Description

Anaplan was previously written up in mid 2019 here https://valueinvestorsclub.com/idea/ANAPLAN_INC/6927487288

I’ll share my thoughts here on why specifically you should see this as a software outperformer across the next 12 months, as well as its case as a medium term 25% IRR investment. I’m not going to share a really detailed and involved write-up as it is very well covered and it was fairly recently written up on VIC. Alex Clayton also wrote a detailed summary of the S-1 when that was published which gives a good basic introduction to the company. Instead I am going to focus on three things specifically – why the composition of the customer base positions them better than most other software companies in this environment, the underwriting of numbers I’m doing for this year and why I’m pretty confident they don’t need to raise capital, and finally why this is a great entry point longer-term. I’m trying to provide something incremental beyond the volumes of information already out there.

I’ll also note that I am currently as bearish as I have ever been short term on software, and I am running my lowest ever net exposure to the sector, and I have moved my longs upmarket into some of the more stable names which have better exposure. I’m net short the mid-cap software contingent.  I’m very cautious and even though I fundamentally am confident in Anaplan over 12 months the hedge fund community is massively overweight software and Anaplan and there certainly is room for de-grossing led technical selling.

 It is a highly liquid stock even at a relatively small market cap, comfortably trading $50+mln a day and multiples of that before March.

Also please note they have a fiscal year end in January. Therefore fiscal 2021 is roughly equivalent to calendar 2020 and so on.

Apologies if numbers in this write-up are a bit rough. The truth is that I have no idea what is going to happen in software buying over the next 6 months so there is no point in trying to be really detailed in making estimates. There is a very wide range of possible outcomes. If you want to build a big position I would wait for the next earnings to get really sized up. I have a mid-sized position currently but this is the first time I’ve been involved since the IPO.

Summary

Anaplan is a company focused on “connected planning” – essentially helping companies to budget, make strategic plans and test different scenarios in a cross-organisational manner.

A combination of the coronavirus sell-off and a poor Q4 have sent shares down a little over 50%. And yet it does not screen as a classical value investment – I estimate that it trades at 10x calendar 2021 EV/GP and I do not see GAAP profitability until fiscal 2025. However, there is a high margin of safety from the strategic nature of their business and the value of their existing customer base. Net of customer acquisition costs, they would have a decent GAAP profit margin, but they are investing for growth. My estimate is that these growth investments carry a CROIC in excess of 30%.

The world is facing an SMB-pocalypse, with millions of small businesses globally likely to shut. On top of that budgets in travel, hospitality and several other sectors will be cut materially. And I’m shorting a bunch of the software providers to small businesses and these sectors. But also I think there are opportunities to buy some really great businesses in software.

There are a few reasons to pick this stock from the mid-cap software universe to outperform over the next 12 months as the virus hits earnings

·         It has one of the most blue-chip customer bases of any mid-cap software company.

·         It’s core focus is lowering operating costs, rather than driving incremental revenue.

·         The virus is forcing meaningful change on budgets and revenue plans across the corporate world. This is one of the key use cases Anaplan was designed to solve. My research suggests that once we get to the other side of the virus every large company will be seriously evaluating their planning and stress-test abilities and Anaplan stands to benefit from this focus.

·         The existing customer base is worth around 70% of the current enterprise value here.

·         If a round of software M&A kicks off, this could be a key target. I know they received bids substantially in excess of the current valuation while private. Management may be more willing to sell now. In any case, chatter around this should support the stock when it comes. In early 2018, Workday acquired substantially inferior competitor Adaptive Insights for 13x TTM revenue, a slight premium to the current multiple of Anaplan. Any acquisition of Anaplan will certainly require a TTM revenue multiple in excess of 20x vs current multiple of 12x.

·         I believe even in 2021 we will see DBNRR >110% i.e. business will grow if services revenue goes to zero.

·         Investor confidence was crushed right before the big sell-off which exacerbated the negative move. I think if they had delivered a good quarter in February, the stock would still be around $50. I think over the next two quarters they can rebuild investor confidence.

·         Anaplan has ratable revenue recognition. This means that comps are easier as they do not have a large upfront component recognised in their fiscal 2020 numbers. In addition, they transferred to ASC606 on a full retrospective transition basis giving best comparability in historic numbers.

What do they do?

The old basic planning model is essentially one of siloed excel spreadsheets that are then filtered to sub-divisional and divisional master sheets which are then in turn filtered into a consolidated central planning sheet. At each level there are amendments and cleaning. This is a slow and laborious process. Some retailers keep spreadsheets for each location where every SKU has its own tab for monitoring for example!

There have been various iterations on this model over time – permissioned entries, locked cells etc. before eventually many companies moved onto internal solutions or external ERP products. This allows better analytics, more reliability and more time efficiency.

While these are vast improvements, they are still slow and complicated to use. More importantly, tools for different use cases may not be able to communicate.

Anaplan offers essentially a cross-organisational planning product with superior UX and calculation speed. It is also cloud-native, improving scalability, accessibility, compatibility and reliability.

Some key additional strengths of Anaplan’s offering:

·         A very natural landing place in FP&A

·         Large expand potential across virtually all enterprise functions. Expand is not pricing dependent.

·         ROI very high. They talk basically every Q about new deployments offering savings 5-6x bigger than their biggest client’s bill.

·         Fast implementation

·         Modular architecture that allows for zero circularity

·         Ease of model build

Customer base

Virtually all of Anaplan’s revenue comes from the 1.5% of global companies with 100 or more employees. 22% of customers and 52% of revenue come from Global 2000 companies. Around 60% of revenue comes from customers with ARR > $250,000 (this is a more basic estimate which I proxied as follows: 300 Global 2000 companies are 52% of revenue, so the 353 largest customers of the company - with ARR>$250k - must be at least 52% + 50*$250k/$350mln = 56% of revenue). You can also deduce from this that ARPA for the bottom 1050 accounts is still around $140k which is pretty hefty even for the entire customer base of a midcap software company. Final comment: at least 90% of revenue must come from accounts with ARR > $25k based on their disclosure.

The conclusion is that the company is overwhelmingly generating revenue from large customers who pay a lot of money to improve their business. I believe that most of this is to save costs and it generates a large ROI. Therefore, I think it is unlikely we see a substantial uptick in gross churn here, and that DBNRR should remain strong.

This is due to them providing most value to complex, large organisations who require sophisticated planning processes. Since 2016, the company has deployed the majority of its resources into focusing on Global 2000 companies. Part of the effect of this has been a dramatic reduction in sales efficiency, with S&M growth substantially outstripping revenue growth over the past few years. The point of this strategy is to lock in and retain very large accounts that have a lot of room to grow over time. Their 25 largest accounts have increased 10x in ARR since their initial deployment. This shows the potential from what looks like a currently very inefficient sales strategy.

Two further items I’m exploring more at the moment:

·         Cloud penetration and the benefits for Anaplan: Anaplan is the main cloud native player in the business. Many companies and industry analysts have flagged an acceleration to cloud as a key consequence of the virus. This reduces long term risk around cloud migration slowing, as well as shifting deployments towards a segment that Anaplan dominates.

·         Incremental deployments from planning needs during virus: I have heard that a number of greenfield/expansion deployments are being fairly hastily prepared by large corporates who lack sufficient planning capability. Anaplan stands to benefit from its share of such deployments.

Risks

·         Q1 2021 numbers are unlikely to be good – the weakness in billings from last Q, the initial virus hit in the second half of the Q when most pipeline conversion happens, plus a lack of time for incremental deployments will hit numbers. I would look at this as a 12 month trade shortest.

·         Like all Software companies, consensus is probably too high right now. Even recent 2021 revenue estimates in the $440-450mln range are optimistic.

·         Clearly there are some well-funded competitors who are not currently focused on and prioritising this opportunity. Could change but I feel well placed to see this happening.

·         A lot of new deals (about half) involve partners. While I’ve heard incrementally positive things about the partner ecosystem in a remote world, I’m not convinced of its efficacy at this stage.

·         There is a very high degree of uncertainty around 2021 numbers! I have tried to be conservative but the reality is that I do not know.

·         Typically Anaplan takes cash payment one year in advance on its contracts. There is a risk that companies will seek to renegotiate this and make cash payments ratable. I think this is manageable.

What could numbers look like in the fiscal year to Jan 2021?

Anaplan’s current guidance for 2021 calls for $463 to $467mln in revenue, a 33-34% growth rate. In 2020 they exceeded their guidance at Q4 2019 results by 12%. Therefore the bogey at the time I set for Anaplan results in 2021 was around $500mln in revenue, or around a 45% growth rate. My base case was for $485mln in revenue.

The rough build up in revenue for this was as follows: $380mln in exit subscription run-rate, DBNRR of 120 takes you to 460 by end next year so 415 roughly overall from  existing customers. 25mln revenue from new customers. So roughly 440 in sub revenue for 2021. Then 40 in services revenue turns into 45 in services revenue so 485 total. Please note these are very rough illustrative numbers – there is a bit more nuance than this!

Clearly this is now in question. While I broadly believe Anaplan will do better than most software companies out of this, and that they will grow subscription revenue by least 20% - mostly driven by the DBNRR and seasonality of customer adds from last year - it is unlikely they will even hit their guidance, let alone exceed it substantially as I was previously looking for.

My minimum scenario:

Here is the factually disclosed build-up of ARR as of end fiscal 2020. Top 25 customers are at least $90mln in ARR (they also recently disclosed that top 10 “deals” were in excess of $5mln ARR – see comments at MS TMT in March – but unclear to me precisely what was meant by this), and there are 328 other ARR >$250k customers who must create at least $82mln more ARR. This is >$170mln in ARR from the top 353 customers. We also know that such customers generated around 60% of revenue in fiscal 2020. Even if you assume they are a higher 65% of exit ARR, this still gives >$270mln in exit ARR. Of course translating this into revenue takes some work and precision but because this is such a rough exercise anyway, it’s not important to be super precise. That basically is the minimum scenario for sub revenue in 2021 once you make an elevated churn assumption. Clearly numbers are likely to be very substantially higher than this as a) the other ARR >$250k customers likely had exit ARR of $150mln, b) the top 353 customers are probably more like high 50s percent of exit ARR, c) there should be net expansion on existing customers, adjusting for seasonality in the DBNRR, and d) there should be new customers in 2021 even if there are no new customers in the 6 months starting from March.

If we haircut services revenue by 50% YoY, we get to a minimum Anaplan revenue level of around $260mln in fiscal 2021. One point to note is that if this revenue level actually happened, and they made no efforts whatsoever to stop growing costs (i.e.  opex grows 20% YoY vs revenue down 25%), they would burn around $180mln in cash in 2021, or around 60% of the current cash position. Therefore I do not believe there is any risk of insolvency at Anaplan.

Now I will present what I view as a fairly conservative base case assumption for numbers in 2021:

I assume they will add 50 customers, vs the 300 last year. I assume DBNRR drops from 122% to 113%, driven by an uptick in churn by 4% (double) and a contraction in the expansion rate by 5%. Basic new customer assumption is $50k from each one in 2021.

$20mln in services revenue, $390mln in revenue from existing clients, and $3mln in new customer revenue. So 420-425 is the basic range I’m looking for.

Gross margins increase slightly due to mix of lower margin services revenue. I assume opex grows 18% YoY, with all items increasing slightly as a % of Sales but the company looking to slow opex growth slightly in the face of the economic disruption.

I then assume a very strong year in fiscal 2022, with net adds inflecting to 400 as there is increased interest in strengthening dynamic planning across the corporate world, and IT budgets improve sufficiently with some catchup for DBNRR to temporarily inflect to the mid 120s.

This leads to 40% revenue growth in 2022.

Valuation

My target price as of early 2024 when they give 2025 guidance is 69 per share, or 150% upside over 4 years. This is based on a multiple of 30x FCF, with margin adjusted for growth based S&M spend. This is equivalent to a 9.4x 2025 sales multiple, with 2025 revenue growth of 25.9%. This is based on the following cost structure, informed by a) user economics, b) my estimates of contribution margin on existing customers , c) my conversations with the company and experts.

Please note that I do not expect these margins to be achieved as I believe the company will continue to pursue market share and net adds. They are simply a look through estimate of where I think the company would be in 2025 if they chose to maximise profitability and focus on only retaining and expanding the existing customer base.

Clearly if software valuations remain highly elevated and Anaplan returns to the premium it traded at just a couple of weeks ago, there is potential for a multiple 50-100% greater than 9.4x to be applied at that stage. However, I expect software multiples to be around historical averages and for Anaplan to trade at a 2-4 turn premium.

This is backstopped by my estimate of customer value. I estimate that by 2025 Anaplan will have around 2,600 customers, and generate ARPU of over $450k, or contribution profit per customer of $200k (some analysts estimate much higher contribution margins). At a DBNRR of 109% in 2025, I estimate 2025 EV per customer of around $5mln, or a total company value on existing customers of $13bln. With cash and DSO of 190mln, this suggests a Jan 2024 share price of 70 based on customer count and net value.

In the context of TAM – let’s say by Jan 2024 they take 25% penetration into the Global 2000 (current >12.5%, up from >10% 1 year ago) and these generate ARPU of $1mln in 2025 vs $600k in 2020, up from $530k in 2019. This would be $500mln (not including adds during 2025) in revenue from Global 2000 clients. Global 2000 clients generated 52% of total revenue in 2020, down from 55% in 2019. So in 2025 you should expect very roughly $1bln in revenue on this basis vs my $1.24bln estimate. So in the same ballpark but this rough measure suggests a more conservative modelling approach. However, I would generally expect Global 2000 client ARPU to inflect in a decent way over the next couple of years and more than double.

I believe there is a strong M&A put in the stock. However, should customer count stagnate at 2,000 and ARPU go to $450k, leading to $900mln in 2025 revenue, I estimate Anaplan could fairly comfortable generate a 21% FCF margin (78 GM, 17 R&D, 20 S&M, 10 G&A, 5 SBC, 21 tax) leading to a bear case 2025 FCF of $185mln. At 20x FCF (company still growing on DBNRR), this would lead to bear case Jan 2024 valuation of 21 per share. This is equivalent to my estimate of the value of the current customer base today at a 10% discount rate, so on an absolute basis it is decently below.

Clearly on a trading basis there is no reason why this stock couldn’t trade at 5x TTM revenue ($13 per share).

That’s the longer term view. I think the set-up short term is great on a relative basis due to the points I’ve flagged in this write-up.

Stats

All metrics below at 28 per share based on fiscal year numbers.

Some customer specific assumptions and tie-ins to reported add, DBNRR, and my rev estimates – this is purely a rough sense checking exercise

Catalyst

Q2 and Q3 2021 should be decent

Investors start to see as a winned from the virus situation