Atlassian Earnings: Good Results, but Seat Expansion and Conversion of Free Users Remain Issues

Atlassian TEAM posted good results for its fiscal third quarter, including revenue and profitability that were better than we expected. The company provided a mixed outlook for the fourth quarter that we think investors will latch on to. Notably, macro conditions continue to negatively affect paid seat expansions at existing customers and conversions from free to paid users. While this is consistent with the last couple of quarters, the cloud version seems to be feeling this effect the most. As a result, we have decreased our growth outlook over the next couple of years, which leads to a reduction in our fair value estimate to $165 per share from $190. Despite the postearnings selloff, we see the shares as attractively valued, but we would prefer to see signs of stabilization in the negative demand trends before putting money to work.

Total revenue in the third quarter grew 24% year over year to $915 million, compared with the high end of guidance of $910 million. Subscription revenue grew 37% year over year to $761 million as Atlassian continues its cloud migration journey. Management continues to expect around 10% of cloud revenue growth to be driven by cloud migrations, attributing loyalty discounts and product improvements as sources for cloud migration resilience. Some February price increases led to early renewals and accelerated buying in the data center option, rather than cloud-based. Customer additions rebounded from last quarter, with about 6,600 new customers in the third quarter, representing 11% year-over-year growth. Top-of-funnel demand remains robust, so overall demand is not problematic, in our opinion. The most immediate concern is the continued trend of lower conversion rates of free users to paid users and a deceleration in paid user growth from existing customers, particularly in the cloud. While we believe this is macro driven and therefore temporary, we are less confident in the timing and the degree of a snapback in demand.