Nov 1623 2020 - Alteryx: The Bullish Thesis Has Been Diluted

Summary

Alteryx has a long way to go towards stabilizing its growth factor.

Alteryx doesn't have some of the features of the new set of SaaS plays.

Investors should anticipate more volatility as Alteryx invests to scale the visibility of its platform.

The earnings volatility means nothing until Alteryx scales to a critical mass.

saupload_alteryx-logo-blue_thumb1.png

Source: PwC

I recently revisited my thesis on Alteryx (AYX). A lot has changed since I last checked on the stock. Alteryx plays in the data analytics/data science space. As data volume grows, simple spreadsheet-like solutions will struggle to address data analytics problems enterprises seek to solve.

In recent quarters, I have reviewed my mental checklist: Good management, competitive moat, minimal exposure to macro headwinds, and solid financials.

Alteryx's financials have been shaky since it reported disappointing top-line metrics in Q2. It also appears to be taking a hit from Covid-related headwinds. I noticed bulls have realized these concerns about Alteryx. This article attempts to reconcile some confusing patterns to the story.

Before delving into the detail, it is important to understand the positioning statement.

Alteryx is a data analytics platform. The chart below breaks down Alteryx's primary goal.

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Source: Author (using insight from Annual Report)

In understanding Alteryx, I combed the IPO filing for three keywords:

1. Cloud

2. SaaS

3. Platform

Moreover, software-as-a-service, or SaaS, business models have become increasingly demanded by customers and adopted by other software providers, including our competitors. While part of our platform is cloud-based, most of our platform is currently deployed on premise and therefore, if customers demand that our platform be provided through a SaaS business model, we would be required to make additional investments to our infrastructure in order to be able to more fully provide our platform through a SaaS model so that our platform remains competitive. - Source - IPO Prospectus

Cloud was mentioned thirty-one times in Alteryx's IPO prospectus. In the instances in which it was referenced, the word addressed Alteryx's desire to invest more in its cloud capabilities. This is currently limited to Alteryx Designer and Alteryx Gallery. This means Alteryx won't benefit much from companies hoping to leverage cloud solutions as their tech teams work remotely.

SaaS was mentioned thrice. In all instances, it referenced the investment Alteryx has to make to transform into a SaaS company.

Finally, Platform was mentioned 330 times. This is important because the way the platform is defined helps understand the product evolution, business strategy, and competitive moat. I value platforms highly because they foster the rapid evolution of new solutions and use cases. They also help predict management's next move.

Let's assume the Google play store is a platform with just a calendar app and Gmail. In an alternate universe, if we find a team of developers working on a social media app called Facebook (FB) because users are using the Gmail app to chat with their friends, then we can make a reasonable guess that Google will take a stab at the social media market. In this universe, we can also collaborate with other email apps where a Gmail user can send mails to a Microsoft Outlook user. Lastly, we can expect some network effect as users send mails on the email exchange client.

Within the broader business analytics software market, our platform currently addresses the business intelligence and analytic tools, analytic data integration and spatial information analysis markets, which collectively represented approximately billion in 2015 and are expected to grow to approximately billion in 2020. - Source: IPO prospectus

In the case of Alteryx, we can travel into the future by understanding the way its TAM (total addressable market) was defined in its IPO prospectus. From the definition, Alteryx aims to address the data analytics market. Closely tied to the data analytics segment are the data prep, data visualization, data warehousing, and data integrity segments. This means that once Alteryx's customers start to demand the consumption of their data analytics offerings with other segments, Alteryx can begin to add adjacent capabilities to its platform. This is based on its resources, its product vision, and the stability of the macro environment. Lastly, we need to have a firm conviction in management's ability to execute.

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It is immediately apparent that there are hidden cracks in the bigger picture. Firstly, there are competitors in adjacent data management segments with cloud capabilities. They also have a SaaS model, which affords them flexible pricing models like consumption-based pricing. It is reassuring that Alteryx can partner with most of these players. However, their cloud advantage is a threat to the rapid evolution of Alteryx's business model. The ease of consuming a cloud platform can't be compared to an on-prem platform in a Covid world.

Another concern I have is the learning curve of the platform. Alteryx was built to improve on the limitations of spreadsheets. While many knowledge workers can be trained to use a spreadsheet in a short period, it's not clear if the same can be said of Alteryx. This means Alteryx has to design its offerings to be self serve. It also has to ensure analysis can be done with little or no code. This is dangerous for citizen developers who aim to grow their technical skills. Unlike a spreadsheet, which is universal, it is tough for a citizen developer that has mastered Alteryx to move to a different company in which Alteryx isn't the primary data analytics tool. This will impact Alteryx's ability to achieve network effects from a developer-focus strategy. Also, I picture a scenario in which the usage of Alteryx is reduced to save cost. Compared to developers who have mastered SQL or Python, it is challenging for citizen developers who have dedicated years mastering Alteryx to be technically competent. I reckon that Alteryx has to keep investing until it attains a critical mass of developers who use its offerings.

42079636-1604827197907944.pngSource: Alteryx

Alteryx has been known for its strong growth factor. In recent quarters, Alteryx's growth has weakened. This was attributed to accounting-related reasons, which were carefully explained by Niki Schranz after the Q2 earnings. This also prompted Alteryx to add a slide to its earnings presentation detailing the impact of its revenue recognition method on its top-line metrics. While the market has digested this message, the long-term implication is still troubling. As cloud-based data analytics companies file to go public, I expect Alteryx to be increasingly challenged by its cloud-native peers. The subscription economy has put more power in the hands of consumers. To rebalance this power shift, companies have increasingly bundled offerings to drive stickiness and switching costs. For a SaaS company that also offers flexible payment terms, this opportunity appears like a solid competitive differential against their on-prem counterparts, such as Alteryx.

Valuation

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Source: Alteryx

Compared to high growth SaaS peers, AYX is fairly valued. ARR sits in the 50th percentile. We can expect ARR to approach the 75th percentile given the ample runway in the data analytics space. Revenue growth is tough to calibrate due to the accounting factors highlighted earlier. GM is best-in-class, though most of the margin advantage is expected to be plowed into sales and marketing. Net Dollar Retention is average. This number is impressive, given the focus on the Global 2000 market (135% DBNER at 38% market penetration). This highlights the significant growth opportunity driving the FY'21 ARR guidance of 25% shared during the last earnings. For Alteryx to pass the rule of 40, it needs to accelerate growth. This is tough to calibrate, given the margins sacrifice impacting FCF. Using FY'21 revenue growth of 24%, Alteryx will need to achieve an FCF margin of 16%. Earnings have been a weak contributor to operating cash flows in recent quarters. Billings has also been weak.

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Given the updated insights, to value Alteryx, it is best to benchmark Alteryx against platforms with significant on-prem exposure. It is also good to remember that Alteryx is tough to classify in terms of its importance to short-term trends like Remote Work, Cloud Migration, and Digital Transformation. In my previous thesis, during the peak of the COVID crisis, I classified Alteryx under non-essential WFH plays.

I see players with a mix of on-prem and cloud offerings as fair comps. These include Splunk (SPLK), Elastic (ESTC), Talend (TLND), and Cloudera (CLDR).

ChartData by YCharts

Compared to its peers, AYX is fairly valued, given its attractive growth potential.

Conclusion

For Alteryx to keep growing, it has to invest in the broad adoption of its offerings. This might be somewhat difficult since it doesn't have a managed cloud platform. I don't see any roadblock in the remote installation of its offerings. Though the sales motion via Zoom (ZM) can't be compared to sending a team of technical experts to a customer's HQ to drive the enterprise-wide adoption of Alteryx. For these reasons, I will be careful about the growth estimates floating around. I expect the growth story to be more drawn out rather than rapid. I also expect more margin sacrifice to drive the global adoption of Alteryx. This means more trading volatility down the road.

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