HubSpot: Headwinds Brewing Ahead Of Earnings (NYSE:HUBS)

Despite its transformation from a single product into a CRM platform and other attractive qualities, HubSpot (NYSE:HUBS) faces some near-term headwinds and a high valuation. While I could become attracted to the stock at the right price, the stock currently looks like a “Sell.”

Company Profile

HUBS is an inbound marketing company that is in the process of trying to transform itself into a CRM platform while moving upstream from the SMB market to serving more of the mid-market. The company says its focus is selling to mid-market business-to-business companies, which it defines as companies that have between 2 and 2,000 employees.

HUBS’ original core product was a cloud-based marketing platform for inbound marketing. Its platform would “help businesses attract visitors to their websites, convert visitors into leads, close leads into customers and delight customers so that they become promoters of those businesses.” The company’s big pitch was that customers were blocking traditional marketing and sales tactics.

A few years ago, the company began to start to focus on a more comprehensive product offering that included marketing, sales, and customer service platforms. This turned into a CRM system that would maintain a unified view of the customer experience and a system of engagement for engaging customers through search engine optimization (SEO), social media, blogs, messaging, email, market automation, ticking support, and more.

Approximately, 39% of HUBS’ business comes from outside the U.S., with Europe representing ~30% of its revenue.

Opportunities

HUBS’ biggest opportunity is to continue to innovate, which it has proven it can do over the years. The company has moved from being a single-product company into offering a connected platform that not only serves marketing, but also sales, service, CMS, and operations. This is generally what you want to see from SaaS companies if they are to succeed over the long term.

The company’s original marketing platform is still growing nicely, but its new platforms are growing even more quickly. Given their smaller revenue bases, there should be plenty of room for these platforms to continue to grow strongly.

HUBS has also moved into the serving the commerce space through a recent offering. This is a nice area to get into, and payments in particular can be a lucrative business. This has the potential to be a big opportunity, and new features for 2023 include invoicing, payment scheduling, tax integration, and consumer onboarding.

HUBS is also looking to kick start additional growth through a free tier. The company has had strong success with its land and expand strategy, and this adds another layer of initially getting a customer in the door. It’s long-term revenue retention has been over 110%, showing that the company has had much success upselling over the years.

Downside Risk

One of HUBS’ biggest risks is its focus on small to medium business (SMB) customers, which tend to have more churn and struggle more during periods of economic weakness. At an average subscription price of just $11,200, HUBS has to aggressively add new customers to fuel growth and overcome 10%+ churn. For this reason, enterprise-focused SaaS companies tend to generally trade at richer multiples, given their perceived stronger customer bases.

In addition, HUBS has a lot of European exposure. A weak euro combined with surging energy prices has hurt European businesses. Thus far, HUBS hasn’t seen its European business much impacted, but it remains a worry.

Most concerning, however, is that HUBS has seen the payback period for its sales and marketing spend rising over the last several quarters. This is a sign that it is becoming more and more difficult for the firm to efficiently add new paying customers.

In fact, deals are becoming more drawn out. On the Q3 call, CEO Yamini Rangan said:

“Yes, we are seeing many of the same trends in our customer base that we saw in Q2. It was just a bit more intensified in Q3. We saw the longer deal cycles that we talked about in Q2. We saw more decision-makers getting involved in deals and more approvals needed.

“Typically, we will talk to the VP of Marketing Sales for approval. Now we’re talking to the CFOs, CEOs and sometimes even the Board. Product evaluations are taking longer as buyers are generally much more risk-averse and the budgets are tight now.”

Valuation

SaaS companies are generally valued on an EV/Revenue multiple. On that front, the HUBS trades at around 8x the 2023 revenue consensus of $2.05 billion.

That’s well below where the stock has historically traded. However, it’s growth rate is now projected to be in the low 20% range versus over 30% in the past and industry multiples as a whole have moved lower from arguably unattainable levels.

Meanwhile, HUBS is projected to generate $256.4 million in EBITDA in 2023. That would give it an EV/EBITDA multiple of around 63x.

Conclusion

While I like the transformation HUBS has undergone and some of its initiatives over the long run, its current valuation and some signs of near-term weakness put me on the sidelines.

It had already become increasingly more costly for HUBS to acquire new paying customers and generate incremental revenue even before economic headwinds began to pick up, thus its exposure to SMBs and Europe in the current climate is a bit worrisome. If the global economy can navigate a soft landing, maybe HUBS will be left unscathed, but it’s not something I’d bet on at the moment.

The consensus for HUBS’ 2023 revenue growth has quietly come down in the last few months to now an expectation of 20% growth this year versus 24% a few months ago. When SAAS companies growth slows down, the stock multiples can really start to shrink. The market also generally prefers enterprise-focused companies over SMB-focused companies, generally giving them higher multiples.

As such, I could easily see HUBS stock rerate lower to a price below $250 on a market sell-off or any earnings misstep.