ChargePoint Stock: Don’t Value It As A High-Growth SaaS Play

Summary

• ChargePoint wants to be recognized as a SaaS company.
• However, when we considered its SaaS metrics against its best-in-class SaaS peers, multiple red flags stood out clearly.
• We discuss why investors should be cautious when valuing CHPT as a high-growth SaaS stock.
• I do much more than just articles at Ultimate Growth Investing: Members get access to model portfolios, regular updates, a chat room, and more.

Investment Thesis

ChargePoint Holdings Inc. (CHPT) is one of the leading players in the US EV-charging infrastructure network. Its business model revolves around its expertise in developing its networked charging system hardware, accompanied by its cloud-based software subscription solutions. Readers should note that the company considers itself mainly as a software company. It doesn’t operate EV-charging infrastructure. The lower-margin hardware aspect is its central funnel to attract customers onto its platform for higher-margin monetization through its charging management software services. CHPT CEO Pasquale Romano emphasized (edited): “We do not sell hardware without subscriptions to our cloud-management software. We are a SaaS company through and through.”

However, we do not think the company deserves to be assigned valuations typical of high-growth SaaS stocks. Moreover, we don’t believe the economics make sense for CHPT stock to be afforded such valuations.

We discuss why we think investors should be cautious when comparing valuations of high-growth SaaS stocks with CHPT stock.

CHPT Stock YTD Performance

CHPT stock has had a disappointing year. It has also delivered the worst performance among its peers listed above while also significantly underperforming the market. The market doesn’t seem to buy the SaaS narrative from ChargePoint, as it posted a YTD return of a whopping -50.4%.

ChargePoint Focuses on L2 AC Products to Drive Up its Subscription Share of Revenue

ChargePoint delivered a mixed FQ3 where it beat the consensus’ topline but missed both adjusted and GAAP EPS. It grew its revenue to $65.03M, up 15.9% QoQ and up 78.8% YoY. Subscription accounted for 20.6% of FQ3’s revenue, was up 24.3% YoY, and was up 11% QoQ. However, Subscription’s share of revenue has been trending down since the start of FY22. Management updated that the change in the mix had led to the reduction. CFO Rex Jackson emphasized (edited):

As I mentioned last quarter, the change in growth rates between network charging systems and subscription revenue is a function of 2 main factors: mix and time lag. In Q3, the mix again favored DC network charging systems and home, which have a lower ratio of subscription to network hardware revenue. Second, for most of our solutions, we began revenue for subscriptions at a fixed time after the associated hardware shipment to accommodate installations, yielding a time lag of at least a quarter. Our deferred revenue from subscriptions representing recurring revenue from existing customer commitments and payments grew nicely, finishing the quarter at over $120 million. (CHPT’s FQ3’22 earnings call)

The company derives its revenue mainly from L2 AC chargers, while it’s also a key player in the L3 DC fast-charging network. ChargePoint also believes that its L2 solutions yield a higher recurring subscription share of revenue. Given the company’s estimates of achieving a 49% recurring revenue share in the long run, its L2 performance could be pivotal to reaching its goal. Moreover, ChargePoint believes that L2 will continue to play a significant role for its customers when deciding whether to install L2 or L3 chargers. CEO Romano articulated (edited):

The average shopper doesn’t want to use L3 fast charger if they’re in their local area. I’m not talking down one or the other. It’s about matching the end-consumer needs correctly. If you don’t match it correctly, you will have a very expensive utilization mistake of the total construction cost and equipment cost versus the number of parking spaces and customers you can serve. A fast charger is such an expensive proposition for the average shopper use case and consumes so much electrical capacity that it would have been a massive mistake. (CHPT’s FQ3’22 earnings call)

Therefore, the company still relies on its L2 AC chargers as its vital product differentiators in penetrating the EV-charging market. It also aligns well with the company’s focus on raising its Subscription share of revenue over time.

But, ChargePoint’s Underlying Profitability is Nowhere Close to its High-Growth SaaS Peers

ChargePoint reported an adjusted gross margin of 27% in FQ3, while GAAP gross margin was 24.7%. Notably, its gross margins in FQ3 have shown considerable improvement over the previous quarters. Over the last nine months, its hardware gross margin was 15.1%, while its Subscription gross margin was 41.9%. Since Subscription is still a much smaller segment, its consolidated gross margins are skewed towards its hardware segment.

But, it’s essential that we consider the consolidated margins instead of taking them apart. ChargePoint relies on the hardware funnel to bring in the customers to monetize on the Subscription end.

Investors who invest in SaaS companies should be keenly aware that ChargePoint’s gross margins are nowhere near the best-in-class. It’s not even near the bottom 25% of high-growth SaaS companies that we track. The bottom 25% reported median gross margins of 68%, while the top 10% reported gross margins of 81%. Therefore, ChargePoint’s “exceptionally low” gross margins profile immediately stood out as a red flag when attempting to evaluate its SaaS economics.

Notably, the company reported robust growth in its Subscription deferred revenue, which reached $120M in FQ3. It shows that the company is gaining momentum in its critical long-term profitability driver. We can also observe from the above chart where it registered a $13.78M increase in the change in deferred revenue. Its trend has also been pointing upwards, demonstrating robust momentum.

But, because of its high operating expenses, its levered free cash flows (FCF) continue to be embedded deep in the red. Moreover, it has gotten worse in FQ3 as the company missed the consensus EPS estimates. The company also reported a worse FCF margin of -128.8% in FQ3.

Therefore, when we look at its rule of 40 (LTM FCF), ChargePoint’s underlying metrics are nowhere near its best-in-class SaaS peers. On a last-twelve-months (LTM) basis, ChargePoint registered a rule of 40 of -32.4%. The “magic number” for the top 10% of its high-growth SaaS peers is 95%. Even the bottom 25% of its cohort is 40%. Despite its robust topline growth, we don’t consider ChargePoint’s underlying metrics anywhere near even the bottom 25% of the high-growth SaaS peers. Then, why should investors value it like one of these high-growth SaaS companies?

ChargePoint’s Valuation as a “SaaS Play” Doesn’t Make Sense

CHPT stock is currently trading at an EV/NTM revenue of 17.8x. It had dropped significantly from our previous article when it was trading at 27.3x NTM revenue. We issued a Neutral rating on its stock previously as we thought the fervor from the passing of the infrastructure bill was overdone. The stock has since dropped 26.4% since our article was published.

However, the broad market retracement has also brought down the valuations of its peers, as seen above. The median NTM revenue multiple of its high-growth SaaS peers has dropped to 16.6x. Therefore, despite the recent retracement, CHPT stock is still trading at a premium.

Based on our discussion above, we don’t see why ChargePoint deserves its premium valuation as a SaaS company. Its economics don’t even come close to the bottom 25% of its peers, but it’s valued at a premium against the SaaS median.

As its price action seems to be treading along a critical support level now, we don’t think it makes sense to adopt a bearish thesis against such a volatile stock. However, we reiterate our Neutral rating on CHPT stock.

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This article was originally published on seekingalpha.