hababapa
Investment thesis
J Frog (NASDAQ: FROG) is the leader in the “liquid” model for updating software, which makes its sticky offering the backbone of many (if not most) of the world’s largest companies. Additionally, JFrog has expanded into security and IoT.
Overall, it’s a rock-solid growth company at a reasonable valuation that operates close to breakeven (but cash flow positive) as it prioritizes growth over earnings. short term benefits.
Background
JFrog is a DevSecOps and SaaS software company that intends to make software “liquid”, which is a more modern approach to updating software. Through acquisitions, the company has also improved its security offering.
With a run rate of around $250 million, JFrog still has plenty of room for growth, as evidenced by its net retention rate of over 130%. JFrog is also used by 85% of the Fortune 500. Its more nascent cloud offering has also grown much faster than the overall business, which is why I initially wrote that the company reminded me of MongoDB (MDB).
Q2 results
Over the past four quarters or so, JFrog has been able to grow nearly 40%, and the second quarter was no different, with revenue of $68 million up 39% year-over-year. Investors may recall that growth plummeted to 30-year lows during COVID-19, so the company successfully executed its plan to re-accelerate growth. The official long-term guidance is 30% over time. In addition, second quarter revenue also increased 8% QoQ.
In the second quarter, JFrog’s revenue exceeded the midpoint of our guidance by more than 3% for the second consecutive quarter. And we’re thrilled to report that our strategic sales team has once again broken all-time highs with multi-year hybrid full-platform agreements signed with some of the world’s largest companies. (…) Our customers tell us that JFrog is an essential piece in the way they [pull] public hub software builds it, manages it, secures it, and distributes it to production. JFrog Artifactory serves their software organization as a single system of record and we continue to see JFrog as a back-end infrastructure and remains a cornerstone of scaling our customer software delivery processes.
Net retention was 132%. Additionally, 94% of revenue came from multi-product subscriptions. As mentioned, cloud was a growth driver and grew 68% in the second quarter to 28% of revenue, up from 24% a year ago. Notably, the growth was also an acceleration from the 63% growth in the first quarter. Customers with over 100,000 in ARR (Annual Recurring Revenue) increased by 56%. JFrog now also has 17 customers with an ARR of $1 million, up from 12 last year.
JFrog
Tips
Third-quarter guidance calls for sequential growth of 5%, which would slow revenue growth to 32%. However, JFrog expects a stronger fourth quarter with revenue of $77 million, ending the year with revenue growth of 35%.
Regarding the current macroeconomic environment, which JFrog has taken into account in its forecast, JFrog said it is experiencing lengthened sales cycles and growth in Asia Pacific below expectations. JFrog maintained its long-term target of 30% growth, unlike for example Palantir (PLTR), a company valued at more than 10x P/S.
Evaluation
JFrog is currently valued at 8x P/S its 2022 exit rate. For a company growing 30-40%, while not cheap, this seems a compelling valuation, as the company has been guided to continue to grow at 30% for the foreseeable future. This means that in 2-3 years, the valuation could be reduced to just 4x P/S, which would only be justified if the growth rate slowed significantly.
However, there is no evidence that there would be a major downturn on the horizon given the high cloud growth rate and historical net retention rate of around 130%, proving that JFrog has a successful land and expansion experience.
Although JFrog has no material profit, it is because the company has chosen to invest in growth. Nevertheless, JFrog has generated more than 5 years of positive free cash flow. The long-term model forecasts an FCF margin of 30% and an operating margin of 23%.
Product innovation
JFrog also detailed how it is adding IoT as a third pillar to its product suite, alongside its DevOps liquid software offering and security software. JFrog also announced integrations with ServiceNow (NOW) and Microsoft (MSFT).
Last May, at our ramp-up user conference, we announced and demonstrated JFrog Connect, a product combining the capabilities of the JFrog DevOps platform with technology from Upswift, a company we acquired in the third quarter of last year. We are already seeing early demand for the product in the business and how it will drive wide platform expansion. No other company provides a complete end-to-end DevOps and security flow to connected devices. Today, over-the-air update solutions are designed by companies forced to create their own technology that does not connect to the CI/CD stream, making them insecure and [ slow ]. The market for on-device software updates takes DevOps beyond not just data centers and the cloud, but to the edge. We believe JFrog Connect is the next logical step in realizing Liquid Software’s vision and it is now offered in the [GH] version.
Key takeaway for investors
The graph above clearly shows that JFrog is a reliable and high-growth software and SaaS company, as revenues have doubled in just over two years. The company continues to innovate to maintain its leadership position in its “liquid software” category, and cloud growth in particular suggests that JFrog’s near-to-mid-term future is likely to be very similar to the past.
The stock, meanwhile, has been on a multi-year decline since its extremely high IPO. Therefore, combined with the revenue growth, the valuation has become much more reasonable in the high single digit P/S. In the current environment, investors are also wary of profits. In this regard, JFrog has been diligently managed to operate close to breakeven to invest in future growth.
Overall, JFrog’s software has proven to be very sticky, even “critical”, which is demonstrated by its successful landing and expansion history. Although the stock is up from its recent all-time low, the current price still offers a compelling entry point.