion.
A stock is usually deemed to be trading at below fair valuation if its earnings valuation multiple is lower than its projected earnings growth rate, and this is the case for RPD.
As per S&P Capital IQ’s consensus data, Rapid7 is valued by the market at 30.2 times consensus next twelve months’ EV/EBIT. In comparison, the current consensus FY 2023-2025 EBIT CAGR for RPD is +35.7%.
RPD is also trading at a discount to its peers as highlighted in the valuation comparison table presented below.
Key Valuation Metrics For Rapid7’s SaaS (Software-as-a-Service) Peers
| Stock | Consensus Next Twelve Months’ Enterprise Value-to-Revenue Valuation Multiple | Consensus Next Twelve Months’ EV/EBIT Valuation Multiple |
| Rapid7 | 4.9 | 30.2 |
| Okta, Inc. (OKTA) | 5.5 | 33.3 |
| Tenable Holdings, Inc. (TENB) | 6.0 | 45.3 |
| Elastic N.V. (ESTC) | 8.0 | 72.1 |
| Zscaler, Inc. (ZS) | 15.0 | 86.3 |
| CrowdStrike Holdings, Inc. (CRWD) | 17.8 | 80.0 |
Source: S&P Capital IQ
Risk Factors
In my opinion, there are there are a number of key risk factors for RPD.
Firstly, weaker-than-expected economic conditions could pose downside risks to Rapid7’s future top line performance. Although cybersecurity is a key priority for many corporations, companies can still choose to defer part or all of their cybersecurity spending assuming that macroeconomic headwinds are substantial.
Secondly, there are certain challenges relating to proposed or completed M&A deals for the company. I had noted in my June 2023 write-up that “RPD has both the intention and financial capacity to engage in future acquisitions.” Rapid7 could overpay for M&A targets or fail to execute well on the integration of past acquisitions.
Thirdly, Rapid7’s standing with existing and potential clients might be negatively affected in the event of a security breach involving RPD.
Lastly, RPD’s future margin improvement could fall short of the market’s expectations, assuming that the company’s doesn’t execute well on its cost management initiatives.
Final Thoughts
2024 is expected to be a good year for RPD in terms of margin expansion and top line growth. My view is that Rapid7 can command a higher valuation in the future based on the comparison of its EV/EBIT metric and its expected operating profit growth. Therefore, RPD is deserving of a Buy rating.
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