hapapapapa
Investment Thesis
JFrog (NASDAQ: FROG) is the leader in the “liquid” model for updating software, making it the sticky backbone offering for many (if not most) of the world’s largest enterprises. In addition, JFrog is expanding into security and IoT.
Overall, it’s a rock-solid growth company at a reasonable valuation that’s operating near breakeven (but cash flow positive) because it prioritizes growth over near-term earnings.
Background
JFrog is a DevSecOps software and SaaS company that aims 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 nearly $250M run rate, JFrog still has ample runway for growth, further evidenced by its over 130% net retention rate. JFrog is also used by 85% of the Fortune 500. Its nascent cloud offering has also grown faster than the general business, which is why I first wrote that the company reminded me of MongoDB (MDB).
Q2 Results
Over roughly the last four quarters, JFrog has been able to grow at nearly 40%, and Q2 was no different, with revenue of $68M up 39% YoY. Investors may recall that growth dipped into the low 30s during the COVID-19 era, so the company successfully executed its plan to re-accelerate growth. The official long-term guidance is for 30% over time. In addition, Q2 revenue was also up a healthy 8% QoQ.
In Q2, JFrog’s earnings exceeded the midpoint of our guidance by more than 3% for the second quarter in a row. And we’re excited to report that our strategic sales team has, once again, broken all-time records in multi-year hybrid, full platform deals signed with some of the world’s leading enterprises. (…) Our customers tell us that JFrog is a mission-critical piece of how they are [pull] Software from public hubs builds, manages, secures and distributes it in production. JFrog Artifactory serves their software organization as the single system of record and we continue to see JFrog as an infrastructure backbone and remains the foundation of our scale of customer software delivery processes.
Net retention reached 132%. Plus, 94% of revenue comes from multi-product subscriptions. As mentioned, the cloud has been a growth driver, and grew 68% in Q2 to 28% of revenue, up from 24% last year. Notably, the growth was also an acceleration from the 63% growth in Q1. Customers with more than 100k in ARR (annual recurring revenue) grew by 56%. JFrog now has 17 customers with $1M ARR, up from 12 last year.
JFrog
Guidance
Q3 guidance calls for 5% sequential growth, which would slow revenue growth to 32%. However, JFrog expects a strong(er) Q4 with $77M in revenue, ending the year with 35% revenue growth.
Regarding the current macro environment, which JFrog factored into its guidance, JFrog said it was experiencing extended sales cycles and Asia Pacific growth was lower than expected. JFrog has maintained its long-term target for 30% growth, unlike Palantir (PLTR), a company valued at more than 10x P/S.
Appreciation
JFrog is currently valued at 8x its P/S 2022 exit run rate. For a company growing at 30-40%, while this isn’t cheap, it seems like a compelling valuation, as the company has guided to continue growing at 30% for the foreseeable future. That 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 materially slowed down.
However, there is no evidence that there will be a material slowdown on the horizon due to the high rate of cloud growth and the historic ~130% net retention rate, proving that JFrog has a successful track record of terrain and expansion.
Although JFrog does not have a material profit, this is because the company chooses to invest in growth. However, JFrog has delivered over 5 years of positive free cash flow. The long-term model requires a 30% FCF margin and a 23% operating margin.
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 its security software. JFrog also announced integrations with ServiceNow (NOW) and Microsoft (MSFT).
Last May, at our user conference ramp-up, we announced and demonstrated JFrog Connect, a product that combines the capabilities of the JFrog DevOps platform with the technology of Upswift, a company we acquired in Q3 of last year. We are already seeing early demand for the product in the enterprise and how it will drive broad 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 made by companies forced to develop their own technology that does not connect to the CI/CD flow, making them insecure and [ slow ]. The market of software updates on devices takes DevOps not only to data centers and clouds, but to the end. We believe JFrog Connect is the next logical step in fulfilling Liquid Software’s vision and it is now offered at [GH] version.
Investor Takeaway
The graph shown above nicely illustrates that JFrog is a reliable high-growth software and SaaS company, as revenue has doubled in a little over two years. The company is constantly evolving to maintain its leadership position in the “liquid software” category, and cloud growth in particular suggests that JFrog’s near-mid future is likely to look very similar to the past.
The stock, meanwhile, is on a multi-year decline from its sky-high IPO valuation. Hence, along with the revenue growth, the valuation has become more reasonable with a high single digit P/S. In the current environment, investors are also wary of profits. In this regard, JFrog is actively managed to operate close to breakeven to invest in further growth.
Overall, JFrog’s software has proven to be very sticky, even “mission critical”, as demonstrated by its successful history of land and expansion. Although the stock has rebounded from recent all-time lows, the current price still offers a compelling entry point.