Software development and collaboration tool provider Atlassian Corp. PLC (TEAM, Financial) is trading at an absurd valuation, yet guru investors Jim Simons (Trades, Portfolio), John Paulson (Trades, Portfolio) and Chuck Royce (Trades, Portfolio) continue to add to their positions.
Granted, the company has built an incredible platform of services using free trials to attract users, similar to how Salesforce.com Inc. (CRM, Financial) created its software-as-a-service organization. The company prides itself in not having built a Salesforce, however.
Regardless, it has a $9 billion market capitalization. Maybe it is because of a void in the market for new big-name cloud software companies, but with Atlassian reporting earnings this Thursday after the market closes, traders have priced in too much future growth too early.
Atlassian has 80% gross margins, spending all of its gross profit on operating expenses, leaving a deficit on the net income line for the last six quarters. With research and development at the heart of the company, engineering and innovation costs will only increase over time. So while analysts are looking for 44 cents in EPS in 2018 and 60 cents in EPS for 2019, these earnings projections may be way off course.
The company has had to issue stock to fund recent purchases like the collaboration service Trello, a project management app with 19 million users. Long term, investors may find the company is able to produce high returns on capital, but despite massive growth across its product line, it needs to start producing a profit.
Financially speaking, Atlassian has $550 million in cash, most of which is from its initial public offering. It has driven annual revenue up from $149 million to over $620 million. Last quarter, the company booked nine cents per share on $174.3 million in sales. It is not hard to see how a 36% quarter-over-quarter growth rate would get investors' attention. While sales are on track to break the $1 billion annual run rate by next year, it is only a matter of time before they drastically slow down. The scary part is that as long as this growth rate continues, the stock could keep inching higher.
We are living through a bull market not held down by the gravity of interest rates. In addition, inflation will continue to cause certain assets to be overvalued. The problem is no one knows when the music is going to stop. But when it does, companies like Atlassian, if they remain priced at 11 times forward revenue and 65 times earnings, will be revalued a lot lower.
Disclosure: I am not long/short any stocks mentioned in this article.Â
