Appian: Still Frothy Amidst Competition Within Low-Code Space, And Rising Interest Rates

Summary

• Appian's valuation is tough to justify despite the attractiveness of its operating segments.
• Topline growth guidance continues to be masked by the shift to a subscription business.
• The forward guidance for profitability is also weak. Unprofitable growth stocks appear to be underperforming in 2021.
• Given the competition within the low-code space and rising interest rates, I expect the multiple expansion motion to remain weak.

For Appian (NASDAQ:APPN), the case for buying the recent dip is weak. The modest growth outlook, declining profitability, weak momentum, and frothy valuation relative to peers make it tough to project a near-term rebound. I am projecting more mean revision in the near term. In the long term, Appian needs to keep investing in its platform to pull away from competitors as it remains tough to pick a winner in the low-code space.

Demand (Bullish)

Low Code-BPO-Digital Transformation-RPA

My bullish rating on Appian's growth outlook stems from the opportunities within the low-code space.

Appian provides a low code platform that employs less tech-savvy knowledge workers to drive work process efficiency. A platform that empowers less tech-savvy internet users is tough to bet against. This explains the impressive 5Y-avg. revenue growth of 23.5% (versus tech sector median of 5.7%). The growth factor has been a major contributor to the impressive returns over the past twelve months.

In recent quarters, growth has benefited from cloud subscriptions, offsetting the declines from the professional services segment.

By 2023, over 50% of medium to large enterprises will have adopted an LCAP as one of their strategic application platforms. - Gartner

In the last earnings slide, Appian separated and shared revenue growth from the cloud segment alongside overall revenue growth to highlight the future growth driver. Going forward, there are ample opportunities for the momentum in the cloud segment to continue. The forward revenue guidance calls for cloud subscription revenue growth of 30%-31% in FY'21. This strengthens my bullish stance despite the overall revenue guidance of 16%-17% for FY'21.

Business (Neutral)

Margins-Platform-Profitability-FCF

Appian's positioning as a platform makes its growth options attractive.

Source: Appian

The last annual report highlighted the huge market opportunity, which extends beyond Low-code to RPA (robotic process automation), application PaaS, BPM (business process management), and case management. These represent fast-evolve segments that will drive the upsell and cross-sell motion in the coming quarters.

In addition to its internal sales team, partners are driving the growing adoption of Appian's offerings. Appian highlighted that partners delivered more than 70% of new logos for the year 2020 during the last earnings call.

Exploring the financials, Appian TTM's gross margin stands at 70.8% (A- rating using SA quant rating). This is an improvement from the 5Y-average of 62%. The professional services business appears to be a modest headwind to gross margin. It is tough to digest a low code platform having a significant professional services segment. Though, we can interpret this as the cost to accelerate the global adoption of low code solutions. The subscription business had a gross margin (non-GAAP) of 90% during the last earnings. This points to the future direction of overall gross margins as Appian grows its subscription business. This is a good sign given Appian's lack of profitability.

Appian is expecting a non-GAAP loss per share of $0.64 to $0.60 in FY'21 (versus FY'20 EPS of -$0.26). The weak profitability guidance suggests Appian is still investing in educating its target market on the need to adopt low-code solutions.

With the forward profitability and growth guidance, Appian will find it tough meeting the Rule of 40. This is a serious concern if competitors overtake Appian in the race to dominate the low-code space. In the meantime, it helps that Appian's ability to manage operating cash flows is improving. TTM OCF (operating cash flow) now stands at -$7.6M. It also helps that Appian has a cash position of $222M and a modest debt level of $58M. This makes for a healthy liquidity profile and cap structure when raising more money to drive new growth initiatives.

Competitors (Neutral)

Positioning-Moat-Threats-Opportunities

Another is that we've been in this space a long time, longer than any of them, any of the vendors I just mentioned anyway. And so, we've thought about workflow to process and low-code for longer - Appian

Appian highlighted its positioning as a pure-play low code vendor during the last earnings call. Appian also highlighted some of its competitive strengths, including its huge market share, experience, and workflow and automation capabilities. I am optimistic about the huge prospect of its capabilities in areas like RPA, BPO, and low-code. I am also excited about Appian's opportunity to keep expanding beyond the US market via its cloud offering. International revenue remains strong. During the last earnings, Appian called out the EMEA region, which recorded 2x the number of new logos than the previous year.

Source: Gartner

While the forward prospects are good, it is tough to picture Appian hitting a home run given the level of competition in the low-code space. This informs my neutral stance.

Valuation (Bearish)

Growth-Profitability-Value-Momentum

In my view the current valuation implies near-perfect execution. Appian trades at a premium (Market cap of $13.2B, EV/Sales of 43x) to its peers despite its relatively modest growth outlook. Analysts have a consensus price target of $144. While it can be argued that the declining professional services revenue is distorting top-line growth, the cloud revenue growth needs to outperform to drive renewed investor interest given the recent sell-off. Also, Appian will need to keep foregoing profitability in the near term. Relative to peers, the profitability profile isn't outstanding. This means margins cannot assist the growth factor in the short term.

With more than 24 years of enterprise technology experience, Broady has helped to grow businesses from start-ups and led a complex $10 billion software business unit with over 3,000 products at SAP. She is an exceptional leader and an expert at creating brand loyalty and value for companies. - Appian

Lastly, data from Google trends and SimilarWeb don't point to any form of hidden virality factor that could drive outperformance in the near term. However, Denise Vu Broady's recent appointment suggests Appian is trying to get ahead of this reality. Regardless, it is tough to make a case for acquiring Appian at the current price given its weak momentum year to date.

Risks

I am not worried about saturation risk; Appian's major operating segments are still expanding. I am moderately worried about consumer risk, given the potential for big tech companies to commoditize the low-code space. I am modestly worried about execution risk given the absence of a glaring virality factor in Appian's business model. This boosts my conviction that a bigger tech company may eventually acquire Appian.

Credit risk is of little concern given Appian's moderate debt load and favorable cap structure. EPS dilution risk is a big concern given the weak profitability guidance. I expect EPS dilution worries to improve as gross margins expand due to more cloud subscription revenue. Appian's improved OCF, cash balance, and positive working capital are supportive of its liquidity risk.

On the macro/competition front, I am mostly concerned about pricing pressure from bigger competitors and the negative impact of the volatile macro environment on Appian's sales motion. I am less worried about stack risk as Appian is expected to benefit more from improved integrations and partnerships with other tech platforms.

On the valuation front, I am worried about Appian's declining momentum and the heightened volatility in the tech space.

Conclusion (Rating: Underweight)

The overall sentiment scale doesn't depict a near-term favorable risk/reward profile given the weak momentum YTD, modest growth factor, and lack of profitability. Also, the current valuation suggests a potential acquisition premium remains priced-in. For investors attempting to buy the recent market dip, the current price remains unattractive.

Analyst’s 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.