GitLab Inc. (GTLB), a software development platform, is set to IPO soon. At the midpoint, the firm would have a valuation of $8.2 billion and earn our Unattractive rating.
GitLab is a subscription based SAAS company with a large total addressable market (TAM), which may entice investors. However, the firm sells to only a tiny portion of its TAM and is competing against some of the largest technology companies in the world. With worst-in-class fundamentals and an already overpriced valuation, we have significant concerns regarding the stock’s profitability.
We believe the stock is worth less, approximately 91% below the midpoint of the expected price range. An $8 billion valuation implies that GitLab will achieve very optimistic milestones, including reversing a downward trend in profits, growing revenue by more than 17x, and nearly tripling its current market share.
With only ~21 months of cash to cover its current cash burn rate, GitLab’s current owners need this IPO to help the company avoid bankruptcy.
Freemium Model Is Not Profitable
GitLab’s model for growing revenue is based on the freemium model: gain users with a free version of its software and convert those users to paying members. As of June 2021, GitLab had 30 million free users with just 15,356 paying users.
In other words, GitLab has converted less than 1% of its user base, which is well below the average estimated freemium conversion rate of 2-5%. Most of these converted users are also on lower priced, less profitable plans. GitLab notes that it has 3,632 “base customers”, which generate more than $5,000 in annual recurring revenue (ARR). It discloses only 383 customers generating $100,000+ in ARR.
This model has proven capable of driving revenue growth, as GitLab’s revenue grew 87% year-over-year (YoY) in fiscal 2021. However, Core Earnings[1] fell from -$125 million to -$213 million over the same time.
Figure 1: GitLab’s Revenue & Core Earnings: 2019-2020
Sources: New Constructs, LLC and company filings
GitLab’s strategy is clearly focused on growing its top line and forgoing profitability for now. While GitLab’s net operating profit after-tax (NOPAT) margin improved slightly from -158% in fiscal 2020 to -141% in fiscal 2021, it remains highly negative. Additionally, the firm’s return on invested capital (ROIC) declined from -41% to -76% over the same time. GitLab’s economic earnings, the true measure of cash flows, declined from -$149 million in fiscal 2020 to -$229 million in fiscal 2021. Despite growing its top line, GitLab is destroying shareholder value.
Small Share of a Large Market
GitLab operates in the highly competitive infrastructure software market, which the firm notes in its S-1 is estimated to be worth $328 billion in 2021 and grow to $458 billion in 2024, or 12% compounded annually. Such a large TAM may entice investors looking for another tech growth story.
However, Gitlab recognizes that it cannot provide products to the entire TAM and, instead, aims to serve $43 billion of the industry in 2021 and $55 billion in 2024. At its current run rate revenue[2] of $233 million, Gitlab has just 0.5% share of its “serviceable” market in 2021.
If we narrow in on the Global DevOps segment of the infrastructure software market, the expected CAGR is higher, but the addressable market is much smaller. Global Industry Analysts projects the Global DevOps market will grow by 20% compounded annually through 2026 to reach $18 billion. Regardless of the addressable market, Gitlab’s IPO valuation implies it will take significant share and grow much faster than either of these market projections, as we’ll show below.
Click here to read the full article – GitLab: Another Overpriced Tech Company
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This article originally published on October 8, 2021.
Disclosure: David Trainer, Kyle Guske II, Alex Sword, and Matt Shuler receive no compensation to write about any specific stock, style, or theme.
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[1] Only Core Earnings enable investors to overcome the flaws in legacy fundamental research, as proven by The Journal of Financial Economics.
[2] Gitlab calculates run rate revenue as revenue for the three months ended July 31, 2021 multiplied by 4.
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Disclosure: New Constructs
David Trainer, Kyle Guske II, Sam McBride, Matt Shuler, Alex Sword, and Andrew Gallagher receive no compensation to write about any specific stock, style, or theme.
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