Why Investors Should be Watching Atlassian

Atlassian (TEAM -0.22%) has huge opportunities to capitalize on in the digital transformation space. 

In this video from The Virtual Opportunities Show, broadcast on Nov. 30, Fool.com contributor Asit Sharma outlines a few reasons why investors should keep this stock on their watch lists.

Asit Sharma: I'm going to breeze through Atlassian. Symbol is TEAM. This is a company based in Australia. They play, again, in the digital transformation space. They offer software to companies in three big buckets: These are software development tools; help desk software, or IT service management; and workflow management software. So, think project management and collaboration tools.

A really central part of the idea of virtual opportunities, again, to Rachel's point from earlier in the show, if the winds of remote work shift, maybe companies like Atlassian and competitors like Asana become a little less important. But at this point in time, they are doing well as a group -- and Atlassian in particular -- because there is a demand for us to become more productive in our separated/hybrid/remote environments. I like that the company has a subscription-based model which has become very huge. Their subscription-based annualized recurring revenue alone is about $850 million every year.

I also like that they started out as a company that was focused on data-center software, and a lot of their deployments, as they move to other types of tools, remain on enterprise servers. So there's big opportunity in the future to migrate their customers to the cloud. They've got several hundred thousand customers, I forget the exact number, but 30,000 of those customers are server-based, and they are going to migrate them over between now and sometime in 2024. Just a really great opportunity to improve their already-high gross margins and, I think, to fuel their economic engine.

Atlassian is extremely well-run. The two co-founders who started this company are still around, very engaged with the business. Mike Cannon-Brookes and Scott Farquhar are the two co-founders. They famously wanted to find a place to work where they didn't have to wear a suit and they could dress casually, so that's part of the reason they created this company. But it wins a lot of accolades every year in the culture department. Just this year, I think they received global awards for the Best Places to Work and also the World's Most Innovative Workspaces.

The co-CEOs have a rating of 95% on Glassdoor.com, and the company itself has a 91% rating over thousands of reviews. I find all that pretty persuasive.

I'll skip over one thing I was going to share, but let's just take a quick run through a couple of financial items worth noting. You can see here -- this is the three months ended Sept. 30, 2021, versus the prior year. Company's revenue is growing very steadily. And also, its gross profit is growing at a rapid rate. I love to see gross profit growing. This is a company that invests a lot in research and development. You can see that it is more than half of gross profit. It also has a decent marketing and sales component, but even though they've reached scale and are trying to get bigger, they don't rely solely on marketing to pump up those revenue dollars.

They did have an unusual item this year which caused this big loss. On an operating basis, you can see last year this time, they had about $12 million in operating income, and this year, they had about $40 million operating income. The item below here is related to capped calls that the company has. The one thing I don't like about Atlassian is that it likes to use convertible debt to fund its growth, and they do everything they can to then manage dilution.

That's on the other side of those convertible notes, and that includes entering into some expensive call options that they have to manage. You see a lot of noise on their income statement as they try to manage the potential that shareholders will get diluted. Sometimes, it's better just to dilute shareholders and persuade them with your business model. That's exactly what Shopify did. They had a huge stock offering, they were already killing it during the pandemic and had a multibillion-dollar shelf offering. I don't know how much of that they've actually utilized, but they're not afraid to dilute shareholders because their reasoning is they're going to create more value over the long term. It's better almost not to try to manage the dilution. If you're going to do it, just raise the money, do a stock offering maybe.

But I don't like this aspect. Other than that, I think the company is extremely interesting. It remains a very worthy investment for anyone who's interested in this collaboration space. It is a leader. Just really, really quick, and then I'll stop this share here. Just wanted to show you that period to period, despite that loss which was propelled by basically managing these exotic instruments, they still had positive operating cash flow, roughly the same as the prior year.