Aug 9 2020 - Alteryx: Don't Buy The Dip

The Q2 earnings shock (-28%) was brutal, but justified given a deceleration in growth and weak future outlook.

Customer-buying behavior has changed: Longer sales cycles, smaller deal sizes, and higher scrutiny on spend characterize the decline in growth; this is expected to continue going forward.

On a positive note, Alteryx unveiled a unified APA platform, expanding its product portfolio and connecting its disparate products under one umbrella.

At an NTM EV/S of 15.7x, it is better to avoid the stock as it is still expensive.

Source: 1-yr Total Return of AYX vs benchmarks, using KoyFin

I rate Alteryx (NYSE:AYX) a "Hold", maintaining my rating from my last article. The Q2 earnings shock has erased most of Alteryx's gains since late April/May due to very weak guidance for the rest of 2020, undercutting analyst expectations. Consumer buying behavior has changed for the worse and the company expects the slump to continue for coming quarters. Investors may be tempted to buy the dip on account of a cheaper valuation, but I think it's best to stay on the sidelines. Alteryx remains one of the most innovative companies in its industry, but the risk/reward isn't ideal for now. I intend to wait for the more favorable circumstances to add it to my portfolio.

Dynamics Of Q2 Growth

• Revenue for Q2 grew 17% yoy and EPS positively surprised at .02, beating guidance and consensus estimates.
• Dollar-based net expansion stood at 126%, ARR grew 40%yoy, and the number of customers increased by 27% yoy.
• The company released an Analytics Process Automation (APA) platform, unifying analytics, data science, and business process automation.

Source: Alteryx 8-K Q2 2020 on Seeking Alpha

While the numbers beat guidance and estimates, investors who may have been expecting a stellar beat would have been disappointed. And given a ~20x EV/S multiple from a few days ago, outperformance should've appropriately been expected (>17% growth). While the company mentioned in its Q1 call that business activity in April was consistent with levels seen in 2019, May and June were very different stories.

The global dislocation experienced as a result of the COVID pandemic followed by shelter in place orders, altered our customers buying behaviors in Q2. We observed notable changes such as higher levels of scrutiny on spending across all sectors resulting in longer sales cycles, smaller deal sizes and less favorable linearity in the quarter. (...)

(...) So what we did see, it was almost like three quarters in one in Q2 with April being very different than May and June. So obviously there was an air pocket that had a big blip in it for April. We didn't see actually much improvement although we anticipated some improvement in May, so linearity wasn't necessarily on our side. (...)

- CEO Dean Stoecker, Q2 2020 Earnings Transcript on Seeking Alpha

The dollar-based net expansion and ARR (Annual Recurring Revenue) growth are quite strong all things considered, while the issues are constricted to new sales and landing customers. The "land and expand" strategy has been disproportionately delivering on the "expand" part compared to pre-pandemic levels. The takeaway here seems to be that the customers who buy the software, love it, and are happy to spend more to unlock digital transformation value in their organizations even during the pandemic. These are good signs for the long-term durability of the business.

The discrepancies in ARR and Revenue can be attributed to "Total Contract Value" and "Annual Contract Value" as explained below:

(...) Our revenue mechanics and ARR are disconnected. Revenue is driven by bookings which is TCV and an upfront portion based on product mix. And ARR is really just the accumulation of ACV over time. So the two are very disconnected in that regard. (...)

- CEO Dean Stoecker, Q2 2020 Earnings Transcript on Seeking Alpha

The company has moved towards offering more short-term contracts (with six-month periods) as an adaptation to uncertainty its customers face in the current environment. This had a material impact on TCV values and therefore revenue recognition. This trend will likely continue and suppress revenue growth for some time in my opinion.

New APA Platform

On the product development front, all Alteryx products are now unified with an end-to-end APA (Analytics Process Automation) platform that features new "Intelligence" and "Insights" suites. What began as a data-prep and blending tool (Alteryx Designer) has now evolved into a comprehensive product portfolio for everything in data science and automation under a single umbrella. The unification makes complete sense and should help keep the expansion rate and ARR growth high even with a weaker customer and contract value add.

Source: Alteryx Investor Relations, Q2 2020 Earnings Presentation

Source: Alteryx

The question investors might be asking is if the newer products produce a reasonable value addition to justify the high prices the company charges. That remains to be seen and it is early to tell how the data science community responds to the unified platform. In my non-tech underqualified opinion, the true star of the Alteryx portfolio has always been "Alteryx Designer", which has proved exceptional as a data-prep and data-blending tool. Data prep takes up a ridiculous amount of time (~70% of the total data science workflow) and the time savings alone with Designer have been brilliant going off of the tech community reviews and ROI perceptions. The ROI for other products and APA has been more questionable on a relative basis. I echo some of Joseph Kowaleski's sentiments from his last article on Seeking Alpha that critiqued the reported Total Addressable Market. Whether the products are "nice to have" or "mission-critical" is an important factor to consider when assessing future growth rates, especially now that the economy is more price sensitive.

All in all, Alteryx continues to be an excellent innovative business in the SaaS space and is likely the best at what it does. It just so happens that selling expensive data-science software, no matter how good it is, in a hampered economy is difficult and will continue to be difficult for some time. So far, the company has shown higher-than-expected exposure to business and economic cyclicality. Not all SaaS is resilient in this pandemic.

Thoughts On Guidance

Source: Alteryx 8-K Q2 2020 on Seeking Alpha

Alteryx will eventually re-accelerate its top line, but that is highly dependent on the speed of a broader economic recovery, which is anybody's guess leaving us a wide range of outcomes. I raised caution previously regarding a potential multi-quarter slump in sales and that indeed seems to be the case going off of guidance. The company has historically guided conservatively and has maintained a beat-and-raise strategy, so I expect outperformance for the rest of the year. It wouldn't be out of the question if revenues exited the year at 15-20% growth or so (above the 11% yoy FY2020 estimate). News of the recovery could catalyze spending from potential customers as well.

So what level of outperformance from the coming two quarters would justify buying the stock? And if Alteryx is an inevitable winner of data science software, what premium does that certainty come with?

I'm happy to pay for a higher share price for AYX if revenue does indeed re-accelerate by the end of the year, but I'll once again wait on the sidelines. Confirmation on new products landing and delivering value to customers beyond data prep would mean that its moat is indeed true and strengthen the bull thesis. The unified APA does appear to be incredibly promising and there isn't an equivalent platform on the planet which appears to have its capabilities. APA warrants some further research from my side.

Valuation

Source: AYX EV/S Multiples, using Koyfin

Alteryx posted a negative FCF during the last quarter and holds a trailing twelve-month FCF margin of 3.4% according to my calculations (FCF = Operating Cash Flow - CapEx). The balance sheet is strong, and management stated it's amassed billion in cash during the earnings call which should help withstand the rocky road ahead.

The vicious drop post-earnings puts the company at a 1-yr Fwd EV/S of 15.7x. That figure might be adjusted higher if some sell-side analysts have yet to lower their sales forecasts. To put profitability and growth into perspective, it is difficult to stomach the valuation with an extended growth rate of <20% and FCF margins at around breakeven for multiple quarters. A sign for re-acceleration may lead me to reconsider. I'm aware that some software stocks are trading at 25-30x sales but they appear to be delivering significantly higher growth rates as well. The multi-year compounding power of sales growth makes all the difference in these valuations. Revenue growth will be a key driver for AYX going forward.

Risks

Upside Risks: Vaccine and/or a quick economic recovery, rapid adoption of APA, further Fed stimulus that may boost digital transformation spending, acquisition risks from big tech, and generally massive outperformance on guidance.

Downside Risks: Systemic market risks and volatility, fund flow rotations out of growth stocks and the tech sector, prolonged economic recovery, competition from cheaper solutions such as Salesforce/Tableau's (CRM) data prep tools, and potentially excessive cash burn.

Conclusion

In my opinion, it's better to stay on the sidelines and not buy the dip. Growth prospects have drastically reduced for good reason and the Alteryx growth runway is more tied to the broader economic recovery which may well be delayed. At an NTM EV/S of 15.7x, the risk/reward isn't attractive. AYX is a "Hold".