Why HubSpot Inc. Could Be a Gold Mine for Growth Investors

9/12/17

By Tim Beyers, MotleyFool

When is the last time you saw a blog post that captured your interest and then went searching for more about the company behind the blog? If your answer was "recently," then you aren't alone. Global organizations spent over $28 billion on content marketing in 2016 alone in an effort to draw prospects in, PQ Media reports. HubSpot (NYSE:HUBS) calls this part of the "inbound marketing" trend it helped to pioneer, and it's still profiting from it today.

A growth gold mine

Content marketing isn't all there is to the inbound process, but that's usually how it begins. Write a blog article or social media post and include lots of useful information to solve a problem for a customer, and the customers will find their way to you, the thinking goes. It's Field of Dreamsmeets modern marketing: Build the content that's most helpful to customers with a need, and they'll come and do business with you.

Man holding tablet showing the elements of inbound marketing

HUBSPOT HELPED INVENT THE FAST-GROWING INBOUND MARKETING SECTOR.

Or maybe just think of it as the opposite of spam. Either way, inbound marketing and marketing automation tools -- including email marketing that serves customers who "opt in" for more information -- is a vast and growing opportunity, led by spending on content. It's also a must for capturing sales. In its own blog, HubSpot cites 2016 data from the Demand Gen Report that says 47% of buyers view three to five pieces of content before engaging a sales rep.

No content, no sale, in other words. Inbound marketing is the new way to get leads that pay.

Profit plan: HubSpot's "growth stack"

But how do you go about getting those sales? HubSpot offers three distinct products called a "growth stack" for inbound marketing and lead generation. First, there's a free customer relationship management system that's free to anyone but is optimized for small to medium-sized businesses. HubSpot doesn't explicitly say so in marketing the online software -- everything HubSpot offers is browser-based, in the cloud -- but it appears designed to entice would-be customers of its premium products, which include a sales tracker and its signature marketing suite, which including everything from blogging software, to social-media marketing tools, to search engine optimization, so the right content gets in front of the right people at the right time.

As a company, HubSpot emphasizes the marketing suite because customers who have success pay more in terms of subscription fees. Here's how the company describes its revenue potential in SEC filings:

Customers pay additional fees if the number of contacts stored and tracked in the customer's database exceeds specified thresholds. We generate additional revenue based on the purchase of additional subscriptions, purchases of our add-on products, and the number of account users, subdomains, and website visits. Substantially all of our customers' subscriptions are one year or less in duration.

Why it works, and what to watch

Investors should love this approach, because it's working well. Total marketing subscriptions are up between 23% and 34% over the past four years, while subscription revenue per customer is up between 15% and 18% per year over the same period. Gross margin has improved nearly 10 percentage points from 2012 through the end of 2016. In Q2, HubSpot grew its marketing customer base over 29%, while marketing revenue per customer improved 6.6% over the same period. Gross margin improved to just over 79%.

A significant slowdown in those figures would be troubling, certainly, but there's no sign that will happen. If anything, HubSpot is positioning for continued growth, incremental margin gains, and a long tail of excess cash flow that's only now starting to show. Expect the stock to outperform along the way.

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