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HubSpot (NYSE:HUBS), the inbound marketing CRM platform, just released its first-quarter earnings results, containing a welcome upside surprise to Wall Street's expectations. To some extent, it was difficult to picture this bullishness on HubSpot. Its flagship product is a CRM, which we expected to be a vulnerable product category in the software sector (with little sales activity going on since the lockdowns began, many companies are cutting headcount in the sales and marketing departments that use CRM tools). In addition, HubSpot - with its free basic CRM and tools oriented around smaller businesses - was expected to be impacted by higher churn given the macroeconomic fallout for small, insufficiently-capitalized businesses.
But while HubSpot cited some challenges stemming from the pandemic, the overall tome of HubSpot's results and its outlook were overwhelmingly bullish. Shares rose ~7% following the earnings release:
Data by YCharts
Even as HubSpot looks to reclaim the all-time highs that the stock set in February, I believe the bullish case in this stock remains very much intact. The key pieces of this bullish thesis include:
- Differentiated product, even in the crowded CRM space. HubSpot is the category leader in a space it has defined as "inbound marketing," which means selling to customers that have already interacted in some way with your brand, versus outright cold calls. HubSpot believes this positioning has helped it in the current sales environment.
- Continuous product development. HubSpot continues to flesh out its suite of sales and marketing tools, and in spite of the pandemic, the company in Q1 rolled out a CMS tool (content management system) that allows users to manage digital content like websites
- Balanced growth/profitability profile. Though HubSpot is expecting growth to crater to the mid-20s this year, we believe in the company's ability to continue expanding operating margins and generating free cash flow
Stay long here - this is a software stock to hold on to for the long term.
Stable Q1 growth trends and bullish commentary suggest upside on HubSpot's lowered 2020 forecast
Given HubSpot's SMB orientation and at-risk CRM product, investors were nervous heading into HubSpot's first quarter, but the pessimism was unwarranted. Take a look at the results below:
Figure 1. HubSpot 1Q20 results
Source: HubSpot 1Q20 earnings release
Revenues grew 31% y/y to $199.0 million, surpassing HubSpot's own guidance of $192-$193.5 million that the company set before anybody knew the coronavirus would derail businesses in March. Wall Street had understandably shaved a few points off HubSpot's original forecast, with its consensus Q1 target at $190.9 million (+26% y/y), which HubSpot surpassed by a solid five-point margin.
Equally important to the numbers is HubSpot's commentary around how it executed during this challenging quarter. HubSpot's management reacted quickly to the coronavirus, lifting certain limitations on the free tier of its CRM product to broaden its appeal, particularly to smaller businesses. The company also gave its sales execs wide latitude to offer discounts and flexible payment terms in the hopes of retaining as many customers as possible. And though HubSpot notes that churn picked up in early March, the company has seen stabilization in the existing customer base plus a more-or-less return to normal new business activity.
It's critical to note that HubSpot's product is well-oriented to the current pandemic. Outbound sales activity (or put in plainer terms, the old-fashioned process of making sales calls to your prospects) has ground to a halt in the face of global travel restrictions, but there's never been a more important time to have a polished digital marketing and inbound sales strategy. To this end, HubSpot's utility as a CRM product was better preserved than other products focusing on outbound sales.
In response to an analyst question during the Q&A portion of HubSpot's Q1 earnings call, here's how CEO Brian Halligan described that product fit and sales trends (key points highlighted)
Starting in mid-March for about 3 weeks there, the real -- a mighty headwind in there, 200-mile in our headwind on the new business side and a big headwind on retention downgrade side. Around the second week of April, the last 3, 4 weeks, kind of the third phase of the year, where the headwind slowed a bit. The cancellations and the downgrades, kind of get back into the new normal. And then a tailwind kind of kicked off. And the tailwind, Stan, is -- there's sort of 2 pieces to that tailwind. One of it is what I talked about on the call, sort of business is moving from offline marketing to online marketing. It's a terrible time to be doing offline marketing right now. Moving from outbound to inbound, moving from outside sales to inside sales. Our value prop and our product pretty matches really well on the way people are going to want to go-to-market these days. The second tailwind, certain industries have benefited from COVID-19 like e-learning and medicine, things like that [...] So I would describe HubSpot as, in mid-March, just a giant headwind, 200-mile of headwind, no tailwind. Last 3 weeks though, the headwind has slowed down and the tailwind has picked up. So I'm feeling cautiously optimistic."
Several other points are worth mentioning on the growth front. While HubSpot's domestic revenue growth was only 25% y/y in Q1, international revenues grew at a blistering 42% y/y pace, despite the fact that the coronavirus hit earlier and harder overseas. This illustrates how much greenfield market opportunity HubSpot has to grow in international markets.
HubSpot's guidance update is also worth mentioning. For Q2, HubSpot has put forth a revenue range of $195-$196 million, representing 19-20% y/y growth, while its full-year forecast is now set at $800-$810 million (+19% y/y at the midpoint), about $40 million lower versus a prior outlook of $840.5-$844.5 million (+25% y/y).
Figure 2. HubSpot guidance update 
Source: HubSpot 1Q20 earnings release
This outlook doesn't make much sense to us, however. HubSpot's commentary on the impacts of the coronavirus seem to suggest that the company was hit hard in March/Q1, and that past the first few weeks of April, HubSpot actually saw a tailwind in sales. If this is the case, we wouldn't expect there to be eleven points of sequential growth deceleration between Q1's 31% y/y growth rate and Q2. HubSpot is likely being overly cautious on the broader macroeconomy and resorting to its usual playbook of setting a low bar to beat, as it did in Q1 (even when the coronavirus hit unexpectedly that quarter). This gives investors a good opportunity to benefit from a beat-and-raise cadence this year.
The only disappointing spot this quarter was the fact that HubSpot's pro forma operating margins fell slightly to 7.3%, 130bps lower than 8.6% in 1Q19. Unlike many other mid-cap technology companies, HubSpot has not announced any mass layoffs or cost-containment measures. Sales and marketing expenses as a percentage of revenues rose 180bps versus the prior year, partially offset by a decline in the percentage of revenues allocated to general and administrative spend. We do think this is an outlier, however, due to the difficult sales conditions in March plus the flexible discounts that HubSpot offered to its struggling clients. Overall, the fact that HubSpot was able to generate high single-digit operating margins plus retain >30% year-over-year revenue growth still puts it in the small bucket of tech stocks that meet (or in HubSpot's case, comes within two points of meeting) the so-called "Rule of 40" test.
Figure 3. HubSpot operating margin trends
Source: HubSpot 1Q20 earnings release
Key takeaways
HubSpot revealed itself to be in much better shape than investors originally thought heading into Q1. We were surprised to hear that HubSpot's sales trends seem to have course-corrected as early as mid-April, which also suggests that HubSpot's guidance revisions for the remainder of 2020 are overly conservative. If anything, the pandemic has only highlighted how critical digital marketing and inbound sales strategies are - positioning HubSpot well for long-term growth. Stay long here.
