ASAN - Atlassian's 2024 Outlook: 50x Forward Free Cash Flow Is Too Rich

2023-11-15 16:59:03 ET

Summary

• I find Atlassian Corporation stock valuation at 50x forward free cash flow quite steep.
• The contrasting views on customer adoption and growth rates introduce an element of uncertainty for me.
• Despite the positive trajectory in the cloud business, questions about Atlassian Corporation's steady growth rates keep me on the sidelines.

Investment Thesis

Atlassian Corporation ( TEAM ) creates software tools that help teams work together more efficiently. Their products, like Jira and Confluence, assist in tasks such as project management, issue tracking, and collaborative documentation, making teamwork smoother for various industries.

It reported fiscal Q1 2024 at the start of November. As you'll see from these results, its customer adoption and revenue growth rates for Atlassian appear to be slowing down. What's more, its stock is still priced at about 50x forward free cash flow.

In summary, I find it challenging to identify significant potential gains for new investors considering this stock.

Rapid Recap

In my previous analysis back in August I said,

Despite its unappetizing profitability, Atlassian's collaboration and workflow business gained traction during the pandemic, attracting more customers. Although growth rates seem to be slowing down, the company is performing better than expected. [...]

Looking ahead, the cloud business might maintain a more moderate growth rate. While I am now less bearish on the stock, certain details make me cautious and keep me on the sidelines.

Since that time, I've remained neutral on this issue, and below is TEAM's performance.

The stock has gone nowhere fast, and as we look further ahead, this investment continues to be a mixed bag.

Team's Near-Term Prospects

In the first instance, I'll discuss some bullish aspects before turning our focus to why I'm not enthusiastic over Atlassian's prospects. I hope that you'll use my insights to build your own thesis.

In the near term, Atlassian appears well-positioned for growth, particularly in its cloud business. The company's strategic focus on cloud migration has resulted in a substantial increase in the number of user migrations over the past year, showcasing a positive trajectory.

The upcoming server end-of-life, scheduled for February 2024, is expected to be a catalyst for further cloud adoption, with significant interest anticipated around this transition. Atlassian's cloud revenue growth is guided to benefit from migrations, and the company aims for a robust year in FY '24, emphasizing its commitment to enabling and unblocking customers to seamlessly transition to the cloud.

That's one version of the bull case. The other version is illustrated in the graphic that follows.

As reported in the fiscal Q1 2024 results, the rate of customer adoption is gradually decreasing over time. Indeed, despite the growth in cloud adoption, the rate of increase in user migrations has fluctuated, leading to questions about the sustainability of this momentum.

Case in point, whether the recent growth slowdown is indicative of challenges such as the law of larger numbers or a potential slowdown in customers' eagerness to migrate to the cloud. Perhaps, it could be due to the competitive landscape continuing to increase.

Furthermore, as the server end-of-life approaches, managing the migration process effectively could see some level of customer hesitancy to transfer to the cloud.

Given this context, let's move ahead to discuss its financials.

Revenue Growth Rates Moderate

As alluded to already, Atlassian's guided growth rates are expected to slow further in fiscal 2024. Management makes a big deal that it's seeing a large amount of growth in its cloud business, but we have to keep in mind that Atlassian is seeking to end its server business.

This is akin to moving customers from one business segment to another, without resulting in a net gain.

TEAM Stock Valuation -- Richly Priced

Above, we can see a comparison of Atlassian's valuation with that of two of its peers. Here, we compare Atlassian's valuation with two of its peers.

All three companies are involved in team collaboration with features supporting communication, file sharing, and team visibility.

However, there are some notable differences. For instance, Atlassian has a broader suite with a focus on software development, while Asana ( ASAN ) and monday.com ( MNDY ) are more general-purpose project management tools. Atlassian leans towards customization and complexity, while Asana and monday.com focus on simplicity. Nevertheless, it's evident that investors have the highest expectations for Atlassian compared to its peers.

From a different perspective, if we assume that Atlassian's free cash flow aligns closely with its guided non-GAAP operating margin, this would see Atlassian's free cash flow reach close to $1 billion over the next 12 months.

This leaves Atlassian priced at 50x forward free cash flow, a figure that I believe is too richly priced for a company that is slowing down its growth rates to around 20% to 25% CAGR.

The Bottom Line

In conclusion, while Atlassian's near-term prospects in the cloud business appear promising, there remains a nuanced outlook for investors.

The contrasting perspectives on customer adoption and the impending server end-of-life, coupled with the company's slowing growth rates, introduce elements of uncertainty.

The rich Atlassian Corporation stock valuation, at 50x forward free cash flow, keeps me cautious. As such, I'm finding more attractive opportunities elsewhere.

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