Investment Memo and Q4 Earnings Teardown for Anaplan

TL;DR

Overview:

Anaplan is pioneering cloud-based connected planning, which allows businesses to consolidate projection planning and decision-making across the whole enterprise. With the unique Hyperblock™ technology, users can model different scenarios and visualize the impact of business decisions on all departments within an organization. Anaplan is leading the future of enterprise projection and uniquely positioned given their penetration of large enterprise, extensive network and growing reputation, proprietary technology, and marketing/growth strategy that allows them to continue to dominate this space for years to come.

Key Metrics

Anaplan benchmarked vs. Top 10 public SaaS

Business Model

• Subscription-based model with 3 levels (Basic, Professional, and Enterprise)
• 1,400+ customers served as of January 31, 2020
• 250+ Global 2000 companies, No customer represents 10%+ of revenue in fiscal 2019

Selling and Marketing

• Direct sales team targets large enterprises (Global 2000 companies)
• Strong network of Global and Regional Partners, targeting mid-market organizations
• Anaplan CPX annual conferences, connect existing and potential customers and reinforce brand
• Training at Anaplan Academy allows clients to efficiently migrate to Anaplan

Competitive Strengths

• Uniquely targets and connects multiple sectors’ planning (finance, sales, operations, supply chain)
• Incorporates easy-to-use modules addressing multiple sectors
• Supports complex financial modeling and connections to operational use cases
• Offers pre-built solutions with the Anaplan App Hub
• No technical knowledge required (familiar excel-style platform usable by everyone)
• “The ability to update a single variable and have that change propagated through the entire model is unparalleled.”
• Ability to have thousands of users working on same model simultaneously (patented Hyperblock)

Competitive Weaknesses

• Unclear and expensive pricing for large amounts of data due to tier-based subscription model
• Too complex for smaller organizations due to high product and implementation cost and governance requirements
• Steep learning curve for syntax and complex financial planning (+ inefficient Anaplan Academy)

Business Performance & Financials

• Gross Margin Expansion - decreasing focus on implementation solution, and expanding on growing their recurring revenue streams will allow steady state gross margins to converge to 80+%.
• Net Dollar Retention - due to the stickiness of recurring revenue enterprise software, Anaplan has an amazingly consistent net dollar retention rate of 123%.
  

Other Interesting Business Metrics

1. Anaplan currently has the worst magic number 0.6 (for every dollar in S&M spend, how many dollars of ARR do you create) among SaaS companies growing 30+% yoy.
2. Anaplan is able to upsell their existing customer contracts. Anaplan’s top 10 customers now average 3.5M in annual recurring revenues, compared to an average of 360k (almost a 10x) on their first contract with Anaplan.
3. Strong unit economics: Anaplan’s LTV/CAC > 5x (Q2 2019 earnings call).
4. Incredibly low churn rate ~1.4% (not a public statistic, approximated calculation).
   

Q4 Earnings Results (Announced 2/27)

• Q4 Revenue of 98.2M, up 42% yoy, FY 2020 Revenue growth of $348M up 45% from FY 2019
• Subscription Revenue up 48% from year prior; RPO of $656M, up 49% yoy
• Over 1400 customers, with large enterprise customers (ARR > $250K) of 353, up 42% yoy
• Dollar-based Net Expansion Rate of 122%
• Full year FCF margin of -8%, strong improvement from the -20% FCF margins in FY 2019.
  

Why the drop after Q4 earnings?

• Despite beating on revenue, earnings, and raising guidance for 2020, many investors expected growth to outperform sell-side and consensus estimates by an even larger margin.
• Q4 billings growth disappointed.
• Departure of Mark Anderson, a seasoned executive hired in Aug 2019, who was expected to lead Anaplan’s sales operations. His industry expertise in scaling Palo Alto Networks and Cisco Systems gave many investors optimism of Anaplan’s similar rise.
  

Market Opportunity

1. Anaplan is pioneering new, essential technology in the cloud category: connected planning.

• Connected Planning will likely see the same growth and IT budget as Application Performance Management/Business Insights: Data driven, forward-looking projections are just as critical as the performance management/insights provided by APM and BI.
• Previous methods are outdated: legacy approaches are typically confined to one department and use a patchwork of disconnected tools and processes that are complex and inefficient. Connected planning enables dynamic, holistic collaboration for organizations. Competitors are often confined to one sector.
• High value-proposition for customers: Anaplan connects disparate data and plans and enables real-time planning and decision-making in rapidly changing business environments.
• We should be optimistic about its growth given that 1) Anaplan is still in the early stages of market penetration (<2% of market penetrated); 2) Success of customer-first strategy - enables Anaplan to effectively execute their land and expand growth strategy; 3) They’ve had a track record of expanding within their customer base: Anaplan is able to renew subscriptions to expand from a single use case (such as finance) across the many various lines of a business, ultimately growing user numbers and use cases and producing stable net dollar retention.

2. Gross margins still have incredible room to expand, boosting FCF margin to satisfy rule of 40.

• Anaplan aims for decreased emphasis on capital intensive service revenue (implementation/configuration services).

Evidence #1: Fixed costs from third party implementation will decrease relative to total revenue as the subscription platform (85% gross margins) increases while service (30-50% gross margins) remains constant.

Evidence #2: Professional service engagements are increasingly performed by Global Partners, a network for which capital costs are lower than third party service providers.

• Contribution margin cycle will result in gross margin boost:

Evidence #1: Revenue growth is largely due to the landing of many new clients, which bears high up-front costs in sales and services to get customers to sign.

Evidence #2: Since Anaplan’s subscriptions are of an average of three years, the contribution margins drastically increase over the duration of the subscription; year 1 has heavy landing costs, whereas years 2-3 operating costs are the only contractual variable costs; it’s typical for contribution margin percentages to go from 72% in year 1 to 80%+ in year three.

• Gross margin expansion will lead to strong response in FCF margins: Anaplan’s typically ignored strong FCF margin will result in Anaplan overcoming the Rule of 40, resulting in greater investor confidence and thus multiple expansion.

3. Anaplan faces little competition in a rapidly growing marketspace, and it's all-encompassing suite, user-friendly interface, and high customer satisfaction will allow it to dominate this space.

• Software is attractive to a diverse set of large enterprises: Enterprise customers prefer a single, consolidated platform, translating to high value and efficiency.

Evidence: Companies can benefit as much as 537% ROI over three years by deploying the Anaplan platform--"Total Economic Impact (TEI)" study by Forrester Consulting

Anaplan competes favorably against its three main competitor categories:

Only Anaplan offers patented, scalable, in-memory technology (Hyperblock) able to not only handle tens of billions of cells in one model but also execute recalculations in less than a second.

Evidence: Four patents on Hyperblock that expire between November 2030 - November 2034.

1. Because in-memory database architecture utilizes a machine’s RAM (Random-Access Memory) and optimization algorithms, in-memory databases are faster and require fewer CPU instructions than their disk-storage counterparts.
2. 1-second delay in page load time results in 11% fewer page views, a 16% decrease in customer satisfaction, and a 7% loss in conversions8

• Strong room to grow (continued penetration of global 2000 customers)

Evidence: Well diversified customer base demonstrates Anaplan’s strong usability and customizability. Customers include: Target, Nokia, HP, Bacardi, etc. 250+/Global 2000.

• Low variance in the Net Dollar Based Expansion Rate: (121-124% over last 12 quarters)
• Heavy focus on accessibility and easy-to-use UI/UX:

Evidence #1: New UX and mobile feature (highly rated), greater flexibility with dashboards, easy to pivot, information easily accessible at the fingertips.

Evidence #2: Implementation of department-specific modules and familiar, excel-style user interfaces allow users with minimal technical experience to leverage Anaplan’s immense functionality.

• Revenues are still accelerating: Billings (with the exception of this past quarter) & Remaining Performance Obligation (RPO) outpaces subscription revenue growth
• Anaplan’s customer-first mentality, and the fact that Anaplan’s service reduces the need for key personnel within a business helps maintain the high switching costs

Evidence #1: Calculated a churn rate of 1.4% in Q3 2019.

Evidence #2: “the key benefit is having a significant number of collaborators, who can all rely on one single source of truth” (Review of service from Tableau)

1. “Land and Expand” will prove to be a successful long-term marketing/growth strategy.

• Anaplan is unfairly criticized for its worst magic number: ($1 spent on S&M results in 60 cents of sales) among high growth software companies (revenues growing 40+% yoy)

Evidence:

Magic Number should not matter for a company like Anaplan: employing the “land and expand” strategy, it lands customers who ease into their cross-functional services and generates significant revenue from its existing customers. Anaplan's value comes in being able to continuously upsell its existing customers.

Low magic number implies high payback period (1/[Magic Number * gross margin]) Enterprise software companies with high net dollar retention with high Average Contract Values ($100k+) may require long payback periods (18m+) which would be worth the tradeoff since the contracts grow for each account over time.

• Anaplan is in the early stages of the market, and has strong operating leverage:

Evidence: average revenue per customer grew 12.5% last year, its top 25 customers are spending $3.5MM ARR vs. ~$360K in initial billings (~10x increase).

• Strong Enterprise Customer growth:

Evidence: 57% yoy increase in enterprises spending >1$M yearly. Furthermore, 324 out of ~1300 customers are paying >250,000$ yearly, an increase of 96 customers from last year (42% growth).

• Honeycomb Effect: seen by selling to executives of large enterprises.

Evidence: Anaplan’s platform is often initially adopted within a specific line of business (finance, sales, and supply chain) for one or more planning use cases. Once customers see the benefits of their platform for their initial use cases, they often increase the number of users, add new use cases, and expand to additional lines of business, divisions, and geographies.

• Growth of partner system: Partners allow Anaplan to get higher in the enterprises and connect to specific projects that are underway.

Evidence: A greater proportion of enterprise customer acquisition, is coming from the partner ecosystem, resulting in lower costs than direct sales reps.

1. Partners provide subject-matter expertise in the implementation of specific use cases and act as an extension of their direct sales force by identifying and referring opportunities.
2. Approximately 50% of Anaplan’s deals involved partners.
3. Annual contract values (ACV) are ~3-5x larger when partners are involved.
4. Anaplan works with partners to create pre-packaged solutions available on the App Hub, facilitating adoption of the Anaplan platform.
5. Partner business growth is over 50%; job openings within partners continues to increase and Anaplan is working with their partners to find new ways of helping to develop some of the talent that they need as well as their customers as the whole ecosystem expands.

• Above average lifetime value-to-customer acquisition cost ratio (>5x)

This is a stellar ratio already, and given Anaplan’s operating leverage and ability to scale revenue growth from existing customers, this number will likely increase.

Competitors

How will Anaplan respond to the Coronavirus and impending market downturn?

1. Anaplan is a mission-critical, recurring revenue, B2B software company that despite its higher price, companies willingly turn to. Given the amount of data and workflow done on its software due to its in-memory calculation feature, it's unlikely that Anaplan will see significant churn.
2. While demand from new customers is likely impacted, Anaplan is deeply entrenched in the large-enterprise space and was lowering their dependence on implementation service revenue (sending a technical expert to manually install and teach new customers how to use their software).
3. Anaplan’s wildly low variance in the net dollar retention metric demonstrates how it is continuously capable of upselling to its existing customers, as customers continue to grow and add more users on  Anaplan’s platform. Even assuming zero growth in new customers, it's likely that net dollar retention remains above 120% (123% every year since FY 2017). Revenue growth of 20% (for a company that can accelerate revenues) implies an 8x forward revenue multiple, which we use as the downside bear case for Anaplan’s valuation.
   
   Valuation

Top Down Approach (sanity check measure):

Anaplan currently has ~2% market penetration and Industry CAGR will likely grow at a rate slightly faster than average GDP growth. To identify a representable region of our 10Y IRR, I look at the implied revenues for 2025 - 2030, presumably the average revenue growth for these years will be lower than our 2024 revenue so we use that as a baseline.

Match the corresponding IRR with reasonable average revenue growth rate).

Assumptions:

I believe that by 2024, Anaplan is yet to reach maturity.

Q4 2019 Total Revenue = Subscription Revenue + Service Revenue

Q4 2019 Base Revenue = revenue generated from existing customers + revenue generated from new customers

Revenue from existing customers = [Q4 2018 customers]*[Q4 2019 projected DNBE rate]

Revenue from new customers = 4*[Q4 projected customers - Q3 2019 customers] * [average revenue per new customer]

Subscription Revenue calculations:

DBNE rate remains 123% for FY2021, tapering to 118% in 2024.

Customer growth falls from ~8% growth qoq to averaging ~5% qoq (adding ~280 new customers in 2020) before tapering to steady 4% qoq growth.

Average revenue from new customers remains constant.

2020 Service Revenue stays constant at 3M/quarter before going back to 10M/quarter (service implementation solution revenue will be significantly impacted by Coronavirus).

COGS: noticing that subscription revenue operates at an 85% gross margin, and the decreased focus on service revenue; we have gross margins converging to 82% by 2024.

S&M: Using Salesforce as a proxy, we scale S&M expenditure to be ~39% of revenue in 2024. Using data from LinkedIn premium, sales headcount grew 9% over the last 6 months. We use this as our assumption for 2020.

G&A: HQ Office Lease expires in 2026. We have G&A expenditure representing <10% of revenues by 2024.

R&D: Being in land-grab mode, we have R&D accelerating; and tapering down to ~15% of revenue by 2024.
We target an implied 2024 FCF multiple of ~21x and FCF yield (excluding SBC to be around 12-15%)
Calculated implied IRR based on today’s stock price and future stock price.

Disclaimer: The author owns stock directly in PLAN. Public Comps (SaaSy Metrics LLC) provides financial and industry information and analysis regarding public software companies as part of our weekly dashboard, our blog, and emails. Such information is for general informational purposes only and should not be construed as investment advice or other professional advice.