History and introduction
To understand why JFrog Ltd. (FROG, Financial) could be a great investment opportunity, it is necessary to know what the company does. Software is now virtually ubiquitous, occupying everything from our phones, laptops, TVs and cars to the websites we use. This software is constantly being updated in the background while we go on with our lives – with new features, security patches and user experience updates.
This wasn’t always the case; software used to be delivered in versions, which were released months apart. Whenever a new version was released, users had to manually update the software. Long development and release cycles meant that software was often buggy and vulnerable with no quick-fix releases. In addition, developers couldn’t iterate quickly enough from user feedback, resulting in subpar experiences. For organizations themselves, dealing with multiple architectures and technologies, coordinating between developers, quality assurance and operations and dealing with deployments across cloud, on-premise and more resulted in a chaotic mess to oversee.
All that has now changed, of course, and JFrog made it possible. The company’s focus is “liquid software,” providing the tools and visibility to enable the flow of software seamlessly and securely from a developer’s keystrokes all the way to production. The company provides a unified, end-to-end platform for continuous software release management that is both hybrid and multi-cloud, reducing time to market and allowing for incremental updates and no disruption to the user experience. Fluid software patch cycles are critical to the modern world – for example, if Boeing (BA, Financial) had implemented them earlier, it could have avoided two crashes, $20 billion in fines and the 20-month grounding of its 737 Max aircraft.
JFrog’s main product is Artifactory, a universal software artifact repository manager centralizing the way binaries are controlled, stored and managed throughout the software release cycle. The “universal” refers to the products interoperability, since it integrates fully with widely used build tools, programming languages and technologies.
The company was founded in 2008 by three co-founders who had a vision on where software development was headed before anyone else, ushering in the era of modern DevOps and giving the company the first-mover advantage in an $18 billion market. All three co-founders, CEO Shlomi Ben Haim, Chief Technology Officer Yoav Landman and Chief Data Scientist Fred Simon, are still with the company today.
How JFrog stands out
How did JFrog get to this point? The company innovated and focused on a core, powerful product and made it relatively inexpensive for small companies. A developer-led freemium software-as-a-service model allows developers to download a trial version of the software, try it out, bring it into their system and see if it works from there. From then on, JFrog offers a tiered subscription model that allows enterprises to move upstream to bigger packages and more features and products depending on their needs.
Once customers are onboarded, they would be hard-pressed to leave. JFrog works across deployments – on-premise, cloud or hybrid, and across different cloud providers, programming languages and with different pieces of software across the DevOps lifecycle. By allowing developers to use virtually whatever software they want, JFrog emphatically makes the buy case during the decision-making process and creates high switching costs once customers have started working with them.
The platform is criticality recognized via the high levels of penetration among the largest, most important companies in the world. JFrog counts 10 of the world's biggest tech companies as customers. Among the Fortune 100, JFrog now counts 75% of them as customers. In the Fortune 500 category, its penetration stands at 70%. Companies increased their JFrog deployments over the course of the pandemic, highlighting a need-to-have product in a time of increased budgetary constraints. For these companies, JFrog is a must-have for continuous code deployment, pipeline and code examination use-cases. The company now has over 6,000 customers, with very low customer concentration risk.
What makes this more impressive is that until 2020, JFrog’s product was bought organically by customers, and not sold. The company didn’t have an outside sales motion until recently, and the new sales organization will be instrumental to their next phase of growth among the Global 2000. At the time of its initial public offering, JFrog had $171 million in cash on its balance sheet, after raising only $162 million, highlighting the capital efficient and cash flow-heavy nature of its business. The company boasts gross margins of 84.5% and benefits from SaaS economics.
The company went public in September 2020, during the height of the pandemic. As of the third quarter of 2021, JFrog grew revenue to $53.7 million, an increase of 38% over $38.9 million in the prior-year quarter and topping the 34% growth seen in the second. The full-year 2021 outlook is projected to be between $205 million and $206 million.
The company continues to be a customer darling – net dollar retention rate for the past four quarters is at 129%, indicating that its customers continue to find more value in the platform to pay for additional services. Customers using the complete JFrog Platform (Enterprise + Subscription) represented 34% of revenue in the third quarter versus 19% in the previous year. Customers with ARR greater than $100,000 grew to 466, a 49% increase year over year, and customers with ARR greater than $1 million grew to 14, a 56% increase year over year. What makes this all the more impressive is the organic nature of the growth, with only a minimum push on the sales accelerator as the company begins to build out its outside sales motion.
Beneath the headline numbers, JFrog’s cloud-based business, which is more scalable, accounted for $13.1 million in revenue for the third quarter, representing 24% of total revenue and up from 22% last year. This expansion ensures JFrog continues to keep pace with the overall secular shift toward public cloud services.
The business has also made attempts to increase the overall size of its pie with the acquisition of Upshift, a development to device platform, and receiving a U.S. Department of Defense certification for JFrog products to be used in the government sector.
The bull case for JFrog
Bears argue that DevOps is now crowded and commoditization is inevitable. Both Sonatype and GitLab (GTLB, Financial) can be considered competitors, while Amazon (AMZN, Financial) Web Services, RedHat, IBM (IBM, Financial), Microsoft (MSFT, Financial), Alphabet's Google (GOOG, Financial)(GOOGL, Financial) and others have launched their own competing solutions. However, JFrog’s depth of functionality and scalability, universal package support, ability to work with multiple cloud deployments and end-to-end nature make it the standout platform in this category.
Despite high penetration, A-list customers and strong differentiators, JFrog remains relatively unknown among investors. At the time of the IPO, JFrog didn’t even have a Wikipedia page. The company provided a price range of $33 to $37 per share at the time of its debut, but ultimately priced the stock at $44 per share. The stock opened at a jaw-dropping $71 per share, reaching a peak of $77 before settling at $64. As of today, the stock is trading slightly below $26 per share with a market capitalization of $2.47 billion and $0.4 billion in net cash. The stock is trading at 13.5 times enterprise value/revenue. In comparison, Microsoft acquired GitHub for $7.5 billion in 2017, when Github had an equivalent $200 million in ARR and was growing at slightly below 50%. If a strategic sponsor were to acquire JFrog today, $7.5 billion would be considered a baseline takeout price.
GitLab, a relevant public comparable, trades at 49 times price-sales; in comparison, JFrog is trading at only 15 times. In other words, JFrog is trading at a significant discount to its competitors. If the company were to capture just 1/18th of the $18 billion DevOps opportunity and get to $1 billion in revenue in five to seven years, and assuming management’s long-term operating target of 30% free cash flow margin, then at $300 million in free cash flow, the stock would be trading at only 8 times FCF and, therefore, could easily double from the current price. With software continuing to rule the world, cloud proliferation only beginning and DevOps far from being a mature industry, JFrog still has immense room to grow.
While the upside is hard to predict, what investors do know is that the market is still in its early stages. The transition to DevOps has gone mainstream, but the market for tools to assist and enable the transition is still young and is very clearly going to grow substantially. Overall, JFrog has a unique differentiated product, a first-mover advantage, low customer concentration and high margins in a space that is not just red-hot already, but also growing rapidly.