Atlassian’s Cloud Segment: Key Revenue Driver, More Than Fully Priced (NASDAQ:TEAM)

Investment Thesis

Atlassian Corporation (NASDAQ:TEAM) helps teams work together more effectively. Their software products, like Jira and Confluence, are used for project management and collaboration. Atlassian’s platform helps businesses streamline their workflow and improve productivity by providing solutions for organizing tasks, and sharing information, and tracking progress on projects. It’s a well-placed business.

Nevertheless, this is my investment thesis in a short sentence: TEAM is a stock that is too expensive for what it offers investors.

More specifically, I estimate that Atlassian Corporation stock is priced at 36x forward free cash flow, with an inflexible balance sheet, and decelerating growth rates.

Therefore, I’m giving this stock a wide pass, as I’m finding much better opportunities elsewhere, particularly given the breather stocks have had of late.

Rapid Recap

Back in November, I said,

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

As it turns out, my caution was rewarded, see below.

Since I penned my previous analysis, Atlassian’s stock has gone nowhere fast. In fact, Atlassian has substantially underperformed the S&P 500 (SP500), which delivered 12% in the same period versus less than 5% for TEAM. Indeed, I reiterate that TEAM is too richly priced for investors considering the stock now with fresh capital. Here’s why.

Atlassian’s Near-Term Prospects

Atlassian has achieved solid prospects in the past, nobody questions this.

However, looking ahead, Atlassian needs to address how to maintain its growth trajectory and competitive edge. And that’s the key blemish in this thesis.

One prominent challenge lies in the fluctuating performance of its cloud business, which has seen a deceleration in growth rates over the past few quarters. Despite strong migration efforts from server to cloud, the underlying growth in the cloud segment has shown signs of slowing down, particularly in paid seat expansion, especially within the SMB segment.

Indeed, before we go further, we should come to terms with Atlassian’s biggest revenue driver:

What we see above is that approximately 60% of Atlassian’s revenues come from its cloud business unit. Hence, whatever happens within its cloud business has an overhanging impact on Atlassian’s revenue growth rates.

Perhaps, to put it more simply, one could make the case that this is to a large extent a cloud business and that its other segments’ performance, are to some extent, a distraction.

Accordingly, I declare that investors should observe the trend in the table above. Getting a firm grip on Atlassian’s cloud growth rates is what will determine the success or failure of this investment thesis.

Given this background, let’s now delve deeper into Atlassian’s financials.

Revenue Growth Rates Are Moderating

There was a time, not too long ago, when Atlassian could be relied upon for more than 30% CAGR on a consistent basis. But now, in the past several quarters, investors have had to embrace a rather rapid deceleration in Atlassian’s growth rates to the low 20% CAGR.

Aside from the obvious consideration that more growth is undoubtedly more attractive to investors appraising the stock for the first time, decelerating growth means that the stock isn’t able to support a high “growth premium.”

Consequently, investors will have to face two different headwinds in the next twelve months. Not only will Atlassian’s growth rates most likely continue to decelerate, driven by Atlassian’s cloud business reaching maturity, but with less growth, this means that Atlassian’s stock will no longer support a “growth premium.” Thus, let’s now turn our attention to Atlassian’s valuation.

TEAM Stock Valuation — 36x Forward Free Cash Flow

As it stands right now, I estimate Atlassian holds approximately $700 million of net cash. This means that Atlassian with its $50 billion market cap won’t find too many needle-moving acquisitions worth making for the relatively small sum of capital it holds on its balance sheet.

Therefore, Atlassian has to solely rely on its organic prospects to reignite its growth rates.

Accordingly, presuming that in the upcoming fiscal year of 2025, Atlassian manages to achieve its ambitious objectives of maximizing its free cash flow margins to 30% and expanding its revenues to $4.5 billion — a formidable task with no certainty of success — this could potentially translate into approximately $1.4 billion of free cash flow at some point during next year.

Therefore, this means that in the best-case scenario, as Atlassian moves forward into the next fiscal year, this stock is priced at 36x forward free cash flow.

The Bottom Line

In conclusion, while Atlassian Corporation undoubtedly offers valuable solutions for enhancing team collaboration and productivity, I believe that its current valuation is excessively optimistic and priced for perfection. Despite its solid track record and potential for growth, the stock appears overvalued at 36x forward free cash flow, especially considering its decelerating growth rates and the challenges it faces in maintaining momentum in its cloud business.

Given these factors, I’m looking elsewhere for more attractive stocks.