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Avalara: Best To Wait

May 06, 2021 11:29 AM ETAvalara, Inc. (AVLR)9 Comments

Summary

  • Revenue is growing rapidly and coming from reliable and predictable sources.
  • Covid and remote work have led to current wins, and are likely to lead to recurring subscription growth.
  • The company sells its solutions as an “ROI story,” and they try to condition customers into believing switching from a manual solution to an automated solution is an investment.
  • Avalara’s primary competitor is the status quo, not necessarily competing companies.
  • Avalara’s recent acquisitions have been strategic and should lead to significant future upsell opportunities.

Budget planning concept
Photo by Pra-chid/iStock via Getty Images

Investment Thesis

Avalara (NYSE:AVLR) has operated admirably both before and during the pandemic, with its revenues growing at high double digits consistently year over year. The company operates in a recession-proof industry and is an industry leader in a nearly untapped

This article was written by

I like to dabble in equity analysis with a focus on value investing, fundamental analysis, and financial modeling. My own portfolio generally only consists of index funds for stability and hand-picked small cap stocks for growth. I will usually only buy companies that I label as Very Bullish. As far as my own investing strategy, I'm long only and in companies I believe are decently priced and that I believe are good growth opportunities over a long time horizon. I like good companies in good industries with a good management team and at a good price. And yes, that's a lot to ask for!

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.

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Comments (9)

D
Do you have thoughts on VERX?
Dividend Streamer profile picture
@Small Cap Connoisseur Thanks for a well researched and written article. I was able to look at the spreadsheet and the assumptions that were made.

In terms of the DCF calculations, I wonder how things might look as we do the same calculations 5 years down the road. Perhaps at that time we might speculate on growth of 15-18% per year for 5 years and then perpetual growth of 4% down the road.

The thing about these wide moat companies that get entrenched in the "processing" end of their customers is they stay around forever. I liken Avalara to ADP or Paychex in that regard. They take a complex task and do it for their customers in a more cost effective manner. Moreover, the complex task changes over time as regulatory and tax systems become more involved. And just like the payroll processors, Avalara has a way to turn the growth of their customers into their own growth automatically.

Avalara might be growing in the 30-40% range now, but I suspect that when this hyper growth period slows down, they will still be able to grow in the mid teens for at least a few decades.
C
In your DCF, why assign a constant perpetual growth rate of 4% instead of forecasting an early period of rapid growth with a degradation to your perpetual growth rate over time? The earliest years have the most impact on dcf calculations right? Being too conservative is just as inaccurate as being too aggressive. Also, I assume that you are basing the dcf on FCF? I’m curious what base FCF you are using to model with? Since they are investing aggressively in growth, I always struggle with what adjustments to make to show normalized current day FCF considering that they aren’t currently reporting positive FCF.
Small Cap Connoisseur profile picture
@cand100por
The DCF is available as a link in the article for you to probe. It's just an Excel file so you can check the cells and change my assumptions to yours. I gave three different valuation cases because I'm sure my assumptions can be way off.

In the bull case, I did assign a rapid revenue growth rate (40%) and then slow degradation. After the most recent earnings call, this actually appears to be most accurate for revenue growth rate.

As I mentioned in the article, assigning a high perpetual growth rate is for two reasons: 1) because I'm expecting high growth rates past the forecast period which I think is fair given the total addressable market and Avalara's moat and 2) to be generous and show that even with a perpetual growth that the company is still aggressively valued.

Also, as I addressed in the article, to be incredibly generous, I left out acquisitions of new businesses in the forecast period even though this is incredibly aggressive, and still came up with the stock being very, very overvalued.

I'm not really trying to show normalized current free cash flow but instead future free cash flow and then discounting that back. With my assumptions, I do have the company reaching free cash flow in every scenario so I can put a value on that.

Sorry if it wasn't clear in the article but the DCF was meant more as an exercise of showing that even with incredibly generous assumptions that the stock is overvalued. It was meant less for realistic assumptions given primarily the difficulty of forecasting future business acquisitions. We know there will be many acquisitions given Avalara's history but dollar amounts with little guidance from management that I could find make it difficult to forecast.

I hope that explanation makes sense. Thank you for commenting and I definitely welcome you to try the DCF and any critiques you have for that.
C
@Small Cap Connoisseur
Thank you for the response. Your explanation makes sense. It seems like the answers and details are in the spreadsheet, but for some reason, I am not able to see the values on the the different scenario tabs. Maybe a lack of tech cooperation on my side. Thanks again.
NINK profile picture
I think you are greatly underestimating the difficulty for competitors to enter this market. This is a very difficult subject matter for software development. Imagine that you were writing accounting software to do accounting in all 50 states and countries around the world, and each state had their own version of GAAP, and they all changed this or that rule several times a year at random times, and you had to keep your program current so that no transactions were recorded in error.
Small Cap Connoisseur profile picture
@NINK
Thank you for commenting. I don't think I'm underestimating anything here. I am an accountant that deals with complex sales tax situations so I completely understand that argument. The article praised Avalara and its moat so I would encourage you to glance at the bullet points again. My argument for being bearish is exclusively based on the current valuation, even giving it a higher perpetual growth rate than I normally would because of the long runway the company has in penetrating this market. I am expecting high growth in the future, just not willing to buy in at this price.
U
This was at 185 and one point now 125 , how much more pullback do you want us to wait for? I expect a great report today and upward yearly outlook.
Small Cap Connoisseur profile picture
@UnStopaBull!

Thanks for commenting. I don't necessarily want anyone to wait if they are interested in buying. I was simply trying to make the case for why it is overvalued and why I am holding off on investing. I think this will continue to be a great growth story once the price comes down and I can certainly be wrong about there being a short term decline, but my DCF shows me it's not at the level I would be willing to buy yet. Even with the near-40% revenue growth they just reported (that matches my still overvalued bull case), the price continued to decline. If you choose to buy now, I hope I'm wrong and that it works out for you. Good luck!
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