All Cheer Atlassian

Atlassian (Nasdaq: TEAM) is planning to price their IPO next week. It's a hot deal, being led by the dream team of Goldman Sachs and Morgan Stanley with seven other banks on the cover. As far as stories and positioning is concerned the company is about as close to "perfect" as one will see. (Of course that comes along with a very high price tag - at the $17.50 mid-point the $3.6B market cap is over 10x revenues and 54x cash flow.)

Atlassian is an odd but enchanting duck in the world of enterprise software - their team collaboration product is bought rather than sold, it was founded in Australia and financed without traditional VC and has enjoyed rapid growth with consistently positive free cash flow. In the most recent fiscal year Atlassian booked $320M from 51,000 customers.

The product family consists of five main offerings: Confluence which is a shared repository, HipChat for communication, Bitbucket for code management, Jira for project management and Jira Service Desk for customer support. The company has a number of additional add-ons and external organizations have created more than 2,000 add-ons which are available to users in the Atlassian Marketplace. In this way Atlassian has done a better job than other collaboration software companies in creating something closer to a platform than just a product. More details are in the TEAM IPO roadshow slide deck. (We will post the transcript here when we have it.)

Consistent with their "bought not sold" approach to the business the company spends a stunning 37% on R&D and a paltry 19% on marketing. This stands in stark contrast to most enterprise software firms with the figures are typically reversed with most spending on sales and marketing versus R&D.

In order for this to work Atlassian puts all their pricing online, allows free trials for all products and makes it very simple to buy and install their software. It's all consistent with the new or "Enterprise 2.0" way of doing business. We've seen other examples in the IPO market with companies including Zendesk (NYSE: ZEN), New Relic (NYSE: NEWR), and ServiceNow (NYSE: NOW).

With the most coveted peers in the group trading at 16x to 20x revenues we can expect shares of TEAM to reach that range. That translates to a $30-$35 stock price. Our IV (shown below) is a more sober $21-26/share but we doubt the stock will trade down there.

One odd thing: During our analysis we noted a curious relationship (or rather lack thereof) between spending on sales and marketing and product revenue growth. As shown in the chart here a doubling of sales and marketing spend is followed by a major ramp downwards over the last several quarters. What's surprising is that there is no apparent change in the rate of product revenue growth. In the case of Atlassian this isn't really alarming since using sales and marketing is not their strategy. Still, it's something we'll be watching in subsequent quarters.

What could go wrong?

Other than the fact that the valuation will be very high there are three things that could weigh on the shares in the near-term and over time:

1. The bulk of revenue is recurring but a significant slice - about 18% is conventional perpetual license software. Their visibility into this revenue stream is very good but as with all outright technology purchases there can be acute delays in the enterprise business. If that segment were to fall short it could create a situation where the company doesn't deliver as much upside as investors may come to expect.
2. Atlassian has grown under their own steam and remained pure to their roots. With a public currency (and a highly valued one at that) they may decide to make acquisitions, something that is fraught with challenges for rapidly growing companies. We've got no reason to expect the company to be aggressive with M&A but management does march to their own drumbeat.
3. Competition is fairly robust in this market and users tend to be somewhat fickle. We've watched "hot" collaboration tools come and go over the last few decades. Atlassian is no flash-in-the-pan to be sure but there are other offerings like Asana that do similar things with enthusiastic users and an "Enterprise 2.0" approach to business. These products are "sticky" but when starting a major new project customers often cast about for alternatives and are often eager to try something new. Hot new upstarts like Slack are gathering great momentum in lightweight collaboration.

For now the company and IPO investors should just sit back and enjoy the ride. The next few quarters will shed light on how management performs under the steady gaze of institutional investors and their banking analysts.