GitLab Stock: Premium Software Company at a Premium Price
Why, after several years on the watchlist, I have finally decided to invest in this growth stock.
Those of you who have been following this SubStack for a while will know that I have a particular soft spot for exciting software companies. Today I’d like to look at another growth story from Silicon Valley, which surprisingly has its origins in Europe.
I'm talking about GitLab GTLB 0.00%↑ , a company that is just 10 years old. When they went pulic in 2021 such high-growth companies were listed on the Nasdaq at inflated prices, and the crash of GitLab's share price by around 80% in 2022/2023 was almost inevitable.
The company is currently trading at an enterprise value of around 8 billion USD. After being on my watch list for a long time, GitLab has now made it into my (private) portfolio for the first time. Here is an introduction to this investment case:
What does GitLab do?
GitLab is a comprehensive toolset (the marketing people would call it a "platform") to support the entire software development cycle, and has established itself as one of the major players in the world of DevOps and DevSecOps.
DevOps is an approach to software development that aims to improve collaboration and communication between the traditionally separate development (Dev) and operations (Ops) teams. The goal of DevOps is to increase the efficiency, speed and quality of software development and delivery by integrating and automating development, testing, deployment and operations processes.
DevSecOps is an extension of the DevOps approach with a focus on security. The goal of DevSecOps is to integrate security considerations and practices throughout the software development lifecycle and operational processes. Unlike traditional approaches, where security controls are often added at the end of the development process, DevSecOps ensures that security plays a central role from the beginning.
This approach aims to proactively identify and reduce security risks, rather than reacting to security issues after the software has been developed or even delivered.
The history of GitLab
GitLab was started as an open source project in 2011 by Dmitriy Zaporozhets from his home in Ukraine. The idea was born out of a need to create a better solution for version control and collaboration in software development projects. Originally started as a non-commercial project by a developer for developers, GitLab offered a web-based interface for Git repositories, similar to GitHub, but with the difference that it could be installed on users' own servers. It wasn't until 2014 that GitLab Inc. was officially founded as a company in the Netherlands by current CEO Sid Sijbrandij to meet growing commercial demands and began selling enterprise licences.
Over time, GitLab has expanded its initial version control platform to include a variety of DevOps features, including continuous deployment (CD), issue tracking, code review and many other tools that are integrated into the overall software development process. GitLab has always differentiated itself by offering a unified solution for the entire software development lifecycle - from the initial idea to the software's operation.
A key milestone in GitLab's evolution was the addition of security and compliance features, marking the company's transition from DevOps to DevSecOps. GitLab has continued to evolve, investing heavily in development and integrating new technologies and methodologies, including artificial intelligence (AI) and machine learning, to further automate and improve software development.
GitLab Market Position and Competition
In just 10 years, GitLab has made an impressive journey from a simple version control tool to a complete DevSecOps platform that enables organisations to develop software faster, more efficiently and more securely.
GitLab has now established itself as a leading platform in the DevSecOps sector. It competes primarily with the two other major players, GitHub (part of Microsoft MSFT 0.00%↑ since 2018) and Bitbucket (part of Atlassian TEAM 0.00%↑ ), and differentiates itself through its comprehensive, integrated solution based on open source principles and a huge customer base.
According to leading industry analyst Gartner, most companies will adopt such a Dev(Sec)Ops platform in the coming years to fully control and secure their software development process. The total addressable market (TAM) is estimated at 40 billion USD. Market penetration is still low.
"By 2027, 75% of organizations will have switched from multiple point solutions to DevOps platforms to streamline application delivery, up from 25% in 2023." (Gartner)
According to the company, over 30 million people are registered on the GitLab platform. Of these, approximately 1 million are paying users. The customer base consists mainly of 8,600 corporate customers, of which around 1,000 pay more than 100,000 USD per year to GitLab. Nearly 100 major customers pay a subscription fee of more than 1 million USD per year, a clear indication of how important the GitLab solution is to large companies.
What makes GitLab unique is that it is run as a "remote company", with 2,000 employees from 60 countries, mostly working together virtually. GitLab does not have any major offices. The company continues to be led by co-founder "Sid" Sijbrandij, who holds 34% of the shares as CEO and Chairman, and is valued in the industry not only as an entrepreneur but also as a thought leader.
Like many other enterprise software providers, GitLab follows a land+expand business model. Typically, developers bring GitLab's open source base into the company and expand from there to other teams and departments.
This land+expand strategy is working very well. The net retention rate was recently an impressive 130%. This means that the revenue stream from the existing customer base is growing strongly, which adds on nicely to the new customer business.
The GitLab business figures for the past FY2024
In FY2024, which ended at the end of January, GitLab's revenue grew 37% year-on-year to 580 million USD. This was a significant slowdown from the previous year's explosive 68% growth. In Q4 FY24, revenue growth was 'only' 33%.
However, yet contracted but unrealized revenue RPO (Remote Performance Obligations) grew much faster at 55% to 674 million USD, suggesting that large customers are willing to commit to GitLab for the long term. Finally, 430 million USD of these RPOs will be realised as revenue over the next 4 quarters, representing 74% of FY24 revenue.
On top of that, of course, there is all the new customer business and the significant upsells to the existing customer base. To me, these numbers look like they should stop the growth deceleration in the coming quarters around 30% growth p.a.
What makes GitLab's numbers so attractive to me is the outstandingly high gross margin of 90% (GAAP). Enterprise software companies with such a profile tend to become real cash machines once they reach a certain size and the cost ratios for sales+marketing, research+development and administration fall accordingly.
GitLab reached cash flow breakeven in FY24, one year ahead of the original plan. In Q4, the free cash flow margin was already 15%.
GitLab's balance sheet is strong and beyond reproach. It has over 1 billion USD in cash and no significant long-term debt. Intangible assets are also negligible, as no expensive acquisitions have been made since the IPO.
High SBC and dilution tarnish GitLab's picture
One weak point in GitLab's figures is the high (non-cash) cost of share-based compensation, even compared to the rest of the industry. These SBC amounted to 28% of revenue in the past financial year, which means that the GAAP results are still clearly negative.
Much more important to me than the SBC is the dilution of existing shareholders through the additional shares. The number of shares outstanding has increased by more than 4% over the last 12 months. This is higher than other software companies such as Snowflake, Datadog or CrowdStrike, which are often criticised for their high SBCs.
I expect this dilution to decrease significantly in the coming years. This should be the case by 2025 at the latest, when the stock option plans issued on the occasion of the IPO in 2021 expire (usually after 4 years). A dilution of 4% p.a. in the long term would be clearly too much for my taste.
GitLab's guidance for FY2025
The initial guidance issued by GitLab's management at the beginning of March 2024, which foresees revenue growth of "only" a good 25% to around $728m for the current FY25, does not quite match my positive assessment of further growth.
The outlook for a marginal improvement in FY25 operating profit to a maximum of 10 million USD (non-GAAP) also seems implausible to me, given the high operating leverage in GitLab's business model.
And the share count is expected to grow by more than 6% over the year to 168 million. So there is no end in sight to the dilution in 2024.
Investors were very disappointed with this initial outlook for the new financial year. As a result, GitLab's share price fell by more than 25% in March 2024.
What do I make of it? I think this initial guidance from GitLab management is very conservative, to say the least. I am convinced that we will see a number of "beat + raise" quarters throughout the year. I simply cannot believe that revenue growth will fall significantly below 30%. And profitability should also progress much faster than currently forecast. In my opinion, there is a lot of "sandbagging" in this guidance.
For FY24, GitLab's management had also initially forecast revenue growth of 25% in Q1 and ended up with 37%. The original guidance was for an operating loss of around 60 million USD; at the end of the financial year, the result was close to break-even.
Will history repeat itself? Let's wait and see...
The valuation of GitLab shares
As a result of the disappointing guidance and the subsequent fall in the share price, GitLab shares are currently trading at a more or less fair purchase price for the first time in a long while.
Based on expected sales for the current financial year, the EV/sales ratio is around 11. Based on the still meager cash flow, the company may not be meaningfully valued regarding the cashflow multiple for another year or two.
A share price of around 55 USD is still a premium price for GitLab. But premium growth companies are rarely cheap. I think the analysts' sales and earnings estimates are far too low and I expect positive surprises.
That is why I have taken a small entry position (for my private portfolio) in the last few days. I expect GitLab to grow into and then significantly exceed its still sporty valuation in the medium and long term.
If you would like to follow GitLab together with me in the future, you can
*Disclaimer:
The author and/or associated persons or companies own shares in GitLab. This article is an expression of opinion and does not constitute any investment or financial advice.
Great write-up on GitHub! Indeed, the SBC is somewhat concerning. But, it will be important to watch how they control it after the IPO option plan is fully away in 2025.