Atlassian's (TEAM -1.60%) stock has rallied nearly 60% this year. Investors turned bullish on the enterprise software company again as its revenue growth stabilized and its operating margins expanded. Let's review its business model, growth rates, and valuations to see if it's too late to hop onto the bullish bandwagon.

Its growth is stabilizing as its business model evolves

Atlassian was founded more than two decades ago in Australia. Its first two major products were Jira, which helps companies plan, track, and release software products, and Confluence, which allows employees to collaborate on documents.

Three people work together at a workstation.

Image source: Getty Images.

At the end of fiscal 2023 (on June 30), Atlassian served 262,337 customers across its cloud, enterprise, and IT service management platforms. That represented 8% growth from 242,623 customers at the end of fiscal 2022.

In the fourth quarter of fiscal 2023, it generated 60% of its revenue from its cloud platform. The rest came from its data center (25%), server (9%), and marketplace and services (6%) platforms. Here's how those four businesses fared over the past year in terms of revenue growth.

Revenue Growth by Segment (YOY)

Q4 2022

Q1 2023

Q2 2023

Q3 2023

Q4 2023

Cloud

55%

49%

41%

34%

30%

Data center

60%

54%

40%

47%

46%

Server

(16%)

(18%)

(22%)

(29%)

(27%)

Marketplace and services

24%

4%

20%

12%

17%

Total

36%

31%

27%

24%

24%

Data source: Atlassian. YOY = Year over year.

Atlassian is currently migrating all of its server-based customers to its cloud and data center platforms, and it plans to pull all support for its server business in February 2024. That's why its server revenue is declining, and why it expects that figure to drop to zero by the fourth quarter of fiscal 2024.

However, Atlassian's cloud-based business still suffered a slowdown over the past year as macro headwinds drove more companies to rein in their spending. Its data center unit experienced a milder slowdown as it absorbed more of its server-based customers, while its smaller marketplace and services segment continued to grow as it expanded its marketplace for third-party apps and subscription-based support services.

For the first quarter of fiscal 2024, Atlassian expects its revenue to rise 18% to 20% year over year as its cloud revenue grows 25% to 27%. For the full year, it expects its cloud revenue to grow 25% to 30%. 

But it didn't provide an outlook for total revenue. Analysts expect that to grow 18% for the full year, compared to its 26% growth in fiscal 2023.

With an enterprise value of $50 billion, Atlassian doesn't seem cheap at 13 times this year's sales. For reference, its bigger cloud-based peer ServiceNow (NOW -1.77%), which is expected to generate 23% revenue growth this year, also trades at 13 times that estimate.

Near-term margins are expected to decline

Over the past year, Atlassian's adjusted gross margins held steady in the mid-80s -- which suggests it has plenty of pricing power -- as its cost-cutting (including layoffs for 5% of its workforce) boosted its adjusted operating margins.

Metric

Q4 2022

Q1 2023

Q2 2023

Q3 2023

Q4 2023

Adjusted gross margin

84%

85%

85%

85%

84%

Adjusted operating margin

14%

18%

20%

22%

22%

Data source: Atlassian.

But for the first quarter of fiscal 2024, Atlassian expects its adjusted gross margin to dip to 83.5% as its adjusted operating margin slips sequentially to 19.5%. For the full year, it expects its adjusted gross margin to drop 130 basis points year over year to 83.5% and for its adjusted operating margin to decline 190 basis points to 18.5%.

During the fiscal fourth-quarter conference call, co-CEO Scott Farquhar attributed that margin compression to its higher investments in its enterprise cloud platform, its cloud-based migrations, and the development of new IT service management products. Farquhar believes fiscal 2024 will represent the lowest point for its operating margins, but that its margins will rise back toward their historical norms in the coming years.

Management didn't provide any guidance for its near-term profits, but analysts still expect its adjusted earnings per share (EPS) to rise 31% year over year in the first quarter and 11% for the full year. Based on those expectations (which we should take with a grain of salt in light of its downbeat margin outlook), the stock still looks expensive at 95 times forward earnings. ServiceNow, which is expected to grow its adjusted EPS by 31% this year, trades at just 47 times forward earnings.

Investors should also recall that Atlassian is still unprofitable on the basis of generally accepted accounting principles (GAAP) and has an alarmingly high debt-to-equity ratio of 5.3. Those fundamental weaknesses, along with its high valuation, could make its stock an easy target for bears in this environment of high interest rates.

Is it too late to buy Atlassian's stock?

Atlassian is still growing, but it seems overvalued right now. I would stay away from this stock until its valuations cool off, it makes more progress toward generating GAAP profits, and it takes more steps toward reducing its leverage.