Yes, it's fun to see a technology startup make it to an Initial Public Offering (IPO). The Hubspot team deserves credit for making it to last week's IPO, with its stock now trading under the symbol HUBS on the NYSE.
But for investors, it's a totally different story. It's time to take a wait and see approach.
With Hubspot still losing money on business operations and insiders now waiting for an IPO lock-up expiration to sell their shares, there's a lot of risk in the shares. I would expect a volatile first year in the public markets for Hubspot.
If you're looking to invest, there will be far less risk if you wait.
For the early venture investors in Hubspot, the IPO represents a goal -- an exit. They are selling their pre-IPO shares and celebrating. Who's buying? The investors in the public market. They are taking a stake in Hubspot as the company enters an entirely new stage of its life, the phase when it uses public capital to accelerate growth.
The company raised about $125 million last week, selling five millions shares at $25 each. The stock initially popped as high as $30, but this morning was changing hands at $27, above the IPO price but below last week's highs.
Hubspot, despite its growth and success, still has significant challenges. And it has many things yet to prove -- the biggest of all is making money. You see, Hubspot is still burning cash. According to its S-1 statement filed with the US Securities and Exchange Commission, Hubspot lost $17.7 million in the first six months of 2014. That's compared with $16.4 million in the first six months of 2013.
The company is growing revenue, which went from $51.6 million in 2012 to $77.6 million in 2013, an increase of 50 percent. It booked $51 million of revenue in the first six months of 2014, so it is on track to do $110 million to $120 million in revenue for 2014.
Hubspot now has a market capitalization of about $840 million, giving it a price/sales ratio on shares of about eight-to-one. This is not unusual for a growth software company, but it does represent a high risk. Hubspot is spending a a lot of money on sales and marketing to drive this growth.
As I wrote last month, Hubspot has done a great job of building a community and marketing itself. But how you monetize that growing community is a different story. And investors will need to hear the story of how it makes money.
As demonstrated by history, investing in technology IPOs without a profitable track record and a high price/sales ratio is a risky proposition. Until the company starts proving it can make money, it hasn't yet shown the true operational strength of its business model.
Lots of Losers
While big losses are often the case with a company in its early growth stages -- typically technology companies reinvest capita in sales staff and product development -- the pattern in recent years has been for companies to start the drive toward profit as they get toward IPO.
In the case in which they aren't making money, there are many cautionary tales. Take a look at tech IPOs such as Groupon and Zynga, which lost money for the investors who bought post-IPO. Groupon, amazingly, is still unprofitable many years after its IPO.
Another reason that investors should wait before diving into an IPO like Hubspot is that these early technology IPOs usually suffer some sort of dip once the share "lock-up" expires in the first six months of trading.
Silicon Valley and Wall St. have an interest in pushing the IPO for an early pop so the insiders and big Wall St. clients can make more money selling their shares when they can. Keep in mind that many of these investors invested in the company at early stages many, many years ago and their first instinct is to cash in. This smart money is locked up from selling in the first few months following the IPO. But as the lock up gets released, these shares find their way to market.
Take a look at Facebook as an example. It went public at $38 per share, but a year later it could be had at $18. Now, Facebook trades in the $70s, but would you have rather bought at $38 or $18? There was clearly a nice post-IPO crash in which to invest.
Other post-IPO tech action has been even more extreme. Take a look at the case of tech security firm FireEye Inc. The IPO was priced at $20 per share in 2013, and quickly traded to $36 in the first 48 hours. The shares then rocketed higher and in February of 2013 climbed to more than $90. Then, the collapse. After insiders sold millions of shares in secondary offerings, the stock price fell precipitously. What does Fireye trade at now? $25.50 -- below where it traded the day after its IPO.
This is a familiar pattern in technology IPOs, which you should remind yourself of if you are thinking of investing: The insiders are standing, waiting to sell millions of shares into any stock rise.
A Rocky Road
Most tech IPOs have significant volatility after an IPO, and you can usually have opportunities to buy the stock later when the market has a better sense of what's going on -- and the insider overhang has been removed. You'll also have several quarters of publicly reported earnings reports to see how the company is progressing.
Bottom line: If you are an investor looking to buy Hubspot, wait a few quarters. You'll have a better sense of the trajectory of the financials and you'll be able to see how many insiders sell when they get that first opportunity to cash out.