Atlassian

Atlassian reported fourth-quarter results that once again crushed guidance, with revenue up 28% year over year to $1.766 billion and non-GAAP operating margin of 36.0%, versus the high end of guidance at $1.661 billion and 30.5%, respectively.

Why it matters: Atlassian continues to report results that blow consensus estimates away. Revenue upside was largely driven by cloud acceleration, broad-based seat expansion, and cross-selling, and not revenue pull-forwards, which is a very high-quality beat in our view. Cloud revenue accelerated to 31% year-over-year growth to $1.214 billion, while data center grew 21% to $462 million and marketplace grew 20% to $91 million. Cloud and marketplace were meaningfully better than we anticipated. Data center migrations did not contribute to cloud strength, unlike last quarter. Artificial intelligence data points remain clearly favorable and highlight the stark disconnect from the all-encompassing software selloff. Rovo users are growing their spending at more than 2 times the rate of nonadopters, which signals that the firm can still thrive in the AI era.

The bottom line: We maintain our fair value estimate for narrow-moat Atlassian at $220 per share. Considering the AI data points, quarterly results, good guidance, and accelerating buybacks, we continue to see shares as attractive.

Coming up: The deceleration in fiscal 2027 that we dreaded in our third-quarter note arrived, with management calling for 13% revenue growth for the year and a non-GAAP operating margin of 25%. We think this guidance is conservative and may border on sandbagging, especially given stellar results over the past few quarters. The first-quarter outlook includes total revenue of $1.710 billion and non-GAAP operating margin of 28.5% at the midpoints. Given the momentum in pricing trends, retention, seat expansion, and cross-sells, we think the implied deceleration after the first quarter may materialize, but just not at the guidance rate.

Our fair value estimate for Atlassian is $220 per share, which implies a fiscal 2027 enterprise value/sales multiple of 7 times and adjusted price/earnings multiple of 40 times.

Our forecast centers around cloud growth after its model transition. We assume there will be some near-term variability to results given Atlassian’s appeal to small teams at organizations of all sizes and the web-driven sales model. We model a 14% CAGR over the next five years for total revenue, with subscriptions driving growth.

We model non-GAAP operating margins increasing from 30% in fiscal 2026 (actual) to expand by several hundred basis points by fiscal 2031. We see this as driven by scale across all operating expenses, mainly research and development, as the transition matures. The company does not offer long-term operating targets. However, we anticipate that Atlassian should eventually have margins near the upper end of the peer group given the mostly low-touch sales and marketing approach.

We assign a narrow moat rating to Atlassian based on switching costs. The company generates revenue from both software sales and other services. We believe Atlassian's software-related revenue has a narrow moat, while services and other revenue has no moat. In our view, switching costs have historically enabled the company to generate returns on invested capital in excess of its cost of capital, and will more likely than not drive continued excess returns over the next decade.

Switching costs for software are often driven by several factors in our view. The more critical the function and the more touch points across an organization a software vendor has, the higher the switching costs. There is also the direct time and expense of implementing a new software package for the customer while maintaining the existing platform and retraining employees on a new system. Additionally, there is operational risk of changing software vendors, including business process re-engineering, loss of data during the changeover, and overall project execution. A major implementation is likely to involve a system integrator and can take in excess of a year in bad cases. Last, lost productivity is likely to be an issue as customers move up a learning curve on the new system along with the distraction of users involved in the function where the change is occurring.

Retention metrics typically help inform investors on both the presence and the durability of a moat. These come in two flavors: gross, which describes what percentage of the customer base remains customers after a given period; and net, which highlights what percentage of the customer spending is retained by the software provider after a given period. Despite a healthy mix of small and medium-size business revenue in the overall mix, we still estimate that customer retention is north of 90%, which is solid, as SMB customers tend to have higher churn.

Atlassian provides project planning and management software, collaboration tools, and service desk solutions. Key products include Jira Software, Jira Work Management, Confluence, Jira Service Management, Trello, Jira Align, and Bitbucket. The company’s first product, Jira Software, helps software developers plan and manage coding projects. Jira Software is frequently used in conjunction with Confluence, the company’s main collaboration solution. Over the years, the company’s workflow software has been adapted to teams and processes outside of software development. Atlassian recognized this and in 2013 formally launched Jira Service Desk, a workflow solution that applies a ticketing and automation logic. The main uses for Jira Service Desk have been IT help desks, customer service, HR, and compliance, but the use cases are broader still. Once these software products are adopted, we believe they become integral to the workflow of software developers, or within the IT function, which we believe establishes switching costs as a moat source for Atlassian.

Atlassian’s customer gathering effort differs from most enterprise software companies. Whereas the vast majority of enterprise software providers push larger deals through a direct salesforce in a lengthy qualification, product-proving, and relationship-building process, Atlassian sells its software over the internet without a direct salesforce. In fact, the vast majority of transactions occur on the company’s website, further reinforcing the notion that the customer base skews more toward small and medium-size businesses. This dynamic is on display in the company’s income statement, which shows sales and marketing expenses are the lowest as a percentage of revenues within our coverage. Further, Atlassian offers free versions with limited functionality to attract new users and encourage adoption.

Our general view is that enterprise software companies compete on features and functionality rather than price. In this case, our assessment is that Atlassian competes on both vectors and has purposefully elected to do so. Attacking the market in this manner makes sense to us. On the pricing front, the company can simultaneously offer competitive (or better) pricing and buying than legacy competitors while offering competitive features. This approach to selling software made it quick, cheap, and frictionless to try or buy Jira. From the company’s perspective, it believes the opportunity in front of it is enormous and freely admits to being in land-grab mode, noting that there will be time to optimize for price in the future.

While Jira’s low price, particularly on the Service Desk solution, is part of Atlassian’s strategy, its solutions are not low-end. Indeed, most industry observers would consider Atlassian a good option that should be considered for service desk and agile planning use cases. Our assessment is that Service Desk is a compelling product and continues to garner recognition and traction, and that the software development tools are a popular option as well. While the company’s sales and marketing expense line might be on the low end compared with peers, its research and development expense is at the high end of the spectrum among peers. Competitors on the software development tools side include Microsoft, Oracle, Amazon.com, Google, and Broadcom, while competitors on the service desk side include ServiceNow, BMC, IBM, Micro Focus, and Ivanti.

Atlassian’s growth has been strong and is expected to remain so, with robust new customer adds, client retention, upselling, and the introduction of new solutions.

The company is disruptive to existing markets, especially to legacy software providers. Additionally, Jira Service Desk has dramatically expanded the addressable market beyond the IT function.

Because Atlassian has a limited traditional direct salesforce, its sales and marketing expenses are materially lower than its peers’, driving already solid non-GAAP operating margins and allowing for expansion over the next five years.

Atlassian has traded at lofty valuations at times, and while it might continue to generate strong growth, the company may fail to live up to the optimistic assumptions that are sometimes embedded in the share price.

As most software vendors have focused on driving down stock-based compensation as a percentage of revenue postpandemic, Atlassian has not, and therefore its SBC remains relatively high.

The cloud transition aspect makes analysis of the company more challenging as comparisons for growth and margins are distorted.