October SOTM: Atlassian Corp (TEAM)
Everyone who has worked in a corporate office knows the ubiquitous (and epithetical!) Microsoft Office suite of software tools.
In fact, if its a weekday, I'd say there is a pretty good chance that you have edited or read a Word document, punched numbers or created charts from an Excel spreadsheet, or viewed or created a business presentation using Powerpoint within the last few hours!
These tools are "de rigueur" in the corporate world. Every business from the corner beauty shop to global industrial titans use them. Individuals have been using them to create important business documents for over 30 years, in literally every single industry sector that exists today.
The key word I want to stress from that last paragraph is this: "Individuals".
While Word, Excel, and Powerpoint are excellent for a single person managing a document, they are not so great for collaboration. How many times have you gotten an email with "Document_version4point0.doc" attached? Or wondered who re-worded that section you wrote? Or gotten confused trying to incorporate the feedback from a dozen people in the meeting into your spreadsheet? Or gone digging around Sharepoint to try to find that spec document from 3 years ago?
Teams are a crucial aspect of completing business projects, and while Office was (and is) a great personal productivity tool, it falls down when trying to meet the needs of teams.
And that's where today's stock comes in.
Its mission statement?
"Our goal is to do for team productivity what Microsoft Office has done for personal productivity."
The Enterprise Team Software Company
Atlassian makes enterprise software that is focused on helping product and project teams work together more efficiently. The company sells 6 products at present:
1) JIRA: A project-management tool that lets teams track tasks, issues, problem reports, enhancement requests, and so forth. In a nutshell, it tracks "tickets" of work, allowing the implementors to estimate and log time against tickets while allowing managers to easily track progress of anything from huge scope projects at a high level to individual bug reports. JIRA was Atlassian's first product and remains its largest revenue generator.
2) Confluence: Remember how we mentioned the old "Document_version4point0.doc" above? Well Confluence is a document management platform that eliminates the need for that. It allows all project based documents to be centrally placed and tracked so that the team can make and track changes - and, of course, find the documents in the first place! Confluence is Atlassian's second largest product.
3) HipChat: Anyone familiar with Slack will understand HipChat immediately as it is basically a direct competitor. HipChat is a messaging platform, not too unlike Facebook or Twitter, but organized around business topics or projects.
4) Bitbucket: Bitbucket is an enterprise source code management system based around Git. It offers a nice front end for Git, advanced code deployment models, hosted repositories (similar to GitHub), and cross-functionality with other Atlassian softwware.
5) JIRA Service Desk: An IT support and customer service system. While similar to a lot of other offerings from BMC and ServiceNow, the real winner here is how JIRA Service Desk integrates right into a JIRA ticket tracking instance, creating a smooth work-flow for getting problems resolved.
6) StatusPage: A recent product that was purchased by Atlassian. StatusPage is a product designed to report (both internally and externally) on the health and status of the wide variety of systems and services that comprise modern IT product offerings.
Atlassian sells its products in two ways. There is the classic "perpetual" sales model, where it charges up-front for a perpetual license to offer its software to the customer to install and manage on their own IT network, paying a recurring maintenance fee for support and updates. This model made up 62% of Atlassian's fiscal 2016 sales, growing 31% over the previous year.
The second sales model is "cloud", where Atlassian hosts and manages the software instance on their own servers and charges a recurring subscription access fee. Cloud was 32% of 2016 sales, but is growing at a much faster 71% rate. Management sees the cloud model as being the predominant revenue driver within a few years.
Let's also not forget the "other" revenue category. Atlassian's software is very modular and built to be expandable through third-party modules and plugins. The company even offers a marketplace for these plugins, fittingly called the Atlassian Marketplace. Of course, the firm takes a cut of all plugin sales, which in 2016 amounted to about 6% of revenue.
Growth and Competition
With a price-to-sales ratio exceeding 13 and an anemic free cash yield of 1.9% (Atlassian reports an operating loss for the trailing 12 months), this is no value stock by any stretch. The firm will need to continue growing revenue rapidly to live up to its current price, let alone a higher one.
Fortunately, prospects look good. TEAM's 3 year compound annual revenue growth is over 40%, and is expected to remain over 30% for the next few years. There is plenty of room for new customers, as Atlassian services just 290 of the Fortune 500, and about 61,000 companies overall - out of a potential customer pool that management estimates at half a million or more.
Cross-selling is also a key part of the thesis. Atlassian may get into a company with JIRA, and as it permeates their business processes, the integration afforded by its other solutions can drive sales to Bitbucket (away from GitHub), for example, or create company demand for Confluence or JIRA Service Desk to simplify existing processes.
Of course, new products are also an opportunity that we can expect management to exploit. Atlassian's R&D budget is large at almost 48% of revenues, and the company has shown the will to add by acquisition with StatusPage. The product portfolio is still in its early stages.
At a $6 billion market cap, Atlassian has a large valuation but not particularly huge for the enterprise software market. Consider that Microsoft's Office empire does over $25 billion in sales a year (vs. Atlassian's $460 million), and other enterprise software companies like Salesforce (CRM) ($51 billion market value) and EMC (purchased for $67 billion by Dell) have gotten quite large. Even niche IT software companies like CA (CA) and Symantec (SYMC) have market caps more than 2x Atlassian's. To put things in perspective, enterprise IT software is a $620 billion dollar market - its enormous! There is plenty of room for Atlassian to grow.
There is tough competition though. While no one company competes against all of Atlassian's offerings, its individual products face competition from huge and established players such as Microsoft, HP, IBM, and Google, as well as smaller specialized software firms like ServiceNow, Rally, and Zendesk. Make no mistake: Atlassian is one of the barbarians at the big boys' gate.
As for competitive advantages, I'd call it a mixed bag. Barriers to entry are low and new competitors pop up in this space all the time. On the other hand, stickiness once integrated into a company's business processes is quite good. It takes a substantial amount of time and effort to switch to and learn a critical new business tool, and managers are hesitant to change unless there is a really good reason to. As add-on modules and additional software products are integrated in, stickiness increases. The reliability of Atlassian's cash flows are better than the average firm.
What's It Worth?
Valuing early-stage growth companies is more of an art than a science. The main piece of data we have to go by is revenues, so we will use the price-to-sales valuation method here.
Fiscal 2016 revenues came in at $457 million, and expectations for 2017 is for about $599 million, a 31% increase. It seems reasonable to model substantial but declining growth rates going forward, steadily ramping down to just over 10% by the end of a 10-year period. That puts Atlassian at nearly $3 billion in sales in 10 years - a high bar for certain, but not inconceivable given the size of the market.
Even today, Atlassian's free cash flow margin is near 25%. As the company matures, I expect operating margins to come in similar to other IT software firms, close to 30%. Using our rule of thumb, that would be a 3.0 price-to-sales multiple at 5% revenue growth. Given the stickiness of IT software and the premiums historically afforded to the sector, I would kick this "par" P/S ratio up to about 3.3.
Now we see that, today, Atlassian is growing sales at a 30%+ clip, or about 6x a "par" growth rate. 6x our "par" P/S ratio is a rather ridiculous 19.8, but it gives you an idea of the short-term valuation potential. I'm uncomfortable with anything over a 13 P/S ratio, so lets use that. 13 times $600 million in sales gives us a one-year target market cap of about $7.8 billion. Management has already estimated their share count at 235 million, giving us a target price of $33.20. That's a modest 14% gainer from today's price of $29.
But I see Atlassian as a long-term play. Certainly, the company's long-term potential is far greater than $600 million in sales, and it should deliver excellent long-term gains for patient shareholders. That said, this is a high flying stock, and better value points may very well present themselves going forward.
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