Hashicorp: A Play on Cloud Computing Growth

There are a handful of investment themes that almost mandate participation because the potential opportunity is so large. Any total addressable market (TAM) upwards of $500 billion deserves some attention because it’s just too big to ignore. NVIDIA believes AI chips represent a $600 billion TAM, and last year they captured less than 5% of that opportunity. Even if the TAM is half of what they estimated, there’s still plenty of upside. Similarly, cloud computing spend is expected to eclipse $1 trillion by 2026, up from a $500 billion TAM today.

Our recent piece on Investing in Cloud Computing. Any Growth Left? made a compelling case for getting more exposure to the growth of cloud computing that’s only accelerated by the emergence of Software-as-a–Service (SaaS) companies offering solutions via the cloud. So, when we came across a SaaS company offering solutions across the three biggest cloud hyperscalers, our ears perked up.

Introducing Hashicorp

Technology becomes complicated very quickly, so the challenge in introducing new tech solutions is to explain things in a sufficiently simple manner such that experts and novices alike will find the interpretation agreeable. With that in mind, check out the below diagram which shows key functions for the three biggest hyperscalers.

Every company has applications which can either live in private data centers (on premise) or in the cloud. These applications need to talk to each other (connect), and they need to be secured such that bad actors can’t infiltrate them (secure). All the while, developers and operations engineers need to deploy application updates and configure new hardware as needed (provision). If you’re using the three largest hyperscalers, along with on premise applications, that translates to twelve different methods for connect/secure/provision (see above diagram). The task of managing all these activities belongs to a “platform team” within an organization that’s tasked with “delivering shared infrastructure, runtimes, and other services consumed by developers across the organization.” The name of this team can vary by organization, but the functions remain the same as does the ultimate goal – to deploy applications seamlessly across cloud providers in a secure manner.

Centralized cloud functions (e.g.,cloud centers of excellence [CCoE], platform teams) are responsible for standardizing cloud services (87%), creating operational policies (86%), and centralizing security (85%).

Credit: Forrester

Whether it’s called a CCoE team, a platform team, or it falls under DevOps, this group is tasked with standardizing an organization’s approach to cloud computing across all applications. So, if you’re moving applications to the cloud (who isn’t?), and you’re using multiple clouds (60% of organizations are), then a consistent approach across all cloud vendors makes life easier.

Today, 60% of surveyed technology practitioners and decision-makers are using multicloud. In the next 12 months, that number will swell to 81%. A majority of respondents (90%) say that it is helping them achieve business goals.

Credit: Forrester

Your organization shouldn’t need a different team for each cloud provider. Going back to the earlier diagram, see how each cloud provider offers different tools for connect/secure/provision? That’s where Hashicorp (HCP) makes things easy with three primary solutions that work across all major vendors including your own on premise applications.

So, let’s review. The majority of businesses are moving to multicloud because it helps them achieve business goals. Consequently, business are establishing “platform teams” or “cloud centers of excellence” to manage the complexity. To reduce complexity, they’ll look for a single solution that works across all the major operational functions of any given cloud provider (connect/secure/provision). That’s when Hashicorp comes into the picture with a SaaS platform that reduces complexity and consequently costs.

Trends Driving Hashicorp

We’ve talked about how cloud computing spending will double and surpass one trillion dollars by 2026. Organizations are not only moving more applications to the cloud, they’re also adopting multiple providers. Chief Technology Officers (CTOs) will look to offset this added complexity by utilizing vendors who offer multiple solutions under the same umbrella. Vendor consolidation is a common theme during cost cutting initiatives, and Hashicorp’s net retention rate will be a key metric to watch for evidence of stickiness.

We expect customers to pull back on spending during a recession, but that decline should be offset by clients who consolidate vendors and expand their use cases with Hashicorp consequently increasing spending. The company’s investment deck highlights three examples of the journey from opensource to commercial for large clients:

• Customer adopts opensource solution and uses for several years
• Customer starts utilizing a commercial subscription measured in hundreds of thousands per year
• Four years later, customer is spending upwards of $10 million per year

Since Hashicorp’s offerings are based on opensource architecture, we believe this helps increase adoption in any given development community. That’s because it’s the development community who helps maintain and refine these solutions as time goes on, so they’ll quickly adapt to the industry’s ever-changing demands. Also, commercialized opensource technologies inherently become freemium business models which easily reel in leads who subscribe after seeing that the technology sufficiently addresses organizational pain points.

Investing in Hashicorp

Hashicorp has the hallmark characteristics of a strong SaaS firm with a growth story that should enjoy headwinds in good times or bad. As with any SaaS stock, it comes down to paying a reasonable price for the growth exposure you’re getting. Let’s start by looking at the simple valuation ratio (SVR) for some popular disruptive technology SaaS firms.

The above firms are all leaders in the niches they operate, so the breadth of their product offerings typically extend beyond the original value proposition. Think of how Crowdstrike has segmented their product offering into modules, then reports on the number of customers who have adopted more than five modules (62% of their customers). Increased adoption helps ensure stickiness, and makes it easier for Crowdstrike to push out niche vendors with adjacent offerings. That’s precisely the same appeal Hashicorp has, only they’re a bit more verbose when describing it. They sell multiple solutions to one business decision making group which helps them get signatures quicker and propose potential vendor consolidations.

Each of these SaaS companies have ponied up annual revenue guidance targets (most likely) for the first time since the recession started. Management teams that see their solutions benefiting from cost-cutting initiatives like “on-premise to cloud migrations,” or “robotic process automation for back office roles” will likely continue forecasting growth reminiscent of what they could accomplish during the good times. Those who see headwinds as having a negative (or even uncertain) impact may proceed with caution when giving guidance.

The only SaaS company in the above list to increase revenue guidance in the face of today’s “macroeconomic headwinds” is UiPath while the rest are expecting growth to stall. This exception is intuitive, because UiPath uses automation to reduce personnel requirements and save firms’ money. SaaS solutions that benefit from vendor consolidation, or that save money in other ways, will likely surprise investors (and management) as they see more resilient revenue growth throughout 2023 leading to a guidance raise or beat. Those firms underestimating the economic headwinds will present better buying opportunities as their share prices adjust to Wall Street’s lofty expectations.

Would-be investors in Hashicorp can enjoy above average growth for a valuation that’s slightly above peer average. Despite losses from operations of $290 million for each of the past two years, Hashicorp’s gross margins are upwards of 80% which means profitability can easily be in sight anytime they want to start chopping heads. Around $1.3 billion in cash on hand means they have about 4.5 years of runway remaining, plenty of time to turn the ship towards profitability.

Conclusion

Companies are moving to the cloud, and it’s not just one cloud provider. As macroeconomic headwinds batter organizations, CTOs are coming under pressure to cut costs, reduce complexity, and streamline vendors. Hashicorp’s solution addresses all these trends, and the company’s current valuation is inline with our portfolio SaaS average. For us, there’s a size concern here given we’re already overweight small-to-medium sized firms, but that’s also a function of how depressed valuations are across the board. We also need to consider opportunity costs as our 36 tech stock portfolio has only four empty slots remaining.

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