Hashicorp IPO

Investment Analysis Clubs Saul’s Investing Discussions
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https://www.sec.gov/Archives/edgar/data/0001720671/000119312…
Ticker HCP, scheduled for December 9
Assumed $70 share price with estimated net proceeds of $1.164B to Hashicorp.
Estimated 181M shares outstanding at IPO, fully diluted is about 188M
TTM revenue 286M
YoY growth of 50% in the last 9 months, so it is supposedly hypergrowth.
SaaS

BACKGROUND
Hashicorp offers an open source software stack that enables organizations to automate cloud infrastructure.
I don’t know anything about tech, but it seems this Hashicorp stuff is widely used:
Users have downloaded their products 100 million times in fiscal 2021.
Approximately 11,500 organizations have downloaded at least one product since inception.
Hashicorp products have been downloaded by approximately 79% of the Fortune 500 as of October 31, 2021.
They have 222599 Github stars, rank 22. https://gitstar-ranking.com/organizations

Q: What is the need that this company fills?
A: There continues to be a ‘shift among corporations going from static on-premises infrastructure to a dynamic/distributed cloud infrastructure’. Apparently, ‘existing procedures to manage this infrastructure and shift to cloud is inconsistent/inefficient with linear ticket driven workflows.’ Development teams often have to ‘file tickets against many different internal teams to provision infrastructure, request credentials to systems, update networks, and deploy their applications. This results in significant friction across these teams, increases costs and risks, and reduces productivity.’

‘Hashicorp’s products aim to connect, secure, and run applications/infrastructure across multiple public/private clouds: Zero Trust architecture, fully automated networking that is application oriented, rather than host oriented.
Hashicorp provides a single, comprehensive, integrated portfolio of products that spans all critical components of cloud infrastructure automation instead of a fragmented environment with dozens of vendors targeting application platforms.’

Hashicorp is platform agnostic. More than 75% of organizations are using a multi-cloud adoption model, and Hashicorp has been recognized as a partner of the year by Microsoft and Google; they accelerate cloud adoption by “creating a consistent set of workflows across private data centers and the public cloud, enabling rapid cloud migration.”

My two questions to the techies on this board:
1. Does all this stuff above mean that, once adopted, Hashicorp is ‘mission critical’ to its customers?
2. If adopted by customers, will Hashicorp products typically be used by its customers for a long time (at least several years)?

Moving on: This company is not truly founder led.
The company was founded in 2012. It was founded by Mitchell Hashimoto and Armon Dadgar. Armon Dadgar serves as the CTO currently.
However, Mitchell Hashimoto resigned from the board of directors earlier this year in July 2021. The CEO has been David McJannet since Dec 2015. This CEO doesn’t have a very impressive background to my untrained-non-tech-world eyes. Before joining Hashicorp, he was just an executive at a venture capital firm…in any case, commercialization of its products began in 2016, literally the very second that this venture capital guy joined as CEO.

Combined TAM for their four primary products (named Terraform, Vault, Consul, Nomad): $41.7B in 2021, estimated to become $72.5B by end of 2026.

GO TO MARKET STRATEGY
“open core, self service, direct sales, partner ecosystem”
As they are open source, it’s noted that “all contributors are required to sign a contributor license agreement that grants HashiCorp exclusive license to distribute any accepted contribution commercially.”

They first allow potential customers to ‘self’ adopt (self serve and open source. Allows Hashicorp to identify initial use cases).
Next they land (sales teams will target and sign customers for subscription contracts to gain access to more product features/support).
Then they expand (upsell/encourage increase usage) and extend (Cross sell additional products).
The average DNBRR in the last twelve months is >120% which might reflect some success in this.

They target large enterprise customers. Customers with $100,000 or greater ARR represented 82% and 87% of revenue for the nine months ended October 31, 2020 and 2021, respectively.
Maybe a network effect: they had over 1,700 providers and integrations and more than 800 partners, including over 190 independent software vendors, as of October 31, 2021

And, as of October 31, 2021, over 44% of customers with $100,000 or greater ARR were licensing more than one product.
Throughout the S1, they try to emphasize that they are in ‘early stages’ of growth.

HOW THEY MAKE MONEY
They make money through subscription revenue, usage based pricing, and one time fees.

1.) Subscription revenue from licensing and product usage (primarily the Terraform and Vault products, which currently comprise 85% of revenue)

2.) Hashicorp also earns money through consumption based revenue on their Hashicorp Cloud Platform (HCP).
This HCP was released in 2019.
This HCP is available on all leading cloud providers and ‘represents a significant growth opportunity for our business, particularly as an increasing number of our customers are looking for a fully managed offering.’ As of 10/31/21, it comprises 6.7% of revenue.

3.) ‘professional services’ revenue. This is a fixed fee basis service that self serve customers can purchase to help training and speed up deployment of Hashicorp products.

THE NUMBERS
I’m putting two screenshots of the spreadsheet I created, as it will be too ridiculous to format manually here:
https://ibb.co/mzNsBLs
https://ibb.co/9ndNyT6

My comments:
Why is license revenue decreasing QoQ at times???
There is clearly some kind of seasonality/crazy fluctuation in growth for some quarters.
There is definitely deceleration of YoY growth in licensing, support, and professional revenue. (Overall revenue growth rate is falling from 75% in FY20-FY21 to 50% for FY21-FY22)
Cloud revenue is accelerating, although from a VERY tiny base.
Gross margins of cloud revenue is terrible. Notably, the S1 states that “during the 12 months ended January 31, 2021, there was a negative margin on cloud-hosted services due to investment in headcount to grow HCP.”
Strong DNBRR >120% with robust growth of TOTAL customers…but the growth rate of ARR >$100K customers is decelerating!
Not typed in my spreadsheet, but also to note is GAAP operating margin has been getting worse over the last 3 quarters: -12%, -23%, -33%

OTHER THINGS I DON’T LIKE
1.) The S1 states that business has been highly seasonal, “with the highest percentage of our sales occurring in our fiscal fourth quarter due to increased buying patterns of our enterprise customers prior to the end of the year and a lower percentage of our sales in our second fiscal quarter due to the summer vacation slowdown that impacts many of our customers. We expect these seasonal trends to continue.” Well I’m not so sure about what they say with 4th vs 2nd quarter …because just looking at the revenue stream growth QoQ it’s all over the freaking map from any quarter in any year!

2.) So they noted that the pandemic last year had negatively impacted their operations, even though they were a remote-first company at founding in 2012! They say the pandemic “negatively impacted in-person conferences, the length and variability of our sales cycles, the rate of sales to new customers, our international operations, and the hiring and onboarding of new employees across the organization.”
But, the pandemic also led to existing and potential customers accelerating transitions to the cloud…right?
In any case, the net result I’m seeing is that growth rates across the board in 2021 are decelerating intensely from 2020, with the exception of the Hashicorp Cloud Platform revenue.

3.) How much can large enterprises spend on this kind of stuff?
THere is no mention of customers with >$1 million ARR anywhere in the S1. Is this because Hashicorp is too early stage in growth, or because almost no one spends that much money for cloud adoption processes?

4.) As cloud becomes a larger portion of revenue, the overall gross margin profile will become lower, due to their lower gross margin on cloud-hosted services. And they explicitly state in the S1 they hope cloud grows faster so it can boost their growth…(From S1: “We believe HCP represents a significant growth opportunity for our business. We expect HCP to continue to grow and represent an increasing percentage of our total revenue over time”)

5.) Valuation. If this prices at $70/share and $13B market cap, that’s TTM P/S ratio of 45 and NTM P/S ratio of 39 (at annual revenue run rate of 328M).

6.) Stock will likely be very volatile.
Estimated 181M shares outstanding at IPO, fully diluted is about 188M
The S1 indicates that existing 5% holders (venture capital folks) will own 59.4% of shares outstanding at IPO.
Executive officers and directors will own 30.6% of shares outstanding at IPO.
Existing stockholders will own 92.5% of all shares and new investors who buy in will own 7.5%…WOW! that is going to be an incredibly low float. I bet it will be a very volatile stock pre-lockup and during lockup expiry.

7.) Open source software, so any competitor can design their own competing product with less overhead/lead time that Hashicorp had to already endure.
Their current competition, from S1:
Internal IT teams sometimes attempt to “do it themselves” using open-source software.
For companies that adopt single cloud solution (however, more than 75% of organizations are using a multi-cloud adoption model), in-house offerings by AWS, GCP, Azure and legacy point product providers (Red hat, Cyberark, VMware, IBM). They compete also with open source Google Istio.
Question to tech folks: is Hashicorp an ‘undisputed leader’ or some kind of disruptor in what they’re doing for cloud adoption? Is it a greenfield opportunity? Or are these listed competitors already dominant in the market?

SUMMARY
I’m not putting this stock in my portfolio.
Despite a strong DBNRR >120%, I’m seeing decelerating YoY growth rates, complicating multiple revenue streams, crazy fluctuating seasonality, low gross margins that are changing all the time for the cloud revenue product (which they are relying on to juice growth), no sign that enterprise customers can reliably spend a lot (no metric on customers with >$1M ARR), not founder led, and worsening operating margins (GAAP).

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All of Hashicorps’s products revolve around software deployment infrastructure. In Hashicorp’s case, most of them have to do with configuration management. They serve a subset of software developers called Site Reliability Engineers/DevOps engineers

Think about a specialized support team to software developers: creates pipelines that let developers deploy their code to cloud, monitor the health of servers, and make sure that websites and servers are up all the time. For example, DDOG is a standard SRE/DevOps tool.

Terraform as the underlying tech is the undisputed leader by a large margin.

What is Terraform

It lets you define the end state of your server then generate the procedure to create those servers for you on the cloud. For example, I can say that I change my running AWS EC2 server from a set of networking parameter to another set of networking parameters, while restricting the access to certain users. You can do this in the AWS UI (Pain), AWS command line tool (Requires writing a procedural script, pain and unsustainable), or just tell Terraform “this is what I want” and let it generate the procedural script and apply the change for you.

This lets you define infrastructure as code which is a big quality of life upgrade for software teams because you can now check them into version controls and let automated deployment make infrastructure changes instead of have a specialized person sitting in front of a laptop applying those changes. Now you have self-service cloud infrastructures for all developers.

I am not familiar with the payment model for Hashicorp. Infrastructure changes tend to be much less frequent and most developers wouldn’t need to touch it. Once you define an infrastructure it can be applied to many cloud containers. So this part I’d leave it out for other experts.

I have not used Vault, but it’s also configuration management tool. I have heard good things about it. In this case it is like a password manager for applications instead of humans. I know a lot of people on Azure use Azure key vault natively provided by Azure. On AWS I’d say people would go for AWS secrets manager first.

I am not familiar with consul or nomad.

About the two particular questions

  1. I don’t think Hashicorps products are mission critical to the level of DDOG (my point of sale machine died!) and more of a developer productivity tool that increases the overall output of the IT organization.

  2. It is very likely that once it is adopted, it will be used for several years. DevOp’s/Site Reliability Engineer’s life tend to be very reactionary (AWS went down! People can’t access our servers!) so when they pick a tool, it is likely a team decision with intention to make their life easier. Only when much better product showed up would they switch eg. NewRelics vs Datadog.

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I have been watching this one as well. For more on the CEO, David McJannet, I found this video from 2020 really helpful: https://www.youtube.com/watch?v=HCQnfWsAfEM. His family emigrated from South Africa to Canada when McJannet was a teen. They could bring no money with them. He helped run a family venison farm outside of Toronto.

He got an accounting degree and then picked up and went to Chile to experience a different culture and become fluent in the language. He ended up working for the largest bank in the country. He left Chile so that his girlfriend could return to the U.S. and ended up in Silicon Valley. He then held marketing positions and learned how to take a company public.

The co-founders of HashiCorp, both in their twenties at the time, asked David to join their team because they knew they didn’t have the experience needed to scale their business.

Business-wise, I noted in the above interview that he said (paraphrasing here) that it’s easy to build good tools, but HashiCorp excels in helping their customers implement and use them. So companies use the free, open-source version and quickly realize that they need help to scale and then upgrade to their paid products. McJannet talked about the necessity of that help because the product is so sticky. He basically implied that once a company adopted their tools, they were not going anywhere.

Lastly, if you subscribe to Muji’s service, he has promised a write-up on HashiCorp sometime today. https://twitter.com/hhhypergrowth/status/1468099761425297409…

JR

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I’m in tech, specifically the area that Hashicorps products target, Cloud hyperscalers.

1. Does all this stuff above mean that, once adopted, Hashicorp is ‘mission critical’ to its customers?

Yes, Hashicorp, specifically Terraform, is mission critical to almost all customers using any public cloud provider (AWS, Azure, GCP). There are other options to manage your infrastructure, even other infrastructure as code options, but they are significantly more difficult than adopting Terraform, all major Cloud providers recommend Terraform to their customers. However, Terraform is completely free and open source. In my 5+ years working in this industry I’ve never encountered an enterprise customer who pays Hashicorp for any of their other products, or their support.

2. If adopted by customers, will Hashicorp products typically be used by its customers for a long time (at least several years)?

Yes, but like I said above, their products are open source, and their most important product with the widest adoption (Terraform) doesn’t even have a paid option.

Personally, I haven’t seen the value in their other products, and don’t know what their strategy is, but this feels very similar to Docker, who gave away the farm for free, then tried to find things to charge people for after the fact.

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Hi Jon,

That was a great write-up on Hashicorp. I wish I could have recced it a half-dozen times. Nice job.

Best,

Saul

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Thanks Jonwayne for the good writeup and the links to your spreadsheets.

Regarding the statement “There is no mention of customers with >$1 million ARR anywhere in the S1”. I also could not find it anywhere (in S-1 or other documents), but Eric Cuko of TMF reported in a Nasdaq post that “HashiCorp has 2,101 customers. 558 of these customers are worth over $100k annually, and 58 customers are worth over $1 million.” Not sure where he got that data.

He also states that while HashiCorp does not report ARR, they have an implied ARR of $295M which is growing ~50% YoY.
The article is at https://www.nasdaq.com/articles/hashicorp-ipo-is-hcp-stock-a… and has a video that details his thoughts of this IaaS company.

A couple other datapoints from the S-1:
“last four quarter average net dollar retention rate”

1/31/20  10/31/20  1/31/21  4/30/21  7/31/21  10/31/21
 131%      127%     123%     122%     124%      127%

Customers with >$100,000 ARR

1/31/20  10/31/20  1/31/21  10/31/21
 338       451      500       595 
 YoY        NA      48%       32%

My 2 cents here – very intriguing, BUT

  • The declining YoY %’s (as you stated) trouble me – key example, YoY Revenue growth dropped from 91% to 49% over the past year
  • Increasing losses and decreasing cash flows (possibly due to increasing headcount to target growth)
  • 8.55% float to Outstanding Shares – quite low
  • Rule of 40 – 22%
  • NDRR of 127% - Given their breadth of 9 total products, I would like this to be higher.

Finally, I find the lack of information they provide on their Investors page very concerning. There isn’t even a corporate overview presentation or an investor presentation.

They do offer a nice quite of tools that can be leveraged as a single solution for many areas vs the customer having to deal with multiple vendors with their competition. This is why I thought the Net Dollar Retention Rate would be higher.

The low float and high pricing/valuation makes this seem like an investor IPO cash-out to me. In the past I threw a few of my hard earned $’s at a couple IPOs that had low floats and little investor facing information, and I lost money on both of them.

So like you, I will wait on this one for a while - though I added this to my watch list to revisit in a couple months. I may miss an opportunity, but there are plenty of others out there with better numbers and more open disclosures.

Thanks again,
BornGiantsFan

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