Avalara IPO: The Goodwill Is An Opportunity

Summary

  • The company has acquired several competitors all over the world. As a result, the goodwill seems elevated.
  • If the merger integration is done properly, the revenue growth could continue.
  • The company’s share price does not seem very high. The EV/2019 Forward Revenues equals 3.4x.
  • The revenue increased by 73% in the last two years; it reached $213 million in 2017.
  • Avalara expects to sell 7.5 million shares at a maximum offering price per share of $21.00.

Growing through a large amount of international acquisitions, Avalara (AVLR) could become a must-follow stock if they work out.

Highly respected auditor Deloitte & Touche LLP is working with the company. Additionally, the underwriters are also important institutions in Wall Street. Have a look at the following list:

Business Objective, Employees And Facilities

In a world in which digital commerce is becoming critically important, corporations also have to deal with constantly shifting taxation and reporting obligations to taxing authorities. Founded in 2004 and headquartered in Seattle, Washington, Avalara provides software solutions to help companies in this regard.

In 2017, the group processed an average of over 16 million tax determinations per day. Read the following words about the software offered by AVLR:

“Avalara’s mission is to provide solutions for this challenge, allowing companies to focus on their core operations. We provide a leading suite of cloud-based solutions designed to improve accuracy and efficiency by automating the processes of determining taxability, identifying applicable tax rates, determining and collecting taxes, preparing and filing returns, remitting taxes, maintaining tax records, and managing compliance documents.” Source: Prospectus

How can a company only dealing with the taxes of others obtain growth? The company has been growing at a high pace because the services are provided through a cloud application. As compared to other tax applications, it seems that this small modification changes everything. The company provides a service combining an advanced database with up-to-date tax information along with sufficient technology to prepare and file tax documents in real time. According to AVLR, thanks to the new cloud solution, the customers are allocating less personnel for tax compliance.

Is AVLR’s solution prepared to interact with other business applications? That’s another feature of this company that I appreciate. According to the prospectus, AVLR owns more than 600 pre-built integrations that enable Avalara Compliance Cloud to link with accounting, POS, ERP, recurring billing, ecommerce, and CRM systems.

Who are the customers? AVLR works for companies and industries of all types, but it has connected very well with mid-market customers with 20 to 500 employees. The amount of customers has increased from 6,250 on December 31, 2016 to 7,760 as of March 31, 2018.

Let’s talk about customer acquisition. Does AVLR have a good customer retention ratio? Yes, the company’s net revenue retention rate averaged 107% for the four quarters ended March 31, 2018. Check the following business indicators for more detailed information about the net revenue retention rate:

Source: Prospectus

Regarding the work force, 1,495 employees work for the company with 1,046 being located in the US. Additionally, there are also employees in Europe, Brazil, Canada, and the UK.

I could not find a table having the role of employees, but I assume that like other business vendors, many work in sales. With that, I did find that 345 employees are working on research and development.

The following text from the prospectus contains more detailed information:

Source: Prospectus

The company leases a 114,510 square feet office in Seattle, Washington, but it also maintains other offices in the U.S., U.K., Belgium, Brazil, and India:

What’s The Market Opportunity? – International Expansion

According to the estimates given by AVLR, the U.S. market for tax solutions makes over $8 billion. Taking into account that 94% of the total revenues are generated in North America, that is approximately the total addressable market that we should use.

With that, the company has also a large amount of employees in the U.K., Europe, India, and Brazil. Thus, if the company is successful in these other countries, the market opportunity could be larger. Bear in mind, for example, that in Europe, the OECD estimates that over $1.2 trillion of VAT was collected in 2016.

Revenue Growth

The revenue growth in the last two years has been incredible, and was mainly driven by subscriptions to the company’s solutions, which represent more than 90% of the total revenue in 2017, 2016, and 2015. According to the prospectus, existing customers and several acquisitions made in 2015 and 2016 are the reason behind these fantastic figures.

With an increase of 73% in the last two years amounting to $213 million in 2017, the revenue line is not the only line growing. The gross profit also increased by 88% in the last two years and touched $155 million in 2017. Have a look at the income statement in the image below:

Source: Prospectus

Like many other cloud vendors, the expenses in sales and marketing are quite significant. They account for more than 60% of the total expenses exhibited in 2017. In my view, these large costs are the reason for the company’s operating losses shown in 2015, 2016, and 2017.

What’s my take on the profit and loss account? I believe that the investors will not really care about the negative results if the company maintains the same revenue growth in the future. I don’t worry either.

The Balance Sheet Is What I Like The Less: Assets And Acquisitions

Rather than the balance sheet, the growth investors prefer to study the income statement deeply. I agree with this vision since what matter here are the revenue growth and the ability to generate cash. With that, I would like to assess the company’s balance sheet since it does not look that good.

As of March 31, 2018, AVLR showed $208 million in total assets, out of which $12 million is cash in hand, approximately $72.8 million is goodwill, and $17 million are intangible assets. Have a look at the image below for more details:

Source: Prospectus

Approximately 42% of the total current assets is represented by goodwill and intangibles. As per the prospectus, the intangible assets consist of developed technology and customer relationships arising from business acquisitions. Furthermore, the goodwill was reported after the acquisition of other companies in Europe and Brazil.

What’s my take on these assets? First of all, they should be seen as an opportunity. The acquisitions were made in 2015 and 2016, so the merger integration is still in the works. In my view, if the company can turn around the businesses acquired and generate revenues, shareholders will largely benefit in the next few years.

That said, if the acquisitions are not successful, the company will need to reduce the value of these assets. Taking into account that they represent 42% of the total amount of assets, I need to note that risk is quite high.

For the interested readers, following are further details about the intangible assets shown in the balance sheet as of December 31, 2017:

Source: Prospectus

Additionally, I believe that it is interesting to review the transactions made in 2015 and 2016. In my opinion, the goodwill and the value of the assets acquired show very well that AVLR expects to make incredible returns from these transactions. With the numbers in mind, I became extremely optimistic about these acquisitions. I hope my readers are optimistic too.

In September 2016, the company acquired Gyori in Brazil for 21.7 million, out of which $19.38 million was goodwill, and $4.6 million was developed technology, customer relationships, and other intangible assets:

Source: Prospectus

Additionally, in June 2015, the company acquired VAT Applications for $16.5 million, out of which $10.4 million was goodwill, and $5.9 million were intangible assets:

Source: Prospectus

Furthermore, in June 2015, the company acquired EZtax for $28.1 million consisting of $23 million in goodwill and $7.7 million in intangible assets:

Source: Prospectus

Finally, the company also acquired HotSpot for $9.1 million, out of which $6.1 million was goodwill, and $2.3 million were intangible assets:

Source: Prospectus

Liabilities

As of March 31, 2018, the company exhibited $245 million in total liabilities, out of which total amount of debt is not that significant. The list of liabilities only includes a credit facility of $55 million. The most significant liabilities are current deferred revenue of $95 million, and accrued expenses and trade payables. Have a look at it in the image below:

Source: Prospectus

When is the debt payable? The company will need to pay approximately $42 million in one to three years. In addition, other obligations of $33 million will be necessary in 2018 as shown in the following image:

How will the company solve this situation? The company expects to solve this liquidity issue with the proceeds from the IPO. The following words were included in the prospectus to explain the use of the proceeds:

“We intend to use the net proceeds that we receive from this offering for general corporate purposes, which we currently expect will include headcount expansion, continued investment in our sales and marketing efforts, product development, general and administrative matters, and working capital. We also intend to use a portion of the net proceeds from this offering to repay the outstanding balance under our revolving credit facility. ” Source: Prospectus

Additionally, I could also read that the company has commenced to execute restructuring efforts. In 2017, the company expensed $0.8 million in restructuring. Read the following words in this regard:

Source: Prospectus

Valuation

Taking into account 66.058 million shares to be outstanding after the offering and an offering price of $21, I get a market capitalization of $1,387 million. Adding debt of $58 million and subtracting $12 million in cash and $181 million from the IPO, I obtain an enterprise value of $1,252 million. Assuming growth of 29% in the next two years, I get forward revenues of $359 million for 2019.

With this number in mind, the EV/ 2019 Forward Revenues equals 3.4x, which doesn’t seem very high for a cloud solution company with high growth. Other cloud solutions that recently executed an IPO are now trading at higher valuations. Investors can check Ceridian HCM (NYSE:CDAY), which is trading at about 5.5x forward revenues, or Pluralsight, Inc. (NASDAQ:PS) that trades at about 8x forward revenues.

I could not compare AVLR with any of the competitors given by the company since most of them are private or they trade in the grey market, like Wolters Kluwer N.V. (OTC:WOLTF):

Source: Prospectus

Low Float – There Is Volatility Risk

The following table represents the shareholders. Note that all executive officers and directors, as a group, own 53.2% of the total shares outstanding.

Source: Prospectus

What’s my take on the positions owned by directors? First of all, I recommend minority shareholders to follow their trades. In my opinion, their opinion will matter a lot to the market. Additionally, I need to warn investors about the low float. Share price volatility can be expected here.

When will they be able to sell shares? According to the prospectus, directors will have to wait 180 days to sell shares. In my view, the downside risk could increase if they commence to sell after this time period:

Source: Prospectus

Finally, I would like to note that the Board of Directors is independent. It is a great news. It means that the Board will really work for all the shareholders:

Source: Prospectus

Conclusion

With outstanding revenue growth, this company seems like a serious opportunity if the recent acquisitions work out. In my opinion, the investors need to closely monitor the goodwill. It will determine the future of the share price. I will use the same investment strategy.

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.

Article by Wilsonville Capital from seekingalpha.com

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