Beware the Valuation on Hyper-Growth Atlassian Stock

Shares of hyper-growth enterprise software company Atlassian (NASDAQ:TEAM) have been on fire for the past several years. Atlassian hit the public markets in December 2015 at an IPO price of $15 per share. Today, TEAM stock trades hands around $130, representing a 767% share price increase in less than four years.

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That’s a huge gain. To put it in perspective, the S&P 500 is up just 42% during that same stretch.

Why the huge run up in TEAM stock? Because Atlassian has found a winning strategy, in a winning market. And it’s rapidly growing revenues, margins and profits. Investors have drooled over all the growth — and have grown optimistic on Atlassian’s opportunity to sustain this big growth for years to come.

In response, TEAM stock has turned into one of the market’s biggest winners. But one thing may derail this red-hot, multi-year rally in TEAM stock. And that is valuation.

Long story short, at current levels, TEAM stock is overvalued. Sure, this company projects as a huge revenue and profit grower over the next several years. But, even under aggressive long-term growth assumptions, it’s tough to justify the current valuation on TEAM stock with the fundamentals.

As such, I think TEAM stock is skating on thin ice here. Eventually, this growth narrative will cool down. Once it does, investor sentiment will go from euphoric to realistic. The fundamentals say that transition could cause a crash in TEAM stock.

Atlassian Is a Great Company

I want to be crystal clear on one thing — despite my bearishness on TEAM stock, I think Atlassian is a great company with a very bright future.

This company does a lot of things in the enterprise software world, but all those things come back to one fundamental idea: teamwork works. That is, as its ticker implies, Atlassian is all about teamwork. It builds digital collaboration and project management tools so that often complex and big enterprise ecosystems don’t feel so disparate and inefficient. The goal? Get everyone in an enterprise to communicate and work together seamlessly, so as to make project development and other workflows more efficient.

The idea makes a lot of sense. Think of a business as a sports team. Atlassian basically provides “coaching tools” which help maximize the efforts of each of the players on the team. Each team has a coach. So, each business should employ collaboration and development tools like the ones Atlassian sells.

In this sense, Atlassian’s addressable market is very big. The company estimates it at roughly 1 million businesses, which is the number of businesses globally that have at least $10 million in annual revenue. Right now, Atlassian counts 150,000, or about 15%, of those businesses as customers — and that’s up from 100,000 just two years ago.

Long term, Atlassian will continue to grow into its addressable market, adding thousands of new customers every year. Those customers will also adopt more services, as Atlassian is expanding its product suite. So, average revenue per customer should go up in the long run, too. All of this revenue is high-margin revenue (85% and up gross margins), and big revenue growth should drive healthy operating leverage.

Atlassian projects as a big revenue grower over the next several years, with upside margin drivers that should driver even bigger profit growth.

Atlassian Stock Is Just Overvalued

The problem with TEAM stock isn’t the growth profile — it’s the valuation.

Here are the numbers. Over the past two years, Atlassian has been adding between 20,000 to and 25,000 new customers every 12 months. This trend should persist, given Atlassian’s large addressable market and the company’s momentum in that market as the de facto collaboration tools provider. Further, average revenue per customer has been marching higher, too, as Atlassian’s customers increasingly adopt more products the longer they are Atlassian customers. This trend will persist, as well, because Atlassian’s collaboration tools can be used across the entire enterprise ecosystem.

Thus, Atlassian should be able to add around 20,000 to 25,000 new customers each year for the next several years, while average revenue per customer rates should climb higher, too. Those characteristics won’t sustain today’s 35%-plus revenue growth rates. But, this company does reasonably project as a 20%-plus revenue grower over the next few years.

Gross margins should remain steady in the 85%-90% range. The operating expense rate should fall gradually with scale. Broadly, then, 20%-plus revenue growth over the next few years should translate into 25%-plus earnings per share growth. Indeed, my modeling pegs FY26 EPS at $4, which represents a 26% compounded annual growth rate from FY20’s guided EPS base of $1.

Based on an application software sector average 35-times forward price-to-earnings multiple and 10% discount rate, FY26 EPS of $4 supports a price tag for TEAM stock in FY20 of less than $100. The stock trades north of $130 today.

Bottom Line on TEAM Stock

Atlassian is a great company. TEAM stock is overvalued. It’s that simple.

To be sure, overvalued stocks can stay overvalued for a long time. But, Atlassian’s guide for FY20 implies that revenue growth rates will slow meaningfully next year. If this slowdown does materialize, investor euphoria today will turn into investor realism tomorrow.

Ultimately, this transition could cause TEAM stock to crash in 2020.

As of this writing, Luke Lango did not hold a position in any of the aforementioned securities. 

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