As the old saying goes, "nothing is certain but death and taxes." It's unfortunate that these certainties aren't particularly pleasant, but what if there were a way for investors to benefit from the reliability with which the taxman comes calling?
Tax-compliance software might not seem exciting or glamorous compared to many other software-as-a-service (SaaS) product categories. Still, it's probably among the most essential for businesses and organizations. That's where Avalara (AVLR) comes in. The company is providing software solutions that are helping business customers keep up with complexities stemming from e-commerce, digital transformation shifts, and cross-border sales -- and it's built for long-term success.
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Strong business performance and long-term strategy
Avalara's tax compliance software makes it easy for small and medium-sized businesses to launch and expand e-commerce and omnichannel operations. Thanks to partnerships, sellers using platforms including Shopify, Etsy, and Wix.com can easily access its services, and the company has also been on an acquisitions push to expand the quality and breadth of its offerings.
The ability to import and cross-reference data across platforms and services can lead to improvements along a variety of lines, and Avalara is pursuing this strategy and shoring up its competitive position. Between new services from acquisitions, the expansion of its partner network, and the ability for businesses to more easily build compliance workflows through its recently launched low-code developer platform, the company is meeting customer needs and helping them work smarter, not harder. The approach is clearly paying off.
Avalara posted a net revenue retention rate of 115% in 2021, which means that existing customers boosted their spending on the company's services by 15% compared to the prior year.
Data source: Avalara. Chart by author.
Along with new customer additions, increased spending from existing clients helped push annual revenue up 40% in 2021 to reach $699 million. It's also worth noting that the business notched a 116% net revenue retention rate in each of its last three quarters, so there could be some room for retention to climb above last year's average -- particularly as the company introduces new service offerings.
Impressive net revenue retention rates point to customers seeing strong value in Avalara's platform and services. Furthermore, the combination of new customer additions and increased client spending should create a growth engine capable of delivering strong returns over the long term. The company also closed out the year with an adjusted gross margin of 73%, so while the tax specialist isn't yet profitable, it should be able to swing into significant earnings and growth when it's appropriate for the business's overall strategy.
Visionary leadership and a strong company culture
CEO Scott McFarlane co-founded Avalara in 2004 and has been shaping the business's direction ever since. Across his more than 30 years in business, the executive has aimed to "blend strategic innovation with rigorous operational discipline to create companies with unique cultures that shake the status quo." That's a fantastic leadership vision, and there are clear signs he's successfully making it a reality at Avalara.
86% of employee respondents on the workplace review platform Glassdoor.com approve of McFarlane's stewardship, and 74% would recommend working at the company to a friend. Operating a high-growth SaaS company in a highly competitive industry isn't easy, but Avalara appears to have a company culture that's up to the task.
What risks does Avalara face?
Avalara's business isn't currently posting profits, and its forward-looking valuation has caused the stock to fall out of favor as the market has moved away from growth-dependent companies toward those that can reliably deliver substantial earnings. If investors continue to move out of growth-dependent software stocks, that could result in more substantial sell-offs for Avalara stock in the near term.
Avalara looks well-positioned in its industry, but significant valuation declines could mean the company winds up issuing more stock than it otherwise would have as part of its employee compensation structure or as part of new acquisitions. The company has increased its total shares outstanding by roughly 25% over the last three years, which isn't terribly worrying. Still, there's a risk that higher levels of dilution will hurt investors.
Avalara will also have to contend with competitors in the tax compliance software space. The industry appears to be on track for strong growth and should be able to support multiple winners, but the company could lose market share to rivals including SAP, TaxCloud, Vertex Inc., Canopy Tax, and Thomson Reuters if it fails to keep up with customer demands and deliver appealing value with its products.
Why Avalara looks like a great buy
Avalara is trading down roughly 33% over the last year and approximately 50% from its lifetime high, and shares look attractively valued at current levels.
There are massive digital transformation and globalization trends taking place across the world economy, and that means businesses and institutions are seeing an increased need for digital solutions that can automate tax filings and ensure compliance. With a market cap of roughly $8.4 billion and the company valued at approximately 10 times this year's expected sales, Avalara still has huge room for growth and looks capable of delivering market-crushing returns for long-term investors.
