Atlassian is unprofitable — the market has its valuation wrong –

Atlassian founders Mike Cannon-Brookes and Scott Farquhar. Source: supplied.

Until a few months ago, no company had created more wealth for its shareholders than Sydney-grown Atlassian. At its peak in October 2021, the Nasdaq-listed business was valued $162 billion. At the time, Atlassian was one of the most valuable Australian companies that ever existed (behind only BHP and CBA, both of which are more than a century old). Atlassian was founded by two university graduates in 2002 using credit card debt.

Even more impressively, Atlassian was able to reach an incredible scale without ever raising money from venture capitalists to fund its early growth. It’s only investment round was from US-fund Accel, which bought shares off existing holders in 2010 before the company listed in the United States in 2015. That means Atlassian’s co-founders and co-CEOs, Mike Cannon-Brookes and Scott Farquhar, remarkably still own around 21% of the business each. For a brief period last year, they were the two richest people in Australia with a combined net worth of well over $70 billion (the duo have also made billions from a prescient investment in the US$55 billion Canva).

But as we’ve since discovered, markets often get it badly wrong and the tech sector has rapidly corrected, with high-profile stocks like Netflix (down 72%), Zoom (down 79%) and Meta (down 56%) hammered, as central banks slowly return interest rates to normal levels. Atlassian hasn’t been immune from the carnage, collapsing 55% from its bubble induced highs.

That drop however may be just the tip of the iceberg, with Atlassian still valued by the market at US$52 billion (75 billion), more than 11 times what the business was valued at when it went public in 2015.

In its most recent earnings report released in April, Atlassian announced that revenue for the past nine months grew from US$1.5 billion to US$2.04 billion ($2.95 billion) (or around 24%). Subscription revenue grew faster, but that was offset by losses in legacy businesses. Even with the near 60% share price calamity, Atlassian is trading on a multiple of more than 19 times sales. If you’re trying to work out what its price-earnings (or EV/EBITDA multiple) is good luck, Atlassian doesn’t make money these days, in fact, it loses money, lots of it.

This was perfectly acceptable in 2021, where investors’ bubble epoque ‘risk on’ stance led to them ignoring any sort of fundamental value analysis, now, not so much.

But Atlassian’s major problem isn’t only that it’s not profitable (Jeff Bezos showed lack of profitability over decades can be forgivable), but that its business is growing a lot more slowly than it used to and it now needs to spend a lot of money on marketing to achieve that growth. Atlassian was able to grow so quickly and profitably during its first decade of existence while famously spent almost nothing on marketing, instead relying on ‘product-led growth’. That is, CTOs and CPOs loved Atlassian’s revolutionary Jira product so much, it was able to grow virally and organically without the business having to spend millions of dollars on an enterprise sales team.

Atlassian’s prospectus noted that in 2015 the business grew by 48%, around double this year’s growth. Even more ominously, for a business that would regularly boast of not having a single salesperson, this year Atlassian is spending almost US$600 million ($866 million) on sales and marketing. Combined with employing more than 8000 people, this means that Atlassian is unprofitable, losing more than US$500 million ($722 million) for the first nine months of this year. Don’t forget, Atlassian isn’t a startup, it’s a 20-year old business. As a comparison, in 1995, 20 years after its founding, Microsoft generated US$6 billion in sales and made net income of $1.5 billion. After 20 years, Google was generating US$145 billion in sales and US$31 billion in net profit.

Atlassian has somehow become the Benjamin Button of the tech sector — profitable as a startup and loss making as it has matured.

While Atlassian will point to its positive operating cashflow as a proxy for EBITDA, Atlassian’s cash flows are positive only because it uses lots of equity to pay its employees.  It will pay more than US$700 million ($1 billion) to staff in share-based payments, that’s almost all operating cash flows.

Atlassian’s offices. Source: Atlassian.

This leads to an even bigger problem — and possibly explains Atlassian co-CEO, Scott Farquhar’s recent posturing on allowing workers to never have to come back to the office. Working for Atlassian has recently become a lot less lucrative. Most Atlassian employees who received equity in the last two years are likely to be underwater, that’s a massive pay cut for employees of a business that until a few months ago had probably minted more millionaires than any other Australian business. Atlassian’s HR team will also have a real problem recruiting and retaining staff given the ability to cash in on Atlassian’s ever-rising equity value is no longer reliable. (The market irrationally inflating Atlassian’s share price isn’t Atlassian’s fault of course, but it now has to deal with the very real impact).

To make matters worse, Atlassian’s legacy Jira product is clunky and has barely evolved in a decade — it’s essentially a ticket-based system which allows developers and product managers to communicate on tasks and is no longer loved by developers. Interestingly, Atlassian’s chief technology officer, Sri Viswanath, is departing the business. While it is still used by many tech businesses (including the author’s), it has no real network effect — that is, users can switch to a competitor product like Asana, Basecamp or Monday.com with minimal cost (other than the initial hassle of switching to a new system). This also explains why Atlassian has gone from boasting about not employing a single salesperson to spending almost US$600 million on sales and marketing.

In short, Atlassian is a two-decade old business with rising costs and an increasingly legacy product operating in a very competitive market. Despite that, it is still valued by the market at almost 20 times revenue. Given its slowing growth and lack of profitability and the increasing scepticism of tech investors generally, Atlassian could return to a more rational multiple of five times revenue, meaning it would be worth closer to US$10 billion than US$50 billion. Salesforce, another giant enterprise software business with a similar growth profile and profitability trades on a multiple of less than six times annual revenue (having a market value of US$185 billion on US$31 billion of sales).

If Atlassian was priced like Salesforce, Cannon-Brooke’s and Farquhar holdings would be worth around US$3 billion ($4.33 billion) each, which still would mean they are two of Australia’s most successful ever founders, albeit with a fraction of their former wealth.

Cannon-Brookes and Farquhar appear to agree the market got it wrong. The US market is far more accepting of founders selling equity and since 2016, the co-founders have shrewdly sold around 15 million shares each through planned sales. These sales are continuing in 2022 and so far, have netted Cannon-Brooks and Farquhar upwards of $2 billion each.