GitLab Inc. (GTLB) is a subscription-based SaaS company that went public in October 2021. The stock climbed 30% and has since fallen from its high almost 50%. While the company has seen strong percentage sales growth over the last 2 years, it is very difficult to judge how much of this was covid effects and what the further prospects are. But this growth would have to be maintained to justify the company’s extremely high valuation. In addition, the company is still making losses, which in times of rising interest rates and inflationary pressures does not make the future outlook any better. Therefore, I’m not looking at investing in GTLB, but it could be a potential short position.
GitLab Inc. is the creator of the open-source platform DevOps, which “enables organizations to deliver better, more secure software, faster”. The company has more than 1 million active license users worldwide and employs over 1300 people in 65 countries (completely remote without headquarter). GitLab is not to be confused with GitHub, which was acquired by Microsoft in 2018.
If you are interested in seeing how the platform works from the user’s point of view, I recommend this video
How Do They Make Money?
When you start reading on GitLab’s website, you get overwhelmed by technical terms and abbreviations. As a software developer it probably all makes sense, but as an investor, you sometimes wonder what they do or offer? I’ll try to explain it in the simplest terms possible. GitLab offers software, directly on their website or in the Amazon or Google Cloud, that is designed to enable companies of all sizes to develop their software faster and more efficiently. This is supposed to be done by having all developers working on the same software and being able to track everything from planning to security, to monitoring changes all from one place. GitLab thus aims to enable its customers to reduce costs and minimize errors. For this software, GitLab is paid, as a subscription model per month per user. Ultimately, you can say GitLab has the world’s increasingly digitizing companies as its target audience.
At the moment they have 4,057 “base customers”, which is defined as “customers generating $5,000 or more in ARR”. And ARR is defined as “monthly recurring revenue multiplied by 12”. (Page 26 and footnotes)
If I understand this correctly, $417 in sales per month multiplied by 12 would mean that the ARR sales are over $5,000, and thus that counts as a base customer. I think this is very awkwardly presented and could have been much easier. So I first had to find out in the footnotes what exactly base customer means. In the end, it turns out that a base customer doesn’t have to generate that much revenue per month, and there are only 4,000 of them. Investors must be aware that most of the base customers are very small. But, they also have 427 customers that contribute more than $100k in annual revenue.
Recent Growth & Expenses
Sales have more than quadrupled in the last 2.5 years, which is very strong growth. In the last quarter alone (what they call Q3 2022), sales YoY increased by 58% from $42.2M to $66.8M.
Customers use GitLab for their most immediate needs and then expand usage over time. This enables them to quickly modernize their software development to meet the demands of digital acceleration. As we look to the fourth quarter and fiscal 2023, we see continued strong momentum toward our large addressable market.
GitLab CEO Sid Sijbrandij
The number of customers with an ARR of more than $5,000 increased to 4,057 (up 66% YoY) and the number of customers with an ARR of more than $100,000 increased to 427 (up 73% YoY). So overall, very rapid growth. However, you have to keep in mind that the last 2 years was exactly the period when the covid-triggered digitalization grew strongly. From now on, growth will be measured from a higher base, and with no further covid push expected, I am curious to see if the company can maintain similar growth figures.
When it comes to expenses, GitLab has an extreme asset-light model overall. All employees have been working from home since 2014 and there is no main office. Most of the costs are caused by sales & marketing, totaling $154M in 2021, which was more than the total revenue. Another big cost was research and development (about $24M last quarter). It looks like the costs for S&M will continue to rise in the current year, but the percentage share compared to sales is decreasing.
However, there is still no profit in sight. For this year, analysts estimate EPS of -$1.41, and even if sales double again in the next two years, a minus will probably remain in front of the EPS for the time being. Overall, the company is on the right track. Sales are increasing and the loss is getting smaller.
What makes me more skeptical than the business performance over the last 2 years is the valuation. The current market cap is $10.24 billion (remember, last quarter’s revenue was only $67M). Even if I assume further fast-growing revenue (for example $90M each for the next 4 quarters), that would be $360M revenue and still an EV/sales ratio of 28.4
Cash Burn & Share Count
The net loss for the most recent quarter was $41.2 million. According to the latest SEC Filing, the company currently has $824 million in cash and cash equivalents on its balance sheet. So for now, there’s more than enough cash for the foreseeable future. According to stock analysis, the share count grew 26.59% QoQ, which probably also has something to do with the latest acquisition. I do not expect the share count to continue to rise so quickly, as there is enough cash, even for smaller acquisitions.
Too Many Uncertainties
In theory, the company has a very interesting business model. But there are too many uncertainties here. Can the growth be sustained? How will the market react in general if the FED raises interest rates? Will the planned small interest increases even be enough to slow down inflation? Growth stocks have already had a hard time on the market for a year. Many highly overvalued stocks, of which there were a lot exactly one year ago, even had a miserable year. From my point of view, a lot of positive expectations are already priced into this valuation. So there is too little upside potential left, but the danger of falling sharply is there. All it takes is one quarter where the sales target is not reached or a surprising announcement by the FED.
The stock is already in very negative momentum. I think the share is a good short and medium-term short candidate. I do not have a short position yet, because I have also only recently analyzed all this and at the moment my portfolio consists of almost 30% short positions and that is enough for me at the moment.
Risks To My Bearish Thesis
It must be said clearly that while the valuation is high at the moment, so is the growth. The company may slowly grow into its valuation without ever suffering major share losses. Another thing I would like to mention in all fairness, because it goes very much against my bearish thesis, is insider buying. I always look at insider trades because I think they indirectly reveal a lot about the state of a company. There is almost always insider selling in the stocks that I do short. Here I was very surprised that there were several insider purchases in December.
Overall, in the current market, it is also the case that asset-light SaaS companies are getting a higher valuation as they have the chance of phenomenal margins in the future. So there are scenarios where the valuation is not enough reason for the share to correct strongly downwards.
GitLab, while being a fast-growing company, is overvalued. From an investor’s perspective, it seems to me to be something of a gamble as to whether the company can maintain this growth rate. The company is still loss-making and in the current inflationary environment, the market is strongly devaluing future profits. I can hardly imagine a scenario in which the share price rises significantly at this valuation, but there are several risks for a downward correction. Given the current market dynamics for overvalued growth stocks, the potential downside is greater than the upside.