Rapid7 (NASDAQ:RPD) is enjoying a comeback. After a lackluster IPO and a couple of down years, Rapid7 seems to have turned the corner. RPD stock has doubled in recent months. The latest quarterly results were strong enough to give life to the stock’s bulls.
For an early-stage growth company, the goal is to reach sufficient scale. At some point, a company will start seeing a large chunk of its incremental revenues trickle down to the bottom line. When this happens, a company that was losing money or at breakeven can suddenly become quite profitable.
When buying tech stocks, you often get the quickest gains when a long-struggling company finally reaches positive earnings-per-share territory. Take Twitter (NYSE:TWTR) for a fairly recent example.
In the case of Rapid7, however, the inflection point into profitability is still way off on the horizon. The company has a strong history of revenue growth, but it simply isn’t translating into better margins. What’s at fault here? Simply put, the company is spending heavily on its sales and marketing.
RPD Stock and Decelerating Growth
In 2015, Rapid7 grew its revenues by 44% for the year. In 2016, this dipped slightly to 42%. However, since then, performance has diminished. Last year, the company increased revenues at just 28%. Q2 results came in at just 23% year-over-year, showing more slowdown. And bookings rose just 9%, raising the specter of even slower quarters ahead.
To be fair, the company’s guidance wasn’t too bad, and Keybanc, for one, thought it was good enough to raise their price target on RPD stock.
Tricky Waters for Smaller Security Stocks
Security stocks in general have had more trouble than other software plays. There is the growing realization lately that security software stocks should trade at lower Enterprise Value to revenues ratios than other SaaS stocks. For example, consider direct RPD competitor FireEye (NASDAQ:FEYE), via their Mandiant subsidiary.
FireEye stock soared to as high as $80-per-share back in 2014, when it was the latest and greatest new cybersecurity IPO. However, its revenue growth rapidly decelerated in 2016, long before it reached profitability. It has since had to rein in its marketing budget, causing its sales growth to slide even further. Despite cost-cutting, FireEye remains far from profitability, and FEYE stock has imploded to just $15 now.
There are simply so many security companies going after the same clients and markets. Rapid7’s SEC filings list much larger niche peers, including Splunk (NASDAQ:SPLK) and Qualys (NASDAQ:QLYS) that have far more access to capital and scale.
And that’s to say nothing of the likes of IBM (NYSE:IBM) and other giants that also participate. The market is inundated with security stocks.
There is so much capital in the space that it is hard for a smaller player like RPD stock to keep up. Almost every month it seems we get a new security IPO. Carbon Black (NASDAQ:CBLK) IPOed earlier this summer. And another Rapid7 direct competitor, Tenable (NASDAQ:TENB) completed its IPO in late July.
A company like Rapid7 has to keep its sales booming. Otherwise, it risks the sort of fate the FireEye has suffered. Once a software company loses investor confidence, it tends to try to cut costs. But in paying less for sales and R&D, it tends to fall farther behind the pack. That’s why it is so important that RPD start to inch closer to profitability before it has to limit its growth spending.
Rapid7 Stock: Major Holders Selling
Rapid7 was a disappointing IPO. RPD stock began trading around the $25 mark in 2015. However, it quickly fell to below $15 and traded there for much of the next two years. Finally, in 2018, RPD stock has taken off as the company has put in a couple of relatively good quarterly reports, or at least in comparison to the market’s subdued expectations.
Unfortunately, major institutional holders are taking advantage of the rally to unload their positions. In January, Rapid7 used a secondary offering to sell 4.5 million shares held by major investors, along with the company selling 1.5 million new shares to the public. In March, insiders unloaded another 2 million shares. On May 14, following another rally in RPD stock, insiders used another secondary jump to get rid of 3 million more shares.
This month, Rapid7, apparently wanting to raise more money for itself rather than preexisting shareholders, announced a convertible bond offering. This will keep the company, which already had $115 million in cash, suitably bankrolled for quite a few more quarters, even if operating losses continue. On the other hand, it serves as potentially more dilution to a stock that insiders have already been eager to sell throughout 2018.
At the time of this writing, Ian Bezek owned IBM stock.