Uncommon Idea: Team Collaboration Software Atlassian TEAM

The Uncommon Idea in Brief

Buy productivity software company Atlassian (TEAM) stock for the long term. (Published July 5, 2017)

-A strong start to the first half of the year recently pushed Atlassian to its highest levels since coming public in 2015. But shares have retraced to 2016 highs, offering an opportunity to begin building a new position with a goal to add aggressively in the $30 to $32 range.

The Industry Opportunity

Teamwork in the age of tech and telecommunication is now essential to the workday.

Efficiency and communication can boost the bottom lines for most companies. Miscommunication between employees, poor organization of projects or downtime in technology cost time and money.

Atlassian aims to deliver software that works in conjunction with a company’s needs to smooth communication and increase efficiency and organization, all while troubleshooting potential problems.

Its suite of enterprise software products increases productivity and collaboration across teams rather than just a single employee and can be used from the largest companies all the way down to individuals.

What Atlassian Does

Atlassian is an enterprise software company offering productivity and collaboration software that helps companies, small businesses and individuals bridge organizational and communication gaps.

TEAM creates tools popular among software developers like:

  • Jira – Bug/issue tracking (helps coders locate and track bugs)
  • HipChat – Messaging app
  • Confluence – Knowledge sharing app for teams
  • Bitbucket – Online repository for storing code
  • Bamboo – Technical workflow interface
  • Trello – Project management tool for individuals and small businesses (virtual post-it notes on a white board)

The company’s main market had been larger companies and developers, but the recent acquisition of Trello has expanded the company’s 85,000 customer base to include small businesses and individuals.

Their large clients include, but aren’t limited to, 85% of the largest companies in America, all eight Ivy League universities, AirBnB, Blackrock (BLK), Paypal, Sothebys (BID), BMW, Flixbus, RyanAir, Spotify, Snapchat (SNAP), Twilio (TWLO), SpaceX and NASA.

SpaceX is using TEAM software to coordinate coding team and rocket scientists, while NASA relied on it to help plan Curiosity Rover’s mission to Mars.

The Uncommon Market Position

Atlassian’s dominance doesn’t equate to a slowing growth market or limited upside. The company is expanding in three directions, none of which are related.

-TEAM continues to migrate from shipping physical software to the public cloud via Amazon Web Services.

-Europe continues to grow and now accounts for 40% of TEAM’s revenue. The company expects international expansion in Europe and beyond to continue.

-With the acquisition of Trello, Atlassian now offers visual management tools to individuals and small businesses, as well as the enterprise market.

The expansion market added by Trello will bring Microsoft (MSFT), and its Microsoft Team product that is tied to Microsoft Office, into play as a partial competitor. Microsoft Teams stands to compete against HipChat, a software on the market since 2012. HipChat accounts for only 15% of Atlassian’s revenue, so if the new Microsoft product has some impact on the revenue derived from HipChat, it won’t be terminal.

Furthermore, HipChat targets software development and business teams, while Microsoft Team targets the Microsoft user given the product’s deep integration into Office 365. It’s meant to be used alone, while HipChat is meant to be used on a larger scope along with other Atlassian products.

Slack, which Amazon (AMZN) could possibly buy for $9 billion, and Asana are Atlassian’s biggest threats, with Slack leading the way. Slack has grown its user base from 16,000 in February 2014 to 5.8 million as of October 2016, with a team count closer to Atlassian’s current count.

What Sets Atlassian Apart

Atlassian may be an enterprise software company, but it acts more like a consumer company (think more Amazon than Oracle (ORCL)). The company was consistently profitable for the decade prior to its 2015 IPO without doing a single round of traditional venture capital financing. It has relied on word-of-mouth referrals and marketing rather than operating with a traditional outbound sales model.

While the company has focused on growth through data-driven marketing, avoiding the time and expense associated with an outbound sales teams has permitted Atlassian to take aim to move beyond software developers and IT markets to challenge office productivity.

Migration to the public cloud (Amazon Web Services) has expanded the ability of the company to aggressively expand and reach new markets. By migrating to the cloud, Atlassian has removed the need to deploy staff around the world to set up data centers. That included setting up everything from air conditioning to racking servers. Those employees can now focus on higher-value activities.

Additionally, the use of AWS allows TEAM to have data centers near its customers.

Finally, Atlassian can take advantage of the services offered by AWS that previously had to be built within the organization, saving both time and money.

Financials — Atlassian by the Numbers

Atlassian delivered 3Q 2017 results that showed a continued trend of solid growth and improvements along the bottom line. Revenues increased 36% to finish at $159.9 million for the quarter with $64 million coming from Europe.

While the company posted an operating loss of $23.1 million, it had free cash flow of $68.3 million. Non-IFRS (International Financial Reporting Standards) free cash flow for the quarter increased 68% to $72.9 million. The company finished the quarter with cash and cash equivalents of $503.6 million, or $2.28 per share, against zero debt.,

On a non-IFRS basis, TEAM delivered net income of $17 million, or $0.08 a share, on gross income of $24.5 million. Non-IFRS free cash flow increased 68% to $72.9 million.

Atlassian increased its customer count to 85,031, adding 16,194 new customers. The Trello acquisition accounted for 12,789 customers, so pre-Trello, the customer count registered 72,242, a year-over-year increase of 26%.

Management issued 4Q 2017 revenue guidance of $170 million to $172 million on gross margins of 80%. Non-IFRS operating margins are expected to remain at 14% and the company expects non-IFRS earnings per share of $0.08. For the full year 2017, revenues of $616 million to $618 million are anticipated at non-IFRS earnings per share of $0.35.

Why the Stock Is a Buy

Those conservative about fundamentals will view Atlassian’s valuation as aggressive given the company is trading at 12x sales and is losing money when measuring earnings per share based on International Financial Reporting Standards. And to some degree, those investors are correct.

But Atlassian is a high-growth company, dominant in its space, with a strong history. The company has been consistently profitable for a decade prior to its 2015 IPO. On a non-IFRS basis, TEAM will earn $0.35 per share in 2017. Top- and bottom-line growth should continue at or above 35% for the next three to five years to gross more than a billion dollars in revenue in fiscal year 2019.

Furthermore, we project free cash flow to grow by nearly twice that amount at 65% to 70%, meaning it could reach $200 million by the end of fiscal 2019. At 10x 2019 sales plus estimated cash and cash equivalents of $750 million, we believe a fair market value for TEAM in 2019 will be a market cap of $12 billion compared with the current market cap of $7.6 billion, or $34.60 per share.

So, we have a two-year price target of $54.60 per share.

The Technical Analysis — At $40 or lower TEAM is a BUY

The spring proved fruitful for the price of TEAM.

Shares surged almost 35%, showing virtually no retracement along the move higher. Despite the move separating price from the 13-week simple moving average (SMA), we still view this just below $35 as initial support. Secondary support rings in at $34, the base of the current trading channel.

As this consolidation channel has formed after a strong run higher, we view it as a bullish flag formation stemming from the March to May 2017 move higher.

There are two approaches to utilizing the bull flag as a trading tool.

-Focus on support and use that area as a price target to acquire stock. TEAM offers up a two-for-one here as the support/lower level of the channel coincides with the 13-week simple moving average (SMA) around $34. We have to trek back to January 2017 to find a time when TEAM shares spent more than one week under the 13-week SMA. Support is very strong within this bull flag. Of course, if support is breached, then an investor should consider protective action such as put protection or potentially stopping out of the trade until the situation appears technically bullish again. We would expect the 20-week SMA to act as support, which translates to downside expectations around $32. But we see $34 as an attractive opportunity to buy shares as we view $30 as the worst scenario on a technical breakdown.

-The second approach to consider is buying the breakout. Investors could choose to wait for a weekly close above resistance, the top of the channel. Once above the resistance level of $37, shares should push higher. Our initial target on a breakout, independent of fundamental views, would be $40 in short fashion with an ultimate upside of $46 within 12 months, based on the current price patterns.

TEAM chart, Atlassian chart
Two ways to play the TEAM bull flag. CLICK CHART FOR A LARGER IMAGER.

 Catalysts for the Thoughtful Investor

HipChat is now available on Amazon Echo. It’s unique because it is designed to be active rather than passive like other Echo skills. The app can call out when certain pre-set conditions are met, as well as answer questions. It’s possible HipChat on Echo could be designed to chirp alerts if a site or system go down. The system would send a message to HipChat, which then triggers the Echo to activate and send an alert to the IT team or company.

Not only would this setup shorten time to respond to issues, but it capitalizes on the overall industry shift towards voice. HipChat plus Echo might act as a virtual assistant, which could drive revenue and the stock price.

Then there’s Atlassian’s moxie.

Not many companies are willing challenge Microsoft. Atlassian tossed aside that thinking when it acquired Trello. Trello can be thought of as virtual post-it notes that can be moved around on a white board. This very visual approach to managing projects and holds significant appeal in its basic yet effective approach. While there are concerns with Microsoft’s own offering, Atlassian views their suite offerings as vastly different. Microsoft’s product is rooted deep in the Microsoft Office 365 platform which is focused more on the individual and individual decision making. Trello, while offering the same, is meant as individual contributions to team collaborations. Atlassian products are complimentary and not restrictive to a base like Office 365.

Finally, Atlassian is transitioning to the cloud. Adopting the cloud is more than just a one-and-done. Adapted software must be rewritten and shipped to the cloud, which required changing the way Atlassian developed, shipped and provided support. Cloud revenue now accounts for one-third of the company’s revenue and should continue to grow.

The Bottom Line

-Atlassian is a leader in the enterprise business software sector specializing in productivity, organization, communication and collaboration.

-Atlassian has migrated to the public cloud to shift along with industry trends and have data centers closer to clients. The move has allowed the company to redeploy employees once needed to set up physical locations to higher-value activities for the company.

-The company’s expansion into the individual and small business market via its purchase of Trello should help fuel growth in both its customer base and bottom line for years to come. While it introduces Microsoft as a partial competitor, it reduces Slack to a partial competitor. Atlassian will be able to earn revenue across all sizes of business from the individual to large enterprise businesses.

-In the range of $30 to $40 we see TEAM as a long-term buy and hold. Furthermore, under $30, we would be aggressive buyers. With its small-cap nature, a strong move over 40% year to date, the evolving nature of its business to the cloud and smaller markets, a high price-to-earnings ratio and potential of competitors Microsoft and Slack, we expect it to be volatile in terms of price movement. From both a buyout and growth perspective along with a dominant position in the marketplace, we believe shares to be undervalued despite the strong move in the first half of 2017.

At the time of publication, neither the author nor the company held positions in the stocks mentioned, but positions may change at any time.