Rumors emerged a few months ago that tech giant Alphabet was considering an acquisition of inbound marketing software provider HubSpot (NYSE: HUBS) . HubSpot sports a massive customer base that skews toward small and medium-sized businesses, a potential gold mine for Alphabet as it looks to expand its cloud computing business.
Alphabet now appears to have walked away from the bargaining table. A report from Reuters on Wednesday indicated that Alphabet had decided to drop a potential bid weeks ago, and that talks never even reached the due diligence stage. Unsurprisingly, HubSpot stock has been tumbling as investors digest the news.
Is this dip a buying opportunity?
The good: Impressive customer growth
HubSpot sells a wide variety of software subscriptions that cover marketing, sales, customer service, content management, and other areas. The company's platform has a lot of on-ramps for new customers, in other words.
HubSpot ended the first quarter of 2024 with nearly 217,000 customers, up 22% from one year prior. In a macroeconomic environment marked by inflation and uncertainty, that's an impressive feat.
This customer growth drove HubSpot's revenue up 23% year over year in the first quarter. The company's bottom line has also been improving. While generally accepted accounting principles ( GAAP ) operating income was in negative territory for the first quarter, HubSpot managed to produce positive net income and a healthy amount of free cash flow. All the numbers are moving in the right direction.
The bad: Customers aren't expanding spending
While winning new customers comes easy to HubSpot, convincing those customers to ramp up spending is another matter. Average subscription revenue per customer grew by just 1% year over year in the first quarter, meaning that essentially all the company's revenue growth came from snagging new customers.
This wouldn't be an issue if HubSpot's platform weren't tailor-made for a land-and-expand strategy, but it is. The platform's various hubs, with pricing in each hub based on the number of seats, offer multiple ways for a HubSpot customer to grow spending over time.
HubSpot recently made some changes to its pricing model, shifting further toward seats-based pricing and making it easier for customers to upgrade from Starter plans to Professional plans. It's too early to tell whether this change will pay off.
The ugly: A lofty valuation
Following its plunge this week, HubSpot is valued at about $25 billion. Any deal would have likely needed to tack on a hefty premium. While we don't know why Alphabet walked away, valuation is a probable suspect.
HubSpot expects to generate between $2.55 billion and $2.56 billion in revenue this year, which puts the price-to-sales ratio at just under 10. The company is barely profitable on a GAAP basis, and only due to interest income from its cash hoard. On a non-GAAP basis, HubSpot expects to generate between $7.30 and $7.38 in per-share earnings this year. That puts the forward price-to-earnings ratio at roughly 66.
At the midpoint of HubSpot's full-year guidance range, revenue is set to grow by about 18% this year. That's a solid result, but perhaps not enough to justify such an optimistic valuation.
Not a buy
HubSpot's challenges in expanding customer spending, its limited GAAP profitability, and its pricey valuation make the stock a tough sell even after this week's dip.
Alphabet walked away for a reason. Investors should follow suit and wait for a more attractive entry point.
Suzanne Frey, an executive at Alphabet, is a member of The Motley Fool’s board of directors. Timothy Green has no position in any of the stocks mentioned. The Motley Fool has positions in and recommends Alphabet and HubSpot. The Motley Fool has a disclosure policy .
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