HashiCorp Could Be The Worst IPO Of The Year

Dec. 10, 2021 12:45 AM ETHashiCorp, Inc. (HCP)8 Comments
Noah Wilson profile picture
Noah Wilson
1.33K Followers

Summary

  • The company has been able to grow at an incredible rate thanks to its freemium model.
  • HashiCorp is one of many open source software (OSS) companies that are trying to monetize the possibilities of OSS.
  • However, the company is deeply unprofitable and losses have been widening.
  • The company operates in a vast, fast growing market with many competitors, and this has meant that the market has attracted many competitors, eroding the pricing power of players like HashiCorp.
  • The company’s core business has a negative value and a conservative valuation of the company is way below what the market assigned to the company. In the long run, HashiCorp’s valuation will go the way of its declining and deeply negative return on invested capital.

New York during the COVID-19 emergency.

Massimo Giachetti/iStock Editorial via Getty Images

Open source cloud infrastructure management company HashiCorp Inc. (NASDAQ: HCP) raised $1.2 billion in its initial public offering (IPO). The company had indicated an initial price range of between $68 and $72, but demand for the offering was so high that the company was able to sell 15.3 million shares of class A common stock at a price of $80 each. Post-IPO, the company has 178,895,570 shares outstanding, or 181,190,570 shares if the underwriters exercise their option to purchase additional shares in full. This means the company attained a valuation of over $14.3 billion or nearly $14.5 billion if options are exercised. HashiCorp’s valuation is obscene considering the business’ awful fundamentals.

HashiCorp’s Business Model

HashiCorp provides a range of infrastructure tools that allow businesses to secure their data (Vault, Boundary), manage their cloud apps (Terraform), granularly manage their networks (Consul), orchestrate cross-platform deployment (Nomad, Waypoint), in its campaign to become a leader in cloud infrastructure.

The company believes that it can profitably build a company on an “open-core software development model”. In other words, the software development occurs through open source platforms by numerous contributors, users and partners. Open source software (OSS) has many attractions, the most important of which are the ability to leverage the wisdom of crowds to build robust software. Monetizing the possibilities of OSS is the Holy Grail of the industry and HashiCorp is one of many OSS startups that have tried to answer the challenge.

HashiCorp’s answer to the problem is that the OSS it builds will be so good that users will be willing to upgrade to the firm’s proprietary code, and pay for it, for support and for hosted versions of its products. Unfortunately, HashiCorp has failed to even come close to earning a profit and is instead an overvalued demonstration of the destruction of shareholder value.

HashiCorp is Growing Fast

HashiCorp grew total operating revenue from $121.26 million in 2020 to $211.85 million in 2021, for a year-over-year growth rate of nearly 75%. According to the BVP Nasdaq Emerging Cloud Index, the median growth rate of all cloud companies in 2021 was 32%. Top quartile revenue growth for the year starts off at 46%. HashiCorp is comfortably beating all those numbers.

Yet, anyone with a basic finance education understands that revenue growth is only one component in the creation of shareholder value. A company must grow and earn a return on capital greater than the cost of capital, in order for it to create value.

HashiCorp is a Victim of the Asset Growth Effect

Net operating profit after tax (NOPAT) has declined from -$55.3 million in 2020 to -$83.19 million in 2021.

Value in millions

2020

2021

Current/TTM

Economic Earnings

($63.97)

($93.51)

($93.51)

Economic Earnings per Share

($1.08)

($1.48)

($1.48)

Economic Earnings per Share Growth

-

(36.4%)

(36.4%)

GAAP Net Income

($53.37)

($83.52)

($83.52)

Diluted GAAP EPS

($0.90)

($1.32)

($1.32)

Diluted GAAP EPS Growth

-

(46.1%)

(46.1%)

Source: HashiCorp filings and Author's calculations

The mystery of why this phenomenally growing company is getting further from profitability is hidden in plain view. HashiCorp’s operating model can be deployed across public cloud, private cloud and multi-cloud environments. The company seeks to unlock the value of operating in the cloud by empowering users with automation while also maintaining reliability, scalability, and security. According to IDC, the global public cloud services market is estimated to be $704.1 billion by 2024. The industry is still in the early stages of its lifecycle. The company estimates the size of its total addressable market size by evaluating the size of the large, existing, and fast-growing markets that it is disrupting. HashiCorp believes that its products address four separate, yet related markets of infrastructure, security, networking, and applications. HashiCorp cites the 650 Group who, in June 2021, estimated that these four markets have a total value of $41.7 billion in 2021 and will be worth $72.5 billion by 2026, and include both legacy markets undergoing a reconstitution because of the transition to cloud, as well as new markets emerging because of the novel ways of deploying applications and managing infrastructure. The company’s four core products correspond to each of these markets.

  • Terraform corresponds to the emerging cloud infrastructure market, with an estimated value of $2.1 billion by the end of 2021 and $12.0 billion by the end of 2026.
  • Vault corresponds to the legacy and emerging security market, estimated to be worth $16.3 billion by the end of 2021 and $20.8 billion by the end of 2026.
  • Consul corresponds to the legacy and emerging networking market, estimated to be worth $22.6 billion by the end of 2021 and $30.9 billion by the end of 2026.
  • Nomad corresponds to the emerging applications and workload orchestration market, estimated to be worth $700 million by the end of 2021 and $8.8 billion by the end of 2026.

According to the 650 Group, the global public cloud market will be worth $607.1 billion and the private cloud market worth $33.0 billion by 2026.

When investors and entrepreneurs see numbers like these, they foam at the mouth. Yet, the massive growth runway of the market has the effect of attracting immense competition, in this case, from well resourced players such as Amazon and Google. The result is that companies engage in price warfare and lack the pricing power to be able to become profitable. Academic research has shown that low asset growth companies tend to overperform high-asset growth companies on the stock market. The asset growth effect can only be defied by a company that has competitive advantages, the most important of which is barriers to entry. In the absence of competitive advantages, the kind of growth that HashiCorp is experiencing will be profitless. Between 2020 and 2021, the company has grown average invested capital from $129.67 million in 2020 to $196.3 million in 2021, all the while getting even further from profitability.

In addition, the company has had a deeply negative return on invested capital (ROIC) of -42% in 2020 and -42.4% in 2021. Thus, revenue growth is undermined as a driver of value creation by the one metric that drives long-term valuation.

HashiCorp’s Valuation is Bonkers

According to the BVP Nasdaq Emerging Cloud Index, the median revenue multiple for the cloud industry was 12.31x. With total operating revenue of $211.85 million in 2021, that gives HashiCorp a baseline valuation of $2.6 billion. Consider that the company’s last private valuation was in March 2020 and valued the company at $5 billion when it raised $175 million in a Series E funding round. Now that we have established a base valuation, let’s take an inside view of the company’s valuation.

Value in millions

2020

2021

Current/TTM

Economic Book Value

($2,592.39)

($3,228.78)

($3,151.94)

Source: HashiCorp filings and Author's calculations

The company’s core business operations have a negative value of around -$3 billion. The company’s price-to-economic-book value per share (PEBV) value is $80/$17.40 which gets us to 4.597. Let’s call it 4.6. That is the difference between the growth expectations implied by a $80 per share price, and the zero-growth value of the business. The market is predicting that the company’s revenues will grow at a rate of 7.5% per year across a 100-year growth appreciation period (GAP), averaging an economic earnings margin of 139.2% in that time. Those are some incredible expectations.

This article was written by

Noah Wilson profile picture
1.33K Followers
I'm an independent investor with experience trading forex, cryptocurrency and stocks. I'm particularly interested in tech and biotech stocks with a long term growth philosophy. Originally from the UK, I worked for Barclays bank in London for 10 years before moving to the East coast of England. I currently run several online businesses while writing about investment as a hobby. None of the views I express should be taken as investment advice and is purely my own musings on a stock's investment potential.

Disclosure: I/we have no stock, option or similar derivative position in any of the companies mentioned, and no plans to initiate any such positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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