February 4th and February 5th, 2016, are days that will live in infamy if you happened to be an investor in Tableau Software (NYSE:DATA). It is without contention, I believe, that in many ways, particularly that of growth and technology innovation, that Tableau Software has been an exemplary company and a great investment until many key assumptions were challenged based on a disappointing earnings release and surprisingly muted guidance. The natural reaction when one sees shares of a company that is still forecasting a 30% growth decline by 50% is to buy the implosion thinking that investors have simply had an incredible and unwarranted brainwave. There are many decent companies in the enterprise software space that will never achieve 30% growth and have sold for more than 3X EV/S, the current metric for DATA. There are often times when the market mis-prices assets in the wake of an earnings disappointment as a company's shareholder base turns over from purely momentum driven investors to those looking for growth at a reasonable price. Most analysts are convinced that the market for data visualization tools and templates is very large and that Tableau continues to maintain a leadership position in the market. It is my own view that perhaps there are alternative and less benign explanations for the growth slowdown and share price debacle that has ensued. I think that before making a purchase commitment to the shares just because they have decreased in value by 50% one simply has to consider the potential scope of the market, the likelihood of management's explanation for the miss, potential competitive encroachments and issues regarding sales force forecasting and sales management. Given that the Tableau story has one negative data point preceded by a whole host of positive quarters, it is unlikely that anyone can write with regard to the future. But there are certainly some patterns seen by this writer on other occasions that might shed some light on what is either a great entry point for investors or a true trap for the unwary.
Tableau was founded in 2003 by the company's current management team. It was the product of research that had been conducted at Stanford University which was focused on visualization techniques that could explore and analyze both relational databases and data cubes that were just then coming into wider use a part of data analysis solutions. Although I cannot claim hands-on experience, many trusted colleagues have told me that the solution set from Tableau is one of the really "cool" products in the software space and I think most readers understand that the mountain of data that arrives almost daily has to be analyzed and presented to decision makers in some easy to understand fashion if it is going to help them make real-life decisions. Tableau is a tool that does that and after some gestation period its sales took off. For those readers unfamiliar with the company's growth, revenues were $34 million in 2010 and they more or less doubled every year through 2013 when the growth percentage began to slow. Again just for the record, Tableau revenues reached more than $650 million last year and guidance suggests that the company will report around $850 million in revenues this year. As many other people have observed the company's operating expenses ballooned last year. To use tech management speak. it was a year of investment and not all of that investment was made efficiently or successfully.
While revenue growth for the full year was 58%, operating expenses grew by 71%. The trend was similar in the 4th quarter when revenues were up by 42% and operating expenses rose by 63%. There were some investors and observers who were discomfited by these trends - the shares had fallen from $127 to $80 prior to Friday's annihilation, but apparently the relatively low non-GAAP profits which reached $.62/share last year with non GAAP operating margins declining 10.3% from 12.9% in 2014 were at least partially accepted as the price one paid for the kind of growth Tableau had been achieving and was expected to achieve going forward.
Although there have been comments on the part of analysts and others about the strength of Q4 results, the fact is that non-GAAP operating margins declined from 22% to 15% in the period, again primarily because of the continued strong growth in operating expenses. There is no evidence that the company has done anything significant to curb the growth in operating expenses. And despite the muted growth outlook it has presented it seems as though management is planning for another year of investment that will reduce operating margins down to 5% at the high end of the guided range. Indeed, management expects to hire another 1,000 heads on a base of 3,000 - that is about the surest guide to the trend of operating expenses in a software company, and it plans on ramping capex from $45 million in 2015 to $100 million in 2016. Talk about pedal to the metal.
Tableau generated plenty of cash last year - $136 million which far surpassed its non-GAAP profits of $45 million. It has $795 million of cash and equivalents, close to $11/share or 27% of its current share value. That being said, it is almost inevitable that cash flow will decline significantly in 2016 and that free cash flow will decline precipitously during the year based on the make-up of its constituents. It should be noted that out of $137 million in operating cash flows, more than $113 million came from the net impact of stock-based compensation. I don't propose to get into a fruitless discussion of that metric but there are some readers with very strong viewpoints regarding the sources of operating cash flows.
Overall, earnings per share estimates for 2016 have come down by more than 50% since before the earnings release and the company's revised guidance. Consensus 2017 estimates also are probably down by 50% or more as well. (I should note that I use the Thomson/First Call estimates that are carried by Yahoo Finance. Writing soon after earnings it is inevitable that not all of the analysts who cover the stock have sent their revised estimates to Thomson/First Call. In the case of 2016, management has made some specific EPS forecasts which are certain to animate the consensus. In the case of 2017, management has not provided guidance but simply just judging from the changes in estimates made by the analysts who have changed their forecast it is very reasonable to believe that a 50% or greater reduction from prior estimates is the most likely scenario.). With those kind of revisions in consensus expectations, Friday's share price implosion begins to make a bit of sense - a combination of valuation compression coupled with substantial changes in the outlook for earnings and presumably cash flow as well, which almost certainly cannot maintain its current relationship to non-GAAP earnings.
The Real Issue - Why Has Growth Slowed and can the company achieve the new set of consensus expectations
At the end of the day there is really only one question on the minds of investors looking out beyond anything other than a trading horizon. Why did growth slow and how likely is it that Tableau can achieve the new set of consensus expectations? Sales growth based on the consensus forecast is expected to be 27% in 2017, down from 30% this year and with operating margins beginning to grow, but at quite modest rates. I think that one could make a reasonable case to buy the shares if one has reasonable confidence that the consensus numbers will be achieved.
Based on the preponderance of the evidence, I am dubious at best and more than a bit skeptical that the scenario represented by the consensus is, in fact, the most likely scenario. The shares may have a dead cat bounce - I would be surprised if they didn't but I think the world for visual data analytics has changed and has set up a new environment in which Tableau must operate. And that new environment is going to make it difficult for the company to achieve sustained growth in the 25%-30% range or to enjoy the kind of margins that many software companies of its size have typically achieved.
Tableau management suggested two interrelated phenomena for explaining its license revenue growth slowdown last and its expectation of significantly lower growth in 2016. Management has suggested that part of the growth slowdown was the product of some hesitation in the expansion of its current base of installed customers. The CFO's precise comment was that "I think what we are seeing inside of our customer base is more caution in how they were spending and how they were allocating dollars. And so…the beauty of our model is it allows people to expand in smaller increments that they want…"
In the same answer, the CFO went on to suggest that "there's stuff we have to do to tighten our approach…But we've got the right sales leadership in place and we're really looking forward to 2016…" Management was equally forthright in proclaiming emphatically that the company was not seeing any shift in the acquisition of its products from on-premise solutions to the server solutions that it offers through cloud deployments. Further, it also called out that "overall win rates, I wouldn't say, have changed dramatically. But we just saw kind of a softness in the overall spending…"
First of all, let me be emphatic in stating that I do not believe that anybody in Tableau management is anything less than forthright and transparent and that the answers and comments that management gave on the conference call were based on anything other than the best understanding and belief of the CEO and the CFO. This management has no record of being anything other than candid and I think the errors that they have made, if indeed they prove to be errors, are a function of simply not having the experience in dealing with a business slowdown. Many other observers including this author have seen dozens of these occurrences. Tableau is and has been a great company but it isn't quite unique. There are very few scenarios in the tech space that haven't been seen before.
Let's take the issue of sales productivity first. Obviously it is a bit of a stretch for management to proclaim that it has the right sales leadership in place when Kelly Wright, the woman who was the company's first salesperson in 2005 and quickly became the head of its sales operations, announced her retirement less than a month ago. Her retirement statement called the decision "bittersweet." One can read whatever one wants into that kind of a statement but in the wake of declining sales productivity coupled with muted guidance it might be inferred that something has gone wrong with the sales process and that the obvious focus of the blame is the VP of Sales.
I have to mention that finding decent sales people at the level needed to sustain the growth for this company might be proving to be elusive. The company grew its overall headcount by 50% last year and I'm sure it grew its sales headcount by a higher percentage than where it was a focus area for hiring. It plans to grow its headcount by 33% this year, again with a focus on sales. The math alone might suggest that there has been a very serious deterioration in sales productivity. If you have more than 50% more sales people and license sales are up by 31% that is very unlikely to be anything like what management might have planned. And if you are going to grow sales headcount by something above 35% and have license sales growth at something like 25% as a plan - let's just say that is not normally what one looks to see in a company of this scope.
We don't know precisely how many customer-facing reps Tableau has but given typical industry norms, the number has to be in the hundreds. It is just simply a daunting proposition to hire, train, coach and yes fire some proportion of an extra 100-200 sales reps per year over any extended period as well as deal with creating a sales management hierarchy and opening sales offices.
I might suggest several reasons for what's going on. One of them is that at the least I'm dubious about management commentary regarding competition. I'm not dubious about what this management is seeing in their competitive win/loss reports. But the fact is that when competition becomes a problem, win/loss reports frequently don't reflect the reality on the ground. Imagine trying to tell your boss, who basically conceived of this product and feels that it is the same to him as a first born, that you are losing deals to the competition. You are basically confessing that you are losing deals to an inferior technology because you were out hustled - if that actually happens in the real world I confess to never having seen it myself.
I would remark parenthetically that none of the three founders of this business who are still its core management team has any specific experience in running a large tech sales operation. And basically the same applies to Kelly Wright who had previously been an individual sales contributor at Southwestern, Dale Carnegie and Bank of America. So I think it is far more reasonable to imagine that the sales machine at Tableau is sputtering simply because of the company's massive growth and new people are going to have to come in and figure out how to get the gears to mesh smoothly. It is hard for me to envision that trying to add 35% more sales people in the midst of that kind of transition is an optimal strategy. It is one that might leave me and many other observers shaking our collective heads.
I'm really not going to try to comment here regarding Tableau's competitive situation. I first became familiar with this company more than four years ago and I was told at the time that it had the best visualization solutions in the world. I'm simply not qualified to comment if that is still the case. But at the end of the day we are talking about desktop applications here and Tableau has had a target on its back for more than a few years now. Is it not at least possible that the solutions that are now available from Microsoft (NASDAQ:MSFT), Amazon (NASDAQ:AMZN), Salesforce.com (NYSE:CRM) and many others are "good enough?" Is it not possible that a potential customer might consider buying a desktop application from a company that already sells the bulk of what is used on corporate desktops? Is it not at least feasible that users might consider buying a visualization solution from the company that just sold your company its web storage or a sales force automation application? Is it not conceivable that even if, as a CIO, one wants to go with best of breed, that the organization will mandate the consideration of the plethora of competitive offerings, significantly lengthening average sales cycles and mathematically requiring more sales contributors to achieve a given growth in volume? I think it would be very hard to believe that DATA is not seeing some of these impacts even if its competitive win/loss reports don't look much different than they have done in the past.
Now let's take a look at the issue of growth within current users. This is a company with a land and expand culture. The company is built on the premise of bringing useful data visualization to the"masses" - the company's word, not mine. The real question, at least to me, is to what extent "the masses" really want to deal with the creation and the analysis of visualized data. Most large companies have discrete professional data analysts. They probably love using Tableau - certainly their testimonials ring true and I have been told that ease of use is one of the great attributes of the product and that it has one of the steeper learning curves that has ever been known on the desktop. Does that mean companies with professional data analysts are going to train thousands of their employees to build dashboards and sift through data? I simply wonder how much data visualization is necessary in order to empower non-decision makers?
The fact is that this company has had lots of success in selling very large deals that actually facilitate this so-called "democratization of data." But to what level is it necessary to empower the head of the mail room or the stockroom or logistics managers to create their own data empires? Might the use of data analyst professionals actually produce better results? I would guess that part of the problem is that Tableau is simply having a harder time in closing the large deals that have been part of its sales operation for no other reason than some IT managers and some senior managers simply do not want to see their entire staffs spend their time working on data visualization projects.
Here is a comment made by the CEO during the conference call quoting a user that might illustrate my point. "Business leaders now wake up with the latest performance numbers in their inbox. Users across the company (by the way this is a Uber like taxi company based in Malysia) drill into dashboards and visualizations to answer further questions. They shifted their mindset to making data-driven decisions?" Data-driven decisions are good - well other than at the Fed, I suppose. But using the executive staff of a company to develop their own dashboards and visualizations doesn't really seem all that optimal to me. Never having had the experience of running a taxi company in Malaysia or anywhere else, I simply wonder what it is that the executives might be doing - analyzing gas consumption or average trip length or driver idle time on a daily or hourly basis.
Clearly I can't prove that some or all of my suppositions are what is really happening and to some my guesses as to the sales problems faced by this company may sound like heresy. But analysts are supposed to be a bit like Sherlock Holmes and in this case tracking down the source of sales disappointments, no matter how unaccepted the explanations might be amongst many fans of Tableau, is necessary before trying to make a recommendation regarding the shares. I think that the problems revealed by Tableau's Q4 results and its forward guidance are not likely to be "one and done" and I wonder if the issues management is now wrestling with can be resolved readily in even the intermediate term future.
I certainly agree with one of the writers on the Seeking Alpha site that a company that might sustain a 30% growth rate is probably worth 3X EV/S. But I have my doubts regarding the feasibility of sustaining the growth rate and I wonder if the spending the company is budgeting is necessary just to allow it to stay in the same place in the market.
I am as sure as a non-technical person can be that Tableau has a great solution and that its founders have played a significant role in advancing the future of the analytical and visualization technology space. Whether their product remains peerless is hard for me to determine but for the moment I will accept that it is the best technology available.
But that doesn't make Tableau a winning stock, not even in the wake of a natural split. I suspect that many user organizations simply are finding that they don't need tens of thousands of desktop visualization platforms and yet this company needs those kinds of customers to grow as it has been or even to sustain 25%-30% growth going forward. I suspect that competition, even if not offering quite as good a product, is lengthening sales cycles and is chipping away at the company's market share. I imagine that it has proved daunting to try to hire at the prodigious rates that are necessary to sustain enough growth in sales capacity. I imagine that management, smart though it may be, simply hasn't the experience to deal with all of these problems simultaneously. Even with a 50% share price haircut, I do not think that the risk/rewards are yet on the side of the investors with the exception of some kind of dead cat bounce which I imagine will be impending.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.