Anaplan (PLAN), a business planning software company that helps enterprises cut down on their use of manual Excel tools and move more of their financial and operational work onto a software-based tool, is a company that investors continue to love. The company just reported Q3 results, which investors cheered and sent shares up nearly 15%.
Though the sector-wide software correction of October/November still puts Anaplan about 15% below its all-time highs near $60, I continue to remain on the sidelines on Anaplan as I have since it went public. Though Anaplan continues to put out enviable performance and re-assert its status as one of the true high-flying growth stocks of the software sector, I’m cautious on investing in a company at the zenith of normal valuation limits especially heading into a turbulent market arena where most spectators are calling for a near-term pullback. At times like these, I’m banking more on value stocks then growth.
We’ll dive into Anaplan’s fundamental performance shortly, but let’s take a look at its valuation first. At current share prices near $51 (15% below an all-time high just above $60), Anaplan trades at a market cap of $6.76 billion – rather steep for a company that is generating revenue at under a <$400 million annualized clip. After we net out the $310.8 million of cash on the company’s balance sheet, we’re left with an enterprise value of $6.45 billion.
For next year (FY21), Wall Street analysts are expecting consensus revenues of $459.1 million, representing 32% y/y growth over FY20 estimated revenues of $346.9 million (per Yahoo Finance). This puts Anaplan’s current valuation at a rather heady 14.7x EV/FY21 estimated revenues. If we compare Anaplan’s valuation against a basket of other similar ~30-40% growth SaaS stocks, we’ll find that most tend to hover just around the double-digit forward valuation range, and Anaplan is trading several turns higher.
Yes, there’s a lot to like about Anaplan – strong growth, high customer retention, improving operating margins. But I fear that most of this outperformance has already been baked into its share price. Until share prices come down significantly toward a valuation that’s more in-line with peers, I’m content to stay on the sidelines here.
Let’s now examine Anaplan’s third-quarter results in greater detail. The company’s earnings summary is shown below:
Revenues grew 44% y/y/ to $89.4 million, beating Wall Street’s expectations of $86.5 million (+40% y/y) by a four-point margin. Though Anaplan still certainly beat consensus by a wide spread, its outperformance came in slightly lower than last quarter, where revenue growth of 46% y/y crushed expectations of 35% y/y (the smaller spread to expectations also justifies some of the compression that Anaplan has seen in its valuation and stock price since last quarter). Note as well that revenue growth decelerated by two points versus last quarter.
Revenue growth, however, falls second in importance in investors’ eyes relative to billings growth – which did see a massive recovery this quarter. As most software investors are aware, for a SaaS company, billings is a better indicator of long-term growth because it measures the value of deals signed in the quarter, not just revenues recognized in that period. Fortunately for Anaplan, the company was able to re-accelerate billings growth to 59% y/y, thirteen points stronger than an abnormally weak Q2.
One of the key drivers behind Anaplan’s billings strength this quarter was its expansion within existing customers, which contributed to a sky-high 123% net retention rate. Because a software company can lower its overall customer acquisition costs over time by leaning more on existing customers rather than new business for revenue growth, this >120% net retention rate is a huge positive.
Anaplan also closed a record number of large, seven-figure expansion deals this quarter. Some helpful key insights on this front from CFO David Morton’s prepared remarks on the Q3 earnings call:
Our dollar-based net expansion rate or NRR was 123% and continues to track above 120%. Overall, this was a very strong quarter for expands. And as mentioned earlier, we had a record number of seven-figure expand deals demonstrating the ongoing traction and success we have with our existing customers.
Our top 25 customers have an average ARR of over $3.5 million, up approximately 40% year-over-year. We also continue to serve a growing base of customers with over $250,000 in annual recurring revenue, which this quarter was 324 customers up from 228 customers this time last year.
Looking ahead, we have a significant and growing opportunity to expand the use of our platform within our customer base. Our unique approach to enterprise-wide planning and the capabilities of our platform encompasses frontline managers and professionals across a wide range of operational areas; finance, sales operations, supply chain and marketing.”
The higher mix of expansion deals also helped to contribute to Anaplan’s profitability this quarter. Pro forma gross margins, already lofty to begin with, increased another two points to 85%, up from 83% in the year-ago quarter – indicating that nearly ever dollar of incremental revenue flows through to the bottom line. Likewise, Anaplan’s operating margins leaped twenty points to -9.9% this quarter. The company noted that it is capturing sales efficiencies and proving its “land-and-expand” business model can drive long-term unit economics:
Pro forma EPS of -$0.08, likewise, soared past expectations of -$0.13. The only red mark on Anaplan’s quarter on the profitability front is that Q3 free cash flow losses grew from -$17.3 million last year to -$19.9 million this quarter, but year-to-date, Anaplan’s FCF loss of -$23.3 million is less than half of the losses incurred in the year-ago period. Eventually, however, investors will want to see Anaplan close this gap and become FCF-positive.
How should investors react?
Despite a strong quarter from both a billings and profitability standpoint, I find few reasons to invest in Anaplan at a ~15x forward revenue valuation especially when many other SaaS companies remain well below all-time highs. My favorite picks at the moment are still reeling from the October correction – Workday (WDAY), Bandwidth (BAND), and HubSpot (HUBS) are some of the mainstays in my portfolio at the moment. Put this company on your watch list and buy it if it drops into a low-teens valuation multiple, but not prior to that.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.