ROP - Atlassian: How To Unleash The Growth Potential

Summary

• Atlassian Corporation is an application software company engaged in improving company processes.
• High growth rates of revenue and EPS characterize the company's financials.
• Atlassian's last few quarters show a slowdown in sales data.

Atlassian Corporation (TEAM) incorporates the high potential to improve and optimize workflows in virtually any type of business organization. It can deal with work management, IT service management ((ITSM)), and the development of existing applications. This year marks 20 years of presence on the market and almost 10 as a public company.

The revenue growth data is impressive and indicates a stable and constant annual growth rate of 29.6%. Net margin, ROCE, and EPS have a similar growth trend, and this represents a further strengthening of the company. A footprint particularly focused on investments in new product development and maintenance of existing ones is aided by a generous cash flow.

But the general picture has not only positive aspects, and it is necessary to record that in the last two quarters TEAM has seen a slowdown in the conversion of free users to paying users and a slowdown also in the growth rate of paying users. This is probably due to a slowdown of customers hiring. This slowdown in the growth of paying users has generated a failure to achieve targets and a consequent collapse in the share price.

For the more daring, this could represent a good moment to go long in an investment that is quite risky but characterized by linear and important growth and by the company's ability to have great visibility on the uses and behavior of customers. Last but not least, the insider ownership share is 42.5%, and this represents, in my opinion, an absolute strength for long-term growth.

My idea is to enter long with a third of my available capital and identify further entry opportunities in the next quarters. My rating is Buy.

General Overview

Atlassian Corporation Plc was founded in 2002 and registered in the UK in 2013 as a public company.

The company’s mission is to facilitate and streamline the work of each team. The main products (Jira Software and Jira Work Management) can be integrated into any type of industry and easily adapt to any type of organization.

The main sales channel is represented by the website, and the purchase process by the potential customer takes place independently. The ease of use of the site and the products is therefore a peculiar feature to facilitating online purchases.

Recently the company has also grown through targeted and strategic acquisitions: Mindville in 2020 (based in Sweden) and Chart.io, Inc. in 2021 (data analytics tool to create dashboards)

Financial Model

New Customers Acquisition

As of October 2022 , the company had 249,173 paying users. If we compare this figure to Q4-20 with 159,433, we register a growth of 34.7% year-over-year. This represents the first data as Atlassian sets its primary target, which is the rapid growth of customers through easy-to-use tools avoiding the traditional sales force and, therefore, also reducing customer acquisition costs. In addition, each quarter grows by 5.1% compared to the previous quarter constantly and linearly. This data represents great stability and sustainability of future growth.

Revenue and Profitability

The growth in the number of customers translates into a constant and linear growth of revenue (yellow bars) over the years. The compounded annual revenue growth rate was 29.6% as of 2016. This trend also makes it possible to venture fairly sustainable forecasts on the future revenue growth rate. The target declared by management ( last earnings call ) is to reach $10B in terms of revenue as soon as possible.

The graph also shows (grey line) the trend of the Non-GAAP (or Non-IFRS - International Financial Reporting Standards) Net income margin. The figure grows from 12.1% in 2016 to 15.6% in 2022. The growing trend virtuously follows the revenue trend and this underlines a linear positive correlation between revenue growth and the net-income margin.

The following graph shows the trend of ROCE (Return on Capital Employed) - orange line - and Capital Turnover (grey bars). In particular, the efficient use of capital has made it possible to triple the turnover index from 0.6 (2016) to 1.5 (2022). This means that today, every $1 employed in the company produces $1.5 in revenue. As a result, ROCE also tripled from 7.5% to 23.2%.

These data underline, in terms of profitability, a constant improvement in the use of capital employed.

Free Cash Flow, EPS, and CapEx

The graph shows the EPS trend (grey bars) and we can see how the data goes from $0.35 (2016) to $1.69 ((TTM)) with a compound annual growth of 30%. It is a truly impressive fact as is the linear and constant trend.

The company is also able to transform profits into Free Cash Flow (blue bars) with an increasing trend and a growth rate of 25.8%. This is slightly lower growth than earnings and this is mainly due to the growth of CapEx or the investments necessary to sustain growth.

The yellow line shows the CapEx to depreciation ratio and identifies that the firm is consistently investing more in CapEx than it has on the balance sheet in terms of depreciation. The ratio is equal to 1.28 ((TTM)).

Atlassian invests significantly in new and existing product development as well as sales automation. In terms of Marketing, it invests in product and brand promotion and also in advertising.

If we think of the slowdown in the growth of paying users recorded in the last quarter and read the philosophy in terms of investments (last earnings call):

And what we have learned is that during those periods of time, like, if you can invest wisely, you can come out the other side with the leaderboard shaking up a little bit and you can come out higher on that leaderboard than you went going in and so that informs a lot of how we think about the investments through this period.

We can understand how the company will continue to invest in growth even in the event of brief setbacks.

In addition to investing, the company also cares about cost containment, and as we can hear from the last earning call:

“First and foremost, we are making reductions in our non-headcount driven discretionary spending, and then, secondarily, we will be moderating the rate of planned headcount growth in the second half of FY 2023.”

The management is also implementing containment measures in anticipation of possible growth slowdowns.

EPS Growth Model Valuation

Since the company is very stable in terms of Revenue and EPS growth, I decided to use the EPS growth parameter over the last 7 years as an estimate of future growth. 30% is the growth rate ((CAGR)) of EPS from 2016 ($0.35) to 2022 ($1.69).

The Formula is (by popular investor Benjamin Graham):

Intrinsic value per share = EPS x (8.5 + 2 g)

Where

EPS = earnings per share

g = EPS growth rate = 30%.

Example of calculation for 2023:

Intrinsic value per share = EPS x (8.5 + 2 g) = 2.2x(8.5+2x30) = $150.54.

The last intrinsic value of $559.11 for 2028 underlines an annualized return ((CAGR)) of 25.2% as the current share price is $145.

25.2% is the annualized expected return for the investment in TEAM. It's a very high figure in absolute value and it requires great confidence that the EPS growth rate can remain at 30% for the next 7 years. This represents an element of risk precisely because the rate is very high and it is very difficult that it can remain so high for the next 7 years.

Peer Comparison

To compare TEAM with similar companies in terms of market capitalization in the Information Technology sector, I have defined the following peers:

• Autodesk, Inc. ( ADSK )

• Workday, Inc. ( WDAY )

• Cadence Design Systems, Inc. ( CDNS )

• Roper Technologies, Inc. ( ROP )

Using Seeking Alpha's Quant Ratings, we have a "Sell" verdict related to the "Hold" rating of the others company.

All Quant Factor Grades indicate a worse rating when compared to other peers. In particular, EPS Revisions and Momentum are (respectively with D+ and D) the parameters with the greatest differential compared to the other companies.

Concerning growth, if we focus on Revenue, however, we can note how both in the last year (33.54%) and the previous 3 and 5 years (31.88% and 34.58%) the revenue growth rate was by far higher than all the others. In particular, the growth of revenue is one of the main objectives of the company and we can affirm that the data has no equal with the competitors.

Another very important parameter in rapidly growing companies is represented by ownership. Atlassian has an insider percentage of 42.53%, and this means that the property has a high rate of skins in the game. In my view, this element represents a key strength for future growth and profitability.

Risks

Rate of converting to paid and user expansion growth

The data of the last two quarters have recorded a slowdown in the conversion rate of users from free to paying and in the expansion rate of existing users. The company commented on this result, identifying contingent macroeconomic events as the main cause. In other words, current or potential customers are reviewing their spending budgets downwards and are limiting new software licenses on the one hand and using their workforce to develop internal solutions on the other. The positive aspect is that the problem is not the abandonment of existing customers but only the lack of development.

The fact is that a slowdown is being recorded and this could represent a risk if the trend is confirmed also in the next quarters. The development of the company is mainly based on the rapid growth of revenue, and if this is lacking, the risk of a loss of margins and less cash flow to be allocated to future investments becomes high.

Cloud and migrations

At the beginning of 2024, support for Server products will end and this involves a massive migration of all customers currently on the Server to the Cloud. The company is closely monitoring this migration process and indicates that the path is fully under control.

Also in support of this demanding process, TEAM announced (last earnings call):

On top of that, in just over the last month, we have announced a partnership with Accenture, which gives us massive scale with one of the large global system integrators in the industry to help our customers through their massive transitions, whether that’s their agile transformation or their cloud transition.

This underlines how delicate the process can be and the harbinger of possible revenue losses. In my opinion, the migration could represent a possible risk in 2023 and 2024 that does not directly depend on Atlassian's shortcomings but, unfortunately, on the inability of some customers to be able to better manage the migration.

Final Thought

Atlassian Corporation Plc records a constant quarter-over-quarter growth of 5.1% in terms of new paying customers and linear and constant growth in revenue at an annual rate of 29.6%. The EPS growth linearly follows that of Revenue with 30% on yearly basis. The FCF/Share growth is 25.8%, slightly lower but respectable. This is the general picture of the last 7 years. In the last 2 quarters, the data shows a slowdown in these growth rates and this could represent a risk, but looking at the big picture, we can state that TEAM represents a solid company with significant growth rates. If we project what happened in the past into the future, the valuation model based on the growth of EPS indicates a possible return on investment equal to 25.2%. Even if the investment appears to be high risk, my thought is to invest a small part of the capital now and continue later with the opening of new long positions. My rating for Atlassian Corporation is Buy.

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