Andrey Popov
Atlassian (NASDAQ: TEAM) is a leading software company that helps others manage their own software development. Its management believes that customers are unlikely to stop using their platform even during a recession, and so far their financial results have rebounded. raise this claim. Atlassian beat top-line estimates for revenue growth in the quarter, and its platform continues to invest heavily in R&D to stay on the cutting edge. The stock price rose 17% in 24 hours and increased 29.6% in the last 5 days. In this post, I’ll break down the company’s business model, its recent earnings report and calculate the valuation, let’s dive in.
Business Model
Founded in Australia in 2002, Atlassian created a software platform that pioneered the “Agile” development methodology. It allows teams to set requirements, design, test and then quickly iterate to improve product features. Atlassian’s flagship Jira platform and Jira boards is a product management platform, used to manage this process. According to the 2021 State of Agile Report, Jira is the number one tool recommended by agile teams.
Atlassian Jira (Website Screenshot)
Atlassian has an efficient and “Low friction” go to market strategy that believes “software should be bought, not sold”. So the company’s Product Marketing Strategy, uses “Product Led” tactics to allow customers to try and start using the product today, without having to talk to Sales reps. Atlassian can expand accounts and benefit from upsells as customers use more features and become more embedded in the product.
Atlassian Go to Market (Atlasian)
The company’s strategy is working well so far, and they have expanded their customer base to 242,623 customers, which is up a rapid 18.6% year over year.
Atlassian Customers (Investor report)
Atlassian has expanded its offering to provide software tools in three key markets; Agile/DevOps, IT service Management and Work Management, its mission is “Unleash the potential of every Team”. To accomplish this, the company expanded its own team increasing the number of employees to 8,813 employees, an increase of 2,300 over the year. In addition, Atlassian practices a “Growth by Acquisition” strategy very similar to Salesforce. In 2017, the company acquired workplace collaboration tool Trello. While Atlassian recently acquired Chartio today Atlassian analytics. This allows customers to consolidate all their “Siloed” big data in one place (Data Lake) and then query this data using “Visual SQL” without requiring any code and thus easier to use, than many others. Datalake providers.
Atlassian Investments (Investor Day Presentation)
Growing Finances
Atlassian reported strong financials for the quarter ending June 30, 2022. Revenue rose to $759.8 million, up 36% year over year and beating analyst estimates of $35.6 million. Gross Profit also showed strong growth, jumping to $627 million, up ~35% year over year.
Revenue at Atlassian (Earnings Report)
This revenue growth was primarily driven by the Cloud ($434 Million) and Data Center Segments ($158 Million) which increased 55% and 60% respectively. Data Center revenue growth was driven by “event-driven demand” as more customers bought in before the price hike that took place in Q3’22. In addition, Atlassian has plans to reduce “loyalty discounts” at the beginning of Q1’23 and thus it also promotes customers to upgrade packages earlier. Server revenue has been declining for the past few years, as the company stopped selling new Server licenses in Q3’21, but will continue to offer maintenance and support to Server customers until February 2024. So, overtime , most of its Server customers are expected to move to its Cloud based or Data Center offerings.
Revenues by Deployment (Q4 earnings report)
As a software company, Atlassian has a very high gross margin of 82.5% and thus generated $626.7 million in Gross Profit in Q422. However, the company was running at a loss of -$63.3 million on an IFRS basis. This may make some traditional value investors afraid of the stock, but I think it makes sense to dive deeper. As you can see from the financial statement below, Atlassian invests 36.4% of its revenue ($379 million) in Research and Development. According to management, this is more than many of its competitors and is a key strategy of its product marketing strategy. By creating an exceptional product and allowing teams to start using it for free, they will use it, find value and tell friends. As a former product manager, I actually discovered Jira through this same method, as a software engineer told me it was great to use. Management could easily reduce this cost and thus be more “profitable” on a traditional basis, but it would also not be as tax efficient as a strategy.
Income Analysis (Q4 Earnings)
The good news is that Atlassian generated strong Free Cash Flow of $194.7 million in the fourth quarter of 2022. This equates to a Free cash flow margin of 26%, which is strong. The company has a solid balance sheet with $1.5 billion in cash. In addition to the $1.3 billion in total debt that is manageable as the majority is long-term debt and the company has positive free cash flow, with a low Capex business model.
Mixed Guidance
Going forward, Atlassian predicts rapid Cloud Revenue growth of 50% per year for the next 2 years, driven by Cloud migrations and the digital transformation of businesses. Data Center revenue is expected to maintain a “high growth rate” in Q1’23, before “moderating” in the remaining three quarters of FY23.
Regarding the macroeconomic environment moving forward, management said in their letter to shareholders.
We are not insulated from the broader macroeconomic impact. We’re seeing a moderate drop in conversion rates of Free opportunities upgrading to paid plans, but we don’t see anything right now changing our view.
The good news for Atlassian is that more than 90% of its revenue is derived from existing customers, and they expect this trend to continue. A customer managing the product of a software project is unlikely to discontinue the entire product or switch providers for short-term headwinds. However, as the company noted, new upgrades to paid plans may be delayed.
Advanced Valuation
To value Atlassian, I plug the latest financials into my advanced valuation model, which uses the discounted cash flow method of valuation. I forecast an optimistic 45% revenue growth for next year, driven by strong Cloud growth guidance. In addition, I predict 40% revenue growth for the next 2 to 5 years.
Valuation Model (created by author Ben at Motivation 2 Invest)
I expect the company’s operating margin to increase to 28% over the next 5 years as its R&D and Marketing spending begins to generate revenue. Note, this includes an adjustment for R&D expenses, which I have capitalized to increase the accuracy of the assessment.
Atlassian Stock Valuation (created by author Ben at Motivation 2 Invest)
Given these factors I get a fair value of $234 per share, the stock trades at $268 per share and is thus ~14% overvalued at the time of writing.
As an additional data point, Atlassian is trading at Price to Sales Ratio = 24.27, which is about 5% cheaper than its 5-year average.
Risks
Appreciation and Recession
Atlassian trades at a high intrinsic valuation, and the stock price has risen ~46% in just the last few weeks. As a contrarian investor, I prefer to buy when others are selling and sell when others are buying. Atlassian is a massive company, but the market’s excitement may be optimistic given the macroeconomic situation and the expected Recession.
Final Thoughts
Atlassian is a tremendous company, beating analyst expectations and continuing to perform strongly in the past quarter, despite macroeconomic challenges. However, the current valuation is a bit too spicy for me right now and given the competition for SaaS platforms which include; Asana, ServiceNow, Monday.com etc., I consider the stock a “Hold”. In addition, one should think about the opportunity cost of buying Atlassian compared to other “cheaper” stocks on the market (feel free to follow and read my other posts).