Atlassian: I expect Strong Gains In the next two years

By my valuation standards Atlassian is very cheap. The company has downside protection because it can easily improve profit by reducing the massive R&D investment. At the same time, the large R&D investment gives, us Atlassian investors, protection against architecture changes in the software development supply chain. Atlassian is a very large position in my portfolio since it reached its 52-week lows. I rate Atlassian a strong buy.

Atlassian provides a comprehensive platform that enhances companies looking to become more digital.

Atlassian provides strong tools for companies looking to produce and manage more technological projects. From agile software development to machine learning and BI projects.

By breaking down silos and uniting product management teams with more technical teams, Atlassian brings a strong value proposition for nowadays companies.

Jira and confluence provide both the ability to conduct agile projects and save information about the project status and history. Rovo gives an extra boost in productivity by searching the Atlassian database with effectiveness and retrieving important information.

Additionally, Atlassian has the ability to ship and manage code using a modern continuous integration (CI/CD) and continuous delivery framework with Bitbucket. All integrated with Jira and Trello to better monitor the projects.

Atlassian also has a strong marketplace. Although it doesn’t generate a big chunk of revenue it enhances the platform offering. To compete with other CI/CD companies such as Gitlab (GTLB), its marketplace offers strong solutions for secret detection, static code scanning, vulnerability scanning, among many others. On the other hand, it also allows teams to integrate with more advanced CI/CD and code analytics tools like Gitlab, providing a strong offering for their customers.

Gen AI coding and management agents could disrupt Atlassian core management architecture.

Due to the automation that AI is bringing, Atlassian is trying to position its platform as a tool that, firstly, brings AI to improve search and product management and, secondly, could be a tool that AI uses to better manage projects and create content.

With its Teamwork graph, that connects tasks, projects, goals, code, documentation, and conversations into a single graph, AI tools have the information to search and understand what is happening on the platform.

I strongly believe that in the future with the creation of capable and autonomous gen AI agents, these models could use the rich data ecosystem that Atlassian provides for autonomous actions and better information management.

Thus, AI could be used inside Atlassian’s platform and, also, outside AI could be brought to work with an Atlassian seat.

Of course, this could be a massive architectural change, and many new players could enter the productivity software business, bringing software that is optimized for autonomous seats.

However, Atlassian has an interesting opex capital allocation, where most of the money goes to R&D and not S&GA. With this strong R&D investment Atlassian could use its established moat as one of the standards for tech and project management work. This way, finding the perfect balance between gen AI usage and human usage.

There is some uncertainty about TEAM’s future prospects if the arrival of autonomous gen AI agents, with both coding and project management capabilities, happens. It could impact the growth of software development seats and even non-technical management seats.

Despite this, in uncertain environments, where the downside is somewhat realized and the upside could be large due to growth acceleration or even growth stability, Atlassian could be a strong investment for the next year.

Atlassian has downside protection because it can easily cut its massive R&D investment and still be an effective R&D company.

At this inflection point, where gen AI tools like Rovo are further integrated in the platform, gross margins should be impacted to the downside. Companies like Monday (MDAY) and Atlassian (TEAM) do not show the impact of higher computing by gen AI tools. This is positive for both businesses but it is something we should monitor in the future.

A major component of the bull thesis that impacts both valuation and resilience against a possible architecture change in project and software management is the very high R&D investment by TEAM.

In my opinion, the R&D opex is easier to reduce than Sales opex. TEAM, that overinvests in R&D could massively make a profit by cutting, for example, half the R&D investment. Some people could consider this very aggressive, but if TEAM cuts half the R&D its investment, it is equal to Datadog (DDOG) investment in research. Datadog is also very know for its strong R&D capabilities.

Furthermore, by having a very lean, intelligent and strong brand derived sales process, TEAM can strongly invest in R&D and thus spend more engineering time in optimizing the platform for gen AI usability, while enhancing the platform by developing more integrations with new tools and acquired companies.

Despite the gen AI automation, new digital jobs could be created fueling Atlassian’s growth.

I strongly believe that with the growth in productivity fueled by gen AI, real income will increase across all industries and new jobs will be created, compensating for the loss of jobs due to AI automation.

The key question is if these new jobs will provide seats for Atlassian. This uncertainty is weighing down on the stock. But I’m willing to bet that Atlassian database and interface will likely adapt to autonomous agents and will be a good platform to manage the same autonomous agents.

In the next transcript extract, TEAM’s management discusses that, from their point of view, the programming workforce will not drop in the future. In the event that gen AI coding tools are much better than, for example, 80% of the programmers, coders will have to take on more testing and product owner roles. We should also consider that more software will be created, not reducing the coding workforce but fueling the digitalization of companies.

Keith Weiss

There's a lot of concern around cogeneration tools and the changing role of a developer, which you seem to see as a positive versus the market seeing as more of a negative.

Michael Cannon-Brookes

I think you kind of have to look at a high level. Let me give you some assumptions that I have or some beliefs. Do I think there will be far less developers in the world 5 years from now? No, I don't think so. I think there'll be far more and far more people creating software in other functions, right, whether they're in finance or HR or marketing, there's going to be a lot more people creating software.

Do I think developers roles change and augment with these tools? Yes. Develops as use of that. This is a big change. It's super productive. We see that internally, but there's still a lot of -- awful lot of work to do, right?

Do I think more people will be creating software? Yes. Do I think more software will be made in the world? Yes, I think there'll be far more software and technology made that they need to be managed, right? Far more people creating software and far more technology significantly expands our opportunity.

Software creation is becoming more efficient. Cost of software building going down. This is all really good for Atlassian and our workflow tools.

Lately, Atlassian has been investing in heavy acquisitions that could impact performance.

Another uncertainty affecting Atlassian is the strong investment in acquisitions when money could be used, for example, to do buybacks. And these acquisitions are sizable, even considering Atlassian’s market cap.

Both The Browser Company and DX are interesting tools. I’m more convinced by the browser acquisition because it expands the Atlassian data graph and engages with the very important dimension of secure and intelligent enterprise browsing.

However, DIA (The Browser Company’s Browser) is not as effective as other tools, creating some R&D and product quality risks for Atlassian.

Valuation

My preferred way of valuing tech companies is by using the earnings power framework exposed by author Adam Seessel.

Because tech companies pump the excess gross profit in Sales and R&D to protect their moat and fuel their long-term growth, we could try to understand what the potential operating profit could be if Atlassian was looking only to optimize the next few years profit.

I strongly believe Atlassian could produce a 25% or higher operating margin on its current revenue and still keep business working at an interesting pace. This could be done by reducing R&D investment by half and slightly reducing the S&GA investment.

Under this valuation framework a 20 fwd PE could be a strong value play. The PE I get is around 29, but I’m being conservative only considering a growth of 15% and the lower range of the potential operating margin.

Conclusion

Atlassian has a strong ecosystem, strong brand and intelligent sales process which allows the company to invest in better product quality than peers. In the future, there could be a large architecture change in software development creating some uncertainties about Atlassian prospects. But I still believe that the company will survive with the arrival of strong gen AI agents, mostly because of its strong project management capabilities that are still needed even if the gen AI does most of the coders work.

Atlassian is at a very low valuation. Even being conservative, it gives me a PE somewhat close to 20. This is my biggest stock position in my portfolio, and the position is very large. I consider Atlassian a strong buy.