The HubSpot takeover appears to have failed: Is the stock a buy?

A few months ago, rumors emerged that the technology giant alphabet considered acquiring an inbound marketing software provider HubSpot (HUBS -2.79%)HubSpot has a huge customer base focused primarily on small and medium-sized businesses – a potential goldmine for Alphabet, which is looking to grow its cloud computing business.

Alphabet now appears to have walked away from the negotiating table. A report from Reuters on Wednesday suggested that Alphabet had already decided to drop a potential offer weeks ago and that talks had not even reached the due diligence stage. Unsurprisingly, HubSpot’s share price has fallen as investors process the news.

Is this decline a buying opportunity?

The good: Impressive customer growth

HubSpot sells a variety of software subscriptions for marketing, sales, customer service, content management and other areas, so the company’s platform offers many entry points for new customers.

HubSpot ended the first quarter of 2024 with nearly 217,000 customers, up 22% year over year. In a macroeconomic environment marked by inflation and uncertainty, that’s an impressive feat.

Thanks to this customer growth, HubSpot’s revenue increased 23% year over year in the first quarter. The company’s bottom line also improved. Although operating income under generally accepted accounting principles (GAAP) was negative in the first quarter, HubSpot managed to generate positive net income and healthy free cash flow. All numbers are trending in the right direction.

The bad: Customers are not spending more

While HubSpot finds it easy to acquire new customers, convincing those customers to spend more money is another matter entirely. Average subscription revenue per customer increased just 1% year over year in the first quarter, meaning the company’s revenue growth is largely due to new customer acquisition.

This wouldn’t be a problem if HubSpot’s platform wasn’t tailor-made for a land-and-expand strategy, but it is. The platform’s various hubs, priced based on the number of seats, offer HubSpot customers multiple ways to grow their spend over time.

HubSpot recently made some changes to its pricing model. Pricing is now more based on seats and makes it easier for customers to move from Starter to Professional plans. It’s too early to say whether this change will pay off.

The Ugly: A High Rating

After this week’s crash, HubSpot is valued at about $25 billion. Any deal would likely have required a hefty premium. While we don’t know why Alphabet pulled out, valuation is a likely reason.

HubSpot expects revenues of between $2.55 billion and $2.56 billion this year, which corresponds to a price-to-sales ratio of just under 10. On a GAAP basis, the company is barely profitable, and that is only due to interest income from its cash reserves. On a non-GAAP basis, HubSpot expects earnings per share of between $7.30 and $7.38 this year. The price-to-earnings ratio is therefore around 66.

At the midpoint of HubSpot’s full-year forecast, revenue should grow about 18% this year. That’s a solid result, but perhaps not enough to justify such an optimistic valuation.

No purchase

HubSpot’s difficulty growing customer spending, limited GAAP profitability, and high valuation make the stock a tough sell even after this week’s decline.

Alphabet pulled back for good reason, and investors should follow suit and wait for a more attractive entry point.