Atlassian: Great Company With Short-Term Risks (NASDAQ:TEAM)

Thesis

Atlassian (NASDAQ:TEAM) is a leading provider of collaborative work management, ITSM, and DevOps solutions, such as Jira, Confluence, Trello, and Bitbucket. The company has a distinctive strategy that has driven its fast growth in recent years, and it is investing heavily to maintain its growth momentum. Looking at its big bets, we believe that the company has a solid strategy in place for long-term success. However, its recent performance and outlook suggest that it is facing some serious challenges that could hurt its prospects in the near term.

In this article, we want to provide a realistic view of Atlassian’s prospects and challenges, and why we think the stock is a Hold at its current levels. Some of the insights are:

• Atlassian’s growth deceleration is not specific to the company but rather due to the macroeconomic headwinds and the overall slowdown in the SaaS market.
• Atlassian is facing intense competition from both traditional and new players in its segments. The company is spending a lot on R&D and acquisitions to stay ahead of the curve, but its returns are limited.
• Atlassian’s valuation is too high compared to its performance and peer averages, implying that the market is underestimating its risks.

Atlassian Growth Strategy: 3 Big Bets

Atlassian is a growth-oriented company that makes risky bets. Even in a challenging macro environment, the company is proactive and continues to invest and pursue ambitious goals. We admire this growth mindset and believe that it will help Atlassian seize more of the market potential in the long run.

Atlassian’s strategy to maintain its growth is based on three key pillars:

• Cloud – Transition of its remaining Server users to its Cloud offerings and deliver constant innovations to its products every quarter using its cloud platform.
• Enterprise – Develop enterprise sales capability through a network of partners and dedicated customer success teams and equip the platform with enterprise-grade features such as scalability, security, and support.
• ITSM – Expand the ITSM business through Jira Service Management’s innovative cross-product functionalities and enable development, IT, and business teams to work together.

Looking at the progress of these three pillars, we observe that the cloud migration is not going as smoothly as expected as the cloud revenue growth is below expectations (25%-30% growth expected in FY24). The Enterprise pillar we regard as the most crucial one as it will attract larger customers to the platform. Establishing partnerships with global consulting firms like PwC, Deloitte, and Accenture is a significant achievement we think. And on ITSM, we acknowledge that there is progress but also think that it will not be easy as there is fierce competition with the market leader ServiceNow.

Revenue Deceleration is a Macro Issue

Atlassian’s revenue growth has been decelerating for the past five quarters, from 37% year-over-year in Q1 2023 to 21% in Q1 2024. The company’s guidance for Q2 2024 implies a further slowdown, as it expects revenue to grow by 17% year-over-year (see below)

This might seem worrying and imply that Atlassian is losing steam in its core business, but we know that this trend is very similar to the rest of the SaaS market. Almost all SaaS companies have experienced their growth moderating over the past 2 years and expect it to continue throughout 2024. For example, Snowflake’s year-on-year revenue growth dropped from 85% to 32%. Datadog’s decreased from 37% to 21%. Direct competitors Asana and Gitlab saw their growth rates fall from 72% to 17% and from 75% to 32%, respectively. So, we don’t view this indicator as something specific to Atlassian, but rather a macro issue.

SaaS Market Will Reaccelerate in 2025 and Beyond

Gartner predicts that global spending on enterprise software will increase by 14% in 2024, up from 13% in 2023. However, this growth will be mainly driven by public cloud services, AI, and cybersecurity segments, not SaaS. Gartner also says that organizations are prioritizing their IT budgets on cost control, efficiencies, and automation, rather than investing in SaaS projects that have longer payback periods. This suggests that Atlassian’s revenue growth might continue to decelerate in 2024, as customers will delay or reduce their spending on SaaS tools.

We expect that the SaaS segment growth will pick up again in 2025 and beyond, as the global economy will recover from the high inflation environment and businesses will restart their digital transformation initiatives. Furthermore, we believe that the SaaS market will benefit from the rising adoption of AI, IoT, and blockchain technologies, which will allow more innovation and customization for SaaS solutions. Atlassian is well-prepared to leverage these trends, as it constantly launches new and innovative products as a result of its innovation-first business strategy.

Competing on Many Fronts

We think that Atlassian’s main challenge is the intense competition it faces in the markets it operates in. The company is up against big players in the enterprise software space, such as Microsoft, Salesforce, Adobe, and ServiceNow. These competitors have larger customer bases, more diversified product portfolios, and stronger financial resources than Atlassian. They are also expanding their presence in the areas where Atlassian operates, such as collaboration, project management, and software development. For instance, Microsoft has been improving its Teams platform with new features and integrations, while Salesforce has been buying and integrating companies like Slack, MuleSoft, and Tableau. These moves threaten Atlassian’s market share and pricing power, as customers may choose more comprehensive and integrated solutions from its rivals.

Atlassian also faces strong competitors in its own dominant segments. For example, in the collaborative work management (CWM) space, the company competes with Asana, Smartsheet, Monday.com, and others, who offer better functionality, often at lower prices or with freemium models (see below).

In the IT service management space, the company competes mainly with ServiceNow, which has more experience and expertise in this domain (see below). Atlassian is trying to win in this space with its innovation and integrated platform strategy.

In the DevOps space, the company competes with GitHub, GitLab, and others, who have more market share and mindshare among developers (see below). Atlassian may find it hard to differentiate and defend its products and services against these competitors.

Unfortunately, Atlassian doesn’t break down its revenue performance per its software segments, so we don’t have any insights into how the company is performing in each of its segments (CWM, ITSM, and DevOps).

R&D Overspending is a Risky Bet

R&D spending is often a key indicator of a software company’s ability to innovate and differentiate itself from its competitors. Atlassian’s strategy to cope with competition is to innovate and deliver more products to the market at a fast pace. The company also invests its sales and marketing money into R&D, as it believes that great products sell themselves. This is a great strategy, but it also comes with some challenges. Atlassian has to spend a lot on R&D to enhance its existing products, as well as to launch new products and integrate its acquisitions.

Atlassian’s R&D spending is very high compared to other software companies, as it allocates around 50% of its revenue for R&D (see below).

According to a BCG report, the average software company spends about 20% of its revenue on R&D, while a high-growth SaaS company spends 26% (see below). Atlassian, however, spends much more than that and still not getting the expected return on its heavy R&D investments. As per BCG’s R&D index, for a company that spends 50% of its revenue on R&D, the expectation is to achieve at least 40% revenue growth (see below), which is not the case for Atlassian. This clearly shows that Atlassian is facing very fierce competition in its segments and is not getting the returns on its R&D spending.

We believe that one of the main reasons for Atlassian’s limited R&D return is that it is trying to enter new segments beyond its core areas, such as ITSM and DevOps. These segments require significant R&D investments, as they involve complex and evolving technologies and customer needs. We also think that Atlassian’s acquisitions make its R&D more costly and inefficient. Acquisitions add more complexity to the integration process and increase R&D costs. Atlassian has to deal with different technologies, architectures, and cultures across its acquired products and teams.

It’s clear Atlassian is taking some risk here and betting that its huge R&D investments will pay off in the long term. Although we like the big bet approach, we also think that Atlassian is no longer a startup and needs to be more careful with its R&D spending. Spending R&D at such a high level is risky, as it can harm shareholder value.

Valuations Too High

Atlassian’s stock price has surged by over 60% in the past year, hitting a value of $242 on Jan 19, 2024. However, this recent rally may have been excessive, as Atlassian’s valuation has become too high. Atlassian’s stock is trading at a P/S ratio of 16, which is overvalued for a company that is growing at around 20% levels.

These high valuations show that the market believes in Atlassian’s growth potential but is underestimating its risks. It is expecting Atlassian to deliver strong revenue and earnings growth in the coming years, despite the current macro challenges and rising competition. Failing to meet these high expectations could trigger a severe correction in the stock price of Atlassian. Therefore, we are reluctant to recommend Atlassian stock at its current levels, as the risk outweighs the reward.

Conclusion

Atlassian is a leading SaaS company that has revolutionized the collaborative work management space with a unique business model and has achieved impressive growth in the past few years. With a cost-effective sales and distribution model, a diversified portfolio strategy, and a strong focus on innovation, the company is pursuing ambitious goals and entering new markets such as ITSM to maintain its growth momentum. Although its revenue growth has been slowing down significantly, we believe that it will re-accelerate starting in 2025 and the company’s big bets will pay off in the long term. Our long-term outlook for Atlassian is positive.

However, the stock is facing some significant risks that could affect its short-term performance, such as macroeconomic uncertainties, competitive threats, and valuation premium. We think the current valuation is too high as the market has already factored in all the positives. Therefore, we are cautious at this point and rate it as a Hold for now.