Atlassian Corporation (TEAM, Financial) is a software company that specializes in developing and providing business collaboration and productivity tools. Its products are installed in more than 80% of the Fortune 500, and once new tools like Atlassian’s are embraced at big firms, it’s extremely difficult to change direction. This has helped Atlassian grow revenue from $145 million in 2013 to more than $2.7 billion over the last 12 months.
Atlassian is impressive
The company has grown to become a global leader in enterprise software solutions with a product mix that is very sticky. The more touch points across a client’s organization a software vendor has, the higher the switching costs, and Atlassian has five main products:
- Jira: a very popular project management tool that helps teams track and organize their work
- Confluence: a collaboration platform for creating and sharing documents, knowledge bases and team wikis
- Trello: a visual tool for organizing and prioritizing tasks and projects
- Bitbucket: a version control system for software development teams
- HipChat: a team communication tool for real-time chat, video conferencing and file sharing
In addition to these, Atlassian also offers a range of integrations and add-ons to help teams customize their workflow and improve their productivity through a diverse marketplace of third-party listed deliverables. The company offers its solutions through both software-as-a-service (SaaS) subscriptions and enterprise license agreements with Jira being its preeminent offering.
Atlassian’s marketing playbook
Atlassian has built its business in the same way Salesforce (CRM, Financial) did, using free trials to gain competitive advantages against would-be competition. The actual building of the software is no longer the hard part. Being able to get first mover advantage and then stay there is what's difficult. Most SaaS companies start by offering free versions of their software, often limited in features, and require payment to access more. The “more” with Atlassian's offering is tied to users, data storage and support.
Atlassian’s flagship project management tool Jira starts at $0 per user per month for up to 10 users. This rises from $7.75 to $15.25 per user for advanced with unlimited storage and 24/7 premium support. At the highest level, which is what most of those Fortune 500 clients are likely on, the service offers the additional benefits of centralized control, security and support. The point being, any company, big or small can get started and scale as needed.
Atlassian’s current revenue is pretty stable considering the penetration in major American corporations and those high switching costs, which comes from the time and expense of implementing a new software package while maintaining the existing platform or the indirect costs in learning a new system. No matter how you look at it, Atlassian is here to stay.
Atlassian seems overvalued by Mr. Market
Desipte the steller product offerings and revenue growth, the stock price has become out of balance with its real value. Of course, this could mean that the problem Atlassian solves is really hard or that investors believe that paying 13 times sales today will translate in someone else paying 13 times sales in a few years when annual revenue has doubled.
A major red flag is that while the company’s gross margins are above 80%, it still spends an inordinate of money on research and development. That’s typically a sticking point when investing in technology companies. Atlassian may have to continuously spend over 60% of its gross profit on R&D just to keep up with competition as it tries to match growth estimates. By comparison, the SaaS pioneer Salesforce only spends 23% on research and development. This one line item on Atlassian’s income statement is the reason the company remains unprofitable. In fact, if that number was in line with Salesforce’s, Atlassian would be able to push nearly $1 billion to Ebitda. Considering its significant growth rate, that could justify a 40 times multiple.
The good news is that 98% of transactions occur on the company’s website, placing Sales, General and Administrative (SG&A) costs at just 46% of gross profit. Salesforce’s SG&A costs eat up 74% of its gross profit. Even though it only generates $340,000 per employee, the company is still keeping the admin costs in check.
For Atlassian, achieving high revenue growth is crucial for justifying its poor management and bloated employee base. In startups, it’s almost a requirement to hire fast and tack on as many people as possible to solve problems. Now, the company needs to scale back and become more efficient. A 30% top line growth rate alone is no longer enough. As the company expands and the industry becomes more competitive, growth could slow substantially.
What price makes sense?
This is one of those situations where value investors can understand the business, keep tabs on where the price fluctuates and act when it reaches a certain level. I believe that level is much lower based on today’s performance indicators.
Even assuming Atlassian can continue to grow at the current rates for the next five years, pushing revenue above $11 billion, the company will still likely be losing money. However, if any quarterly report shows research and development expenses stabilizing or declining, that would be good news for the bottom line.
At this point, I believe a price-sales ratio of around 5 seems more in line with the market. Salesforce is priced at that level and it is the undisputed industry leader. That would place the market capitalization closer to $15 billion today and up to $55 billion in the future as long as Atlassian can continue the strong performance over the next five years.
