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Should You Buy JFrog Stock After Its Post-IPO Leap?

By Leo Sun – Sep 18, 2020 at 8:23AM

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This tech company has carved out a high-growth niche, but its stock is already trading at frothy valuations.

JFrog (FROG -0.70%), a California-based tech company that provides a platform for managing software updates, priced its IPO on Sept. 15. Its original per-share price range for the IPO was $33 to $37, but robust demand lifted its final price to $44.

JFrog raised about $352 million by selling 8 million shares, as its existing shareholders sold 3.6 million shares. The stock price surged to nearly $65 on the first trading day, valuing the company at over $5.7 billion. That post-IPO pop generated big gains for JFrog's initial investors, but is the stock still worth chasing at these levels?

A team of IT professionals work on a computer.

Image source: Getty Images.

What does JFrog do?

JFrog's core product, Artifactory, stores software updates on a universal platform, which enables the release of continuous software updates across "any system."

JFrog claims this approach, known as CSRM (continuous software release management), supports its long-term vision of "Liquid Software," wherein software is constantly updated across multiple computing platforms. It believes this approach will strengthen an organization's overall security, streamline upgrades, and prevent disruptions from outdated software.

In its S-1 filing, JFrog claims current industry approaches to software updates -- which are separately installed on different computing architectures like microservices, containers, and hybrid and multi-cloud environments -- create "silos and bottlenecks around critical steps, such as building, testing, securing, and delivering software."

JFrog believes the convergence of those new architectures and "legacy approaches" applies "significant strain on the traditional software build and release workflow." But if companies manage those updates with Artifactory, they can simultaneously update their software across all those architectures.

How fast is JFrog growing?

JFrog served about 5,800 organizations at the end of June, including 75% of the Fortune 500, up from 5,600 organizations at the end of 2019. Its revenue rose 65% to $104.7 million last year and increased another 50% year-over-year to $69.3 million in the first half of 2020.

The company still isn't profitable, but its net loss narrowed from $26 million in 2018 to $5.4 million in 2019. In the first six months of 2020, its net loss narrowed year-over-year again from $2.1 million to $0.4 million.

Those numbers are promising, but JFrog warns that its "operating expenses will increase substantially in the foreseeable future" as it enhances its products, expands its customer base, and boosts its sales and marketing efforts.

It isn't immune to COVID-19

JFrog's trailing 12-month net retention rate -- which gauges its ability to retain its old customers, attract new ones, and cross-sell new services -- also dipped from 142% at the end of 2019 to 139% at the end of the second quarter of 2020.

It attributed that decline to the pandemic, which shut down businesses and postponed software upgrades, and it expects that rate to continue sliding in the near term. Nonetheless, a net retention rate above 100% is already impressive, and it indicates JFrog's platform firmly locks in its customers.

Another soft spot is JFrog's annual recurring revenue (ARR). Its ARR grew 56% and 45% in the first and second quarters of 2020, respectively -- but both growth rates decelerated from a year ago. JFrog noted the COVID-19 crisis caused a "substantial decrease" in its growth in new ARR from existing and new customers throughout the second quarter.

It still faces formidable competitors

JFrog's Artifactory carved out a high-growth niche in the crowded enterprise software market, but it faces indirect competition from tech giants like IBM's (IBM -0.33%) Red Hat, Amazon's (AMZN -1.44%) AWS (Amazon Web Services), Microsoft's (MSFT 0.13%) Azure DevOps with GitHub, and Alphabet's Google Cloud Platform.

A network of cloud computing connections.

Image source: Getty Images.

All these rivals offer similar software update tools within their broader suite of cloud-based services. Amazon, Microsoft, and Google can leverage their dominance of the public cloud infrastructure market to pull new customers away from JFrog. IBM, which is expanding its hybrid cloud presence under a new CEO, could also promote Red Hat's OpenShift as a viable alternative.

JFrog's Artifactory is compatible with all those platforms, but it admits its larger cloud rivals could "leverage these resources to gain business in a manner that discourages customers from purchasing our offerings."

Its valuations are too high

Some investors might claim valuations don't matter for high-growth stocks. But with a market cap of $5.7 billion, JFrog now trades at 55 times last year's sales. Even if JFrog's revenue rises another 50% in fiscal 2020, it would still trade at 36 times this year's sales.

To put that into perspective, Zoom Video Communications (ZM -4.03%), which is expected to generate 286% sales growth this year, is already considered very pricey at 49 times that estimate.

In short, JFrog is priced for perfection at these levels, and any sign of weaknesses -- which will likely appear due to its lack of profits, its exposure to COVID-19, and potential competition from bigger tech companies -- could sink its stock. If that pullback happens, JFrog might be worth a closer look. But until that happens, investors should stick with more reliable cloud stocks instead.

John Mackey, CEO of Whole Foods Market, an Amazon subsidiary, is a member of The Motley Fool's board of directors. Suzanne Frey, an executive at Alphabet, is a member of The Motley Fool's board of directors. Teresa Kersten, an employee of LinkedIn, a Microsoft subsidiary, is a member of The Motley Fool's board of directors. Leo Sun owns shares of Amazon. The Motley Fool owns shares of and recommends Alphabet (A shares), Alphabet (C shares), Amazon, Microsoft, and Zoom Video Communications and recommends the following options: long January 2022 $1920 calls on Amazon, long January 2021 $85 calls on Microsoft, short January 2022 $1940 calls on Amazon, and short January 2021 $115 calls on Microsoft. The Motley Fool has a disclosure policy.

Stocks Mentioned

JFrog Ltd. Stock Quote
JFrog Ltd.
FROG
$22.60 (-0.70%) $0.16
International Business Machines Stock Quote
International Business Machines
IBM
$148.67 (-0.33%) $0.49
Microsoft Stock Quote
Microsoft
MSFT
$255.02 (0.13%) $0.33
Amazon.com Stock Quote
Amazon.com
AMZN
$94.13 (-1.44%) $-1.37
Zoom Video Communications Stock Quote
Zoom Video Communications
ZM
$74.31 (-4.03%) $-3.12

*Average returns of all recommendations since inception. Cost basis and return based on previous market day close.

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