Atlassian(NASDAQ: TEAM) is a leading software company that helps others manage building their own software. Its management believes that customers are unlikely to stop using their platform even in a recession, and so far their bottom line is going up. until this claim. Atlassian beat early estimates for revenue growth in the quarter, and its platform continued to invest heavily in R&D to stay on the cutting edge. The stock price is up 17% in 24 hours and up 29.6% in the last 5 days. In this article, I’ll break down the company’s business model, its recent earnings report, and calculate the valuation, let’s dive in.
Founded in Australia in 2002, Atlassian created a software platform that pioneered the “Agile” development methodology. This allows teams to quickly define requirements, design, test, and then iterate to improve product functionality. Atlassian’s flagship Jira platform and Jira Cards is a product management platform, which is used to manage this process. According to the State of Agile 2021 report, Jira is the number one tool recommended by agile teams.
Atlassian has an effective, “low-friction” go-to-market strategy that believes “software should be bought, not sold.” Thus, the company’s product marketing strategy uses “product-centric” tactics to allow customers to try and start using the product today, without the need to chat with sales reps. Atlassian can then expand its accounts and receive upsells as customers use more features and become more integrated with the product.
The company’s strategy has worked well so far and it has grown its customer base to 242,623 customers, up a rapid 18.6% year-over-year.
Atlassian has expanded its offering to provide software tools in three main markets; Agile/DevOps, IT service Management and Work Management, its mission is to “Unleash the potential of each Team”. To do this, the company has expanded its own team by increasing its workforce to 8,813 employees, or 2,300 more over the year. Additionally, Atlassian has implemented a “growth by acquisition” strategy very similar to Salesforce. In 2017, the company acquired workplace collaboration tool Trello. While more recently Atlassian acquired Chartio Now Atlassian Analytics. This allows customers to gather all their “siloed” big data in one place (Data Lake) and then query that data using “Visual SQL” which requires no code and is therefore much more user friendly than many other Data Lake Providers.
Atlassian reported strong financial results for the quarter ending June 30, 2022. Revenue soared to $759.8 million, up 36% year-over-year and beating analyst estimates of 35 .6 million. Gross profit also showed strong growth, reaching $627 million, up about 35% year-over-year.
This revenue growth was primarily driven by the Cloud ($434 million) and Data Center ($158 million) segments, which grew 55% and 60% respectively. Data center revenue growth was driven by “event demand” as many customers bought ahead of the price increases that occurred in Q3’22. Additionally, Atlassian plans to reduce “loyalty discounts” early in the first quarter of 2023, which has also prompted customers to upgrade packages sooner. Server revenue has declined over the past few years as the company stopped selling new server licenses in Q3 2021, but will continue to offer maintenance and support to server customers through February 2024. , over time, the majority of its server customers are expected to migrate to its Cloud or Data Center offerings.
As a software company, Atlassian has a very high gross margin of 82.5% and thus generated $626.7 million in gross profit during Q422. However, the company records a loss of -$63.3 million on an IFRS basis. This may scare off some traditional value investors, but I think it makes sense to dig deeper. As you can see from the financial statements below, Atlassian invested 36.4% of its revenue ($379 million) in research and development. According to management, this is more than many of its competitors and a key strategy in its product marketing approach. By creating a great product and allowing teams to start using it for free, they will use it, find value, and tell their friends about it. As a former product manager, I actually discovered Jira through this same method because a software engineer informed me that it would be great to use. Management could easily reduce this expense and thus be more “profitable” on a traditional basis, but that wouldn’t be as tax-efficient a strategy either.
The good news is that Atlassian generated a strong free cash flow of $194.7 million in Q4 2022. This equates to a strong 26% free cash flow margin. The company has a strong balance sheet with $1.5 billion in cash. In addition to $1.3 billion in total debt which is manageable given that the majority is long term debt and the company is free cash flow positive, with a low investment business model.
Looking ahead, Atlassian forecasts rapid cloud revenue growth of 50% per year over the next 2 years, driven by cloud migrations and digital business transformation. Data center revenue is expected to maintain a “high rate of growth” in the first quarter of 2023, before “moderate” in the last three quarters of FY23.
Concerning the future macroeconomic environment, the management indicated it in its letter to the shareholders.
We are not immune to broader macroeconomic impacts. We are seeing a slight decrease in conversion rates from upgraded free instances to paid plans, but nothing we are currently seeing changes our outlook.
The good news for Atlassian is that over 90% of its revenue comes from existing customers, and they expect that trend to continue. A customer managing a software product is unlikely to discontinue the entire product or switch vendors for short-term headwinds. However, as the company mentioned, new upgrades to paid plans may be delayed.
In order to value Atlassian, I incorporated the latest financial data into my advanced valuation model, which uses the discounted cash flow valuation method. I forecast optimistic revenue growth of 45% for next year, thanks to strong cloud growth forecasts. Additionally, I have projected 40% revenue growth for the next 2-5 years.
I have optimistically forecast that the company’s operating margin will grow to 28% over the next 5 years as its R&D and marketing spend begins to generate a return. Keep in mind that this includes an adjustment for R&D expenses, which I capitalized to increase the accuracy of the valuation.
Considering these factors I get a fair value of $234 per share, the stock trades at $268 per share and is therefore overvalued by around 14% at the time of writing.
As an additional data point, Atlassian is trading at a price-to-sales ratio = 24.27, which is about 5% cheaper than its 5-year average.
High valuation and recession
Atlassian is trading at a high intrinsic valuation and the stock price has jumped around 46% in the past two weeks alone. As a contrarian investor, I prefer to buy when others are selling and sell when others are buying. Atlassian is a great company, but market exuberance may be optimistic given the macroeconomic situation and the expected recession.
Atlassian is a formidable company, which exceeded analysts’ expectations and continued to deliver strong performance in the prior quarter, despite macroeconomic challenges. However, the current valuation is just a bit too spicy for me right now and considering the competition for SaaS platforms which includes; Asana, ServiceNow, Monday.com etc. I consider the stock to be a “Hold”. Also, one has to think about the opportunity cost of buying Atlassian versus other “cheaper” stocks on the market (feel free to follow along and read my other articles).