HashiCorp IPO Filing: Growth Slowing Down

HashiCorp's IPO and Business Model

This week marked HashiCorp’s initial public offering (IPO), adding another notable company to the increasing number of anticipated fourth-quarter IPOs.

The company, a prominent player in cloud infrastructure, distinguishes itself through a unique combination of open source and proprietary code.

Understanding HashiCorp’s Market Approach

To accurately assess HashiCorp’s potential, it’s crucial to examine its market strategy. For those interested in open source software (OSS) and the monetization strategies of companies built around open code, this analysis will be particularly insightful.

HashiCorp experienced approximately 50% growth in its latest quarterly results compared to the same period last year, alongside a reduction in its losses.

Having achieved nine-figure revenue, the company – previously valued around $5 billion in 2020 – is poised to have a significant impact upon entering the public market.

Delving into the OSS Business Model

Let's now focus on the specifics of HashiCorp’s OSS model, how it translates into a viable business, and a review of its performance up to July.

The company presents a blend of freely available tools and commercially licensed offerings.

This dual approach allows HashiCorp to attract a broad user base through its open-source projects while generating revenue from enterprise features and support.

The combination of recurring revenue streams and a developing hosted product offering contributes to the company’s overall financial health.

This structure is key to understanding its valuation and future growth potential.

HashiCorp’s Open Source Strategy

HashiCorp operates as a cloud infrastructure provider, developing a comprehensive suite of tools designed to assist organizations in managing their cloud-based applications. These tools include Terraform for application management, Boundary and Vault for robust security measures, Consul for detailed network control, and Nomad and Waypoint for orchestration and cross-platform deployment.

This represents a concise overview of HashiCorp’s software portfolio. Given the company’s trajectory towards a public offering, a substantial codebase was anticipated, distinguishing it from earlier-stage startups.

A key aspect of HashiCorp’s approach, as detailed in its S-1 filing, is the deliberate use of an open-core software development model. This means that all of HashiCorp’s software products are initially developed as open source projects.

These projects benefit from extensive collaboration with users, contributors, and partners. The increasing importance of open source software (OSS) as a competitive advantage has been noted recently. HashiCorp’s IPO serves as a clear indicator for investors who are only now recognizing the monetization potential inherent in open source models.

But how does HashiCorp generate revenue from its open source offerings? The company supplements its open source products with proprietary code, and also provides support services and hosted versions of its software.

The company’s revenue streams are categorized into several key areas. The largest portion comes from subscription revenues, with professional services representing another significant component.

The subscription revenue segment encompasses several elements. These include licenses for proprietary features, revenue from support and maintenance services, and income generated from cloud-hosted services.

Here’s a visual representation of the company’s revenue breakdown:

Analyzing the revenue data, we can observe how licenses, support, and cloud-hosted services contribute to the overall subscription revenue. This is then combined with professional services to determine the total revenue. HashiCorp’s revenue increased from $121.3 million in the fiscal year ending January 31, 2020, to $211.9 million in the subsequent year, representing growth of nearly 75%.

More recently, during the six-month periods ending July 31, 2020 and 2021, HashiCorp reported revenues of $94.8 million and $142.0 million, respectively. This translates to a more moderate growth rate of just under 50%.

The rate of growth at HashiCorp is demonstrably slowing. Successfully addressing investor concerns regarding this deceleration will be crucial in determining the pricing and valuation of the company’s IPO.

A Deeper Dive into HashiCorp’s Financial Performance

To gain a more comprehensive understanding of HashiCorp’s revenue streams, a detailed examination from a gross-margin standpoint is necessary. The company designates its largest revenue source as “Support,” which might initially raise concerns about its quality. Let's investigate further:

The results are, in fact, quite positive, and are demonstrably improving. Each component of HashiCorp’s revenue portfolio has shown stronger performance in the most recent two quarters compared to the corresponding period in the previous year.

The company’s hosted solution currently exhibits the lowest gross margins among all revenue categories, with the exception of professional services, which typically do not contribute significantly to gross profit. This hosted offering is known as the “HashiCorp Cloud Platform,” or HCP, and also represents the company’s anticipated stock ticker symbol.

While HCP currently constitutes a relatively small portion of HashiCorp’s overall business, the company anticipates its expansion. Within its risk assessment, the company articulated the following:

This can be interpreted as HashiCorp acknowledging the industry trend towards increasingly hosted, rather than self-hosted, software delivery models. This shift aligns well with the core principles of their product design. However, at present, HCP’s contribution to the company’s total revenue remains modest.

The following graphic illustrates the evolution of HCP revenues as a percentage of total HashiCorp revenues over time:

This represents substantial growth! It’s important to remember, however, that HCP currently operates with lower gross margins. Improved profitability may be realized as the platform scales and contributes a larger, double-digit percentage to overall revenues. Conversely, a failure to improve margins could lead to a shift in HashiCorp’s revenue mix towards a lower gross-margin range, potentially hindering future revenue expansion.

Considering HashiCorp’s statement that “HCP supplements [its] direct sales motion with a self-serve offering that enables us to serve small- and medium-sized businesses, or SMBs, through a low-touch solution,” it’s possible that the hosted service may not achieve comparable gross margins to other products.

A Different Growth Model

HashiCorp's method of acquiring customers differs somewhat from typical enterprise software vendors due to its commitment to Open Source Software (OSS). Rather than initially securing a client and subsequently increasing contract value, HashiCorp employs a sales strategy termed “adopt, land, expand, and extend.”

This approach involves identifying users of its OSS products or HashiCorp Cloud Platform (HCP). Subsequently, enterprise sales teams engage these users, transitioning them to subscription-based contracts for the company’s software.

Traditional enterprise upselling then follows this initial engagement. Despite the additional stage in its customer acquisition and expansion process compared to companies without an OSS focus, HashiCorp continues to demonstrate strong net retention rates.

The data illustrates this point effectively:

• Net Retention Rate Q2 2023: 138%
• Net Retention Rate Q3 2023: 135%
• Net Retention Rate Q4 2023: 131%

While a slight downward trend is observable, all reported figures remain above 120%. These results are demonstrably positive and indicate a healthy growth trajectory.

It’s important to note that being an OSS-centric company does not hinder HashiCorp’s performance; in fact, it appears to be a successful model.

HashiCorp's Financial Performance

During the full fiscal years concluding January 31, 2019, 2020, and 2021, HashiCorp experienced net losses of $47.4 million, $53.4 million, and $83.5 million, respectively.

Is this simply another instance of an enterprise software company experiencing substantial cash burn? The situation is more nuanced. In the six months ending July 31, 2021, the company reported net losses of $40.5 million.

This represents a decrease from the $67.5 million net loss recorded in the same period the previous year. It's encouraging to observe the company reducing both its net loss percentage relative to revenue and the absolute loss amount.

Factors Contributing to Loss Reduction

The reduction in net losses was achieved through revenue growth and an increase in gross profit that outpaced the growth of operating costs. This improvement brought the company’s financial inflows and outflows into better alignment.

While HashiCorp is not yet profitable, it can now assure investors that the period of increasing losses is likely over, assuming the current trend continues.

For those interested in a deeper look at HashiCorp’s adjusted profitability metrics, consider the following:

This analysis involves adding back the expense of share-based compensation to the company’s operating losses, resulting in a reduced loss figure. However, this perspective presents a less optimistic picture.

After removing non-cash stock compensation costs, HashiCorp actually incurred greater losses in the most recent two quarters compared to the prior year, although as a smaller percentage of overall revenue.

• Key Takeaway: While losses are decreasing, profitability remains a future goal.

Determining the Value of HashiCorp

The company is highly valuable. This assessment stems from HashiCorp’s consistent generation of substantial, recurring revenue with notably high margins, demonstrating strong customer retention. Such financial characteristics are particularly appealing to investors.

During the quarter ending July 31, 2021, HashiCorp reported revenues totaling $75.1 million. This performance extrapolates to an annual revenue run rate of $300.4 million. Considering this, surpassing its last private valuation of $5 billion appears readily achievable.

However, a potential $10 billion valuation presents a different scenario. Achieving this would result in a run-rate multiple of nearly 33x. Whether this is feasible depends on the company’s continued growth trajectory.

It will be interesting to observe how any deceleration in HashiCorp’s revenue growth impacts its final share price and overall valuation. Further details will be provided once the initial price range is announced.