Description

We believe the “Unicorn” bubble has burst and Hashicorp was a late-stage IPO entering the public market in December 2021. On March 8^th HCP will report its first quarter as a public company. We believe there are four key risk factors that the market will not love:  1) The sell-side has -60% EBIT margins for ’22 (and a FCF burn of $800 million over the next several years) 2) with a valuation of 15x revenue 3) we do not believe the barriers to entry are very high and 4) venture capital firms and insiders own 86% of the company (big overhang). We believe given the bursting of the Unicorn bubble that VC firms will be motivated to find liquidity in public shares they own especially for a business w an aggressive cash burn and high valuation.

We believe this risk profile could become deeply out of favor with the market and that the risk/reward is attractive with the downside of $10-15 per share vs. the current $39.

About HCP

HCP is a software company focused on cloud infrastructure automation.

Terraform

HCP’s highest selling software is Terraform, an infrastructure provisioning product allowing teams to apply an Infrastructure-as-Code (IaC) approach, with integrations with multiple cloud, software, and hardware platforms, including AWS, Azure, GCP, and others.

A big selling point for Terraform is that it allows for integration with multiple cloud computing platforms. This is an advantage for customers as it prevents “vendor lock”, or over concentration into any one cloud computing platform.

Heavy Competition

Companies that were historically infrastructure-as-service (IaS) providers such as Amazon’s AWS and Microsoft’s Azure are developing their own IaC software. Microsoft recently launched Azure Bicep, which provides a superior user experience when deploying, describing, and validating Azure infrastructure. Similarly, AWS’s CloudFormation is superior when working with AWS resources. Terraform, however, is still superior when the company’s’ infrastructure relies on multiple 3^rd party resources. It is possible that these tech giants may offer a compelling reason to utilize a single-cloud solution, if the user experience is significantly better, potentially causing HCP to lose market share.

“We face competition that we expect to become more intense over time, and which could adversely affect our business, financial condition, and results of operations.

For select companies adopting a single-cloud solution, we compete with the well-established public cloud providers such as Amazon Web Services, or AWS, and their in-house offerings. We also compete with similar in-house offerings from Microsoft Azure, Google Cloud Platform, and other cloud providers; legacy providers with point products such as Red Hat, CyberArk, VMware, and IBM; and alternative open-source projects, such as Google Istio.” – HCP S1

Low Barriers-to-Entry

HCP develops all products as open-source projects. This allows for higher levels of contribution and feedback for HCP’s software. The issue with open-source is that it allows for easy redistribution of the software and underlying code. Companies with larger marketing and R&D budgets can potentially develop software based on HCP’s code, improve it, and distribute/scale up much faster than HCP. We are already seeing large players invest in open-source, such as Google Istio.

We believe this risk profile will become deeply out of favor with the market and that the risk/reward is attractive with the downside of $10-15 per share vs. the current $38.

About HCP

HCP is a software company focused on cloud infrastructure automation.

85%+ of their revenue comes from Terraform and Vault, which will be the focus of this write-up.

Terraform

HCP’s highest selling software is Terraform, an infrastructure provisioning product allowing teams to apply an Infrastructure-as-Code (IaC) approach, with integrations with multiple cloud, software, and hardware platforms, including AWS, Azure, GCP, and others.

A big selling point for Terraform is that it allows for integration with multiple cloud computing platforms. This is an advantage for customers as it prevents “vendor lock”, or over concentration into any one cloud computing platform.

Heavy Competition

Companies that were historically infrastructure-as-service (IaS) providers such as Amazon’s AWS and Microsoft’s Azure are developing their own IaC software. Microsoft recently launched Azure Bicep, which provides a superior user experience when deploying, describing, and validating Azure infrastructure. Similarly, AWS’s CloudFormation is superior when working with AWS resources. Terraform, however, is still superior when the company’s’ infrastructure relies on multiple 3^rd party resources. It is possible that these tech giants may offer a compelling reason to utilize a single-cloud solution, if the user experience is significantly better, potentially causing HCP to lose market share.

“We face competition that we expect to become more intense over time, and which could adversely affect our business, financial condition, and results of operations.

For select companies adopting a single-cloud solution, we compete with well-established public cloud providers such as Amazon Web Services, or AWS, and their in-house offerings. We also compete with similar in-house offerings from Microsoft Azure, Google Cloud Platform, and other cloud providers; legacy providers with point products such as Red Hat, CyberArk, VMware, and IBM; and alternative open-source projects, such as Google Istio.” – HCP S1

Low Barriers-to-Entry

HCP develops all products as open-source projects. This allows for higher levels of contribution and feedback for HCP’s software. The issue with open-source is that it allows for easy redistribution of the software and underlying code. Companies with larger marketing and R&D budgets can potentially develop software based on HCP’s code, improve it, and distribute/scale up much faster than HCP. We are already seeing large players invest in open-source, such as Google Istio.

“Because of the permissive rights accorded to third parties under our open-source and source available licenses, there are limited technological barriers to entry into the markets in which we compete, and it is, and may continue to be, relatively easy for competitors, including public cloud operators, to enter our markets and compete with us.”

“Such competition can develop without the degree of overhead and lead time required by traditional proprietary software companies, due to the rights granted to licensees of open-source and source available software. It is possible for competitors and new entrants to develop their own software, including software based on open source or our products, and for public cloud operators to expand their offerings to compete directly with ours, potentially reducing the demand for our products and putting pricing pressure on our subscriptions” -HCP S1

Burning Cash: R&D and Marketing

In the last 3 fiscal years, R&D and Sales & Marketing combined were 90%+ of revenue.

HCP is also spending significant amounts (~70% of revenue) on marketing. Marketing efficiency has been poor but improving. HCP is currently earning ~$1.50 – 1.60 in revenue per dollar in marketing. This has increased from ~$1.35 – 1.40 in FYE 2018 - 2019. Although HCP has improved marketing efficiency, HCP will need significant and drastic improvements to become cash-flow positive.

It is possible the combination of heavy competition from larger players, low barriers to entry, and the need to continuously improve and market the product will significantly impact HCP’s ability to be cash-flow positive. HCP believes they will be cash flow-negative for the “foreseeable future”. We think this is too high a risk for a company trading at over 15x sales and burning cash.

“We anticipate that our operating expenses will increase in the foreseeable future as we continue to enhance our products, grow our relationships with existing customers, broaden our customer base, expand our sales and marketing activities, expand our operations, hire additional employees, and continue to develop our technology. These efforts may prove more expensive than we currently anticipate, and we may not succeed in increasing our revenue sufficiently, or at all, to offset these higher expenses.”

“We expect to continue to incur operating losses and generate negative cash flows from operations for the foreseeable future due to the investments we intend to make as described above, and as a result we may require additional capital resources to execute strategic initiatives to grow our business.” – Source: HCP S1

To conclude, we believe HCP is in a highly competitive environment, requiring the company to invest significant amounts in R&D and marketing for the foreseeable future. No matter how much HCP is willing to realistically invest, giant tech players can invest significantly more in both product and awareness.

"The permissive rights accorded to third parties under our open-source and source available licenses, there are limited technological barriers to entry into the markets in which we compete, and it is, and may continue to be, relatively easy for competitors, including public cloud operators, to enter our markets and compete with us.”

“Such competition can develop without the degree of overhead and lead time required by traditional proprietary software companies, due to the rights granted to licensees of open-source and source available software. It is possible for competitors and new entrants to develop their own software, including software based on open source or our products, and for public cloud operators to expand their offerings to compete directly with ours, potentially reducing the demand for our products and putting pricing pressure on our subscriptions” -HCP S1

Burning Cash: R&D and Marketing

In the last 3 fiscal years, R&D and Sales & Marketing combined were 90%+ of revenue.

HCP is also spending significant amounts (~70% of revenue) on marketing. Marketing efficiency has been poor but improving. HCP is currently earning ~$1.50 – 1.60 in revenue per dollar in marketing. This has increased from ~$1.35 – 1.40 in FYE 2018 - 2019. Although HCP has improved marketing efficiency, HCP will need significant and drastic improvements to become cash-flow positive.

It is possible the combination of heavy competition from larger players, low barriers to entry, and the need to continuously improve and market the product will significantly impact HCP’s ability to be cash-flow positive. HCP believes they will be cash flow-negative for the “foreseeable future”. We think this is too high a risk for a company trading at over 15x sales and burning cash.

“We anticipate that our operating expenses will increase in the foreseeable future as we continue to enhance our products, grow our relationships with existing customers, broaden our customer base, expand our sales and marketing activities, expand our operations, hire additional employees, and continue to develop our technology. These efforts may prove more expensive than we currently anticipate, and we may not succeed in increasing our revenue sufficiently, or at all, to offset these higher expenses.”

“We expect to continue to incur operating losses and generate negative cash flows from operations for the foreseeable future due to the investments we intend to make as described above, and as a result we may require additional capital resources to execute strategic initiatives to grow our business.” – Source: HCP S1

To conclude, we believe HCP is in a highly competitive environment, requiring the company to invest significant amounts in R&D and marketing for the foreseeable future. No matter how much HCP is willing to realistically invest, giant tech players can invest significantly more in both product and awareness.

Valuation

$500 billion in unicorn value+ was created during COVID

EV/Sales multiple of US Tech IPOs' 

% of IPO's that are profitable 

 DISCLAIMER: This does not constitute a recommendation to buy or sell this stock. We own shares of the company, and we may buy shares or sell shares at any time.

Catalyst

Earnings are on March 8th after the close. 

Higher discount rate required for higher-risk business models?