Tableau Incentives For Conservatism Make An Attractive Long

Tableau: Incentives For Conservatism
Make An Attractive Long
|Must Read Sep. 25, 2015 9:25 AM ET4 comments
by: Lester Goh
Summary
• Shares of Tableau have suffered a beating (off 30% from July) due to
missing on stratospheric market expectations - the firm posted a beat-and-
raise quarter. The stock is oversold.
• Tableau currently trades at a ~2x turn EV/sales discount to a close peer
Splunk. The discount is unwarranted given Tableau's superior financial
metrics.
• DATA's lower S&M spending/larger gross margins indicates a lower
CAC/higher customer LTV respectively. Upon maturity, this would translate
into far greater profits/cash flows as compared to SPLK.
• If DATA trades in line with SPLK, it would see a 20% upside. A case could
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be made for DATA to trade at a premium, given its superior metrics.
• A short-term long position in DATA appears to carry minimal risk at current
levels, given its growth runway, possible normalization of market
expectations, as well as unneeded capital markets funding.
Thesis
Following the 30% selloff since July, Tableau (NYSE:DATA) appears attractive at
current levels. Specifically, it is my view that shares are attractive because:
• Tableau posted a beat-and-raise quarter. Yet, shares fell drastically. Clearly, the
culprit here is market expectations; although DATA beat Street estimates and
guided strongly above consensus, market expectations were higher. In spite of a
Q2 beat, growth decelerated from prior quarters (with guidance indicating further
deceleration - a scenario I view as highly unlikely), suggesting that the selloff
was warranted. However, Splunk (NASDAQ:SPLK), a close peer of DATA
(although not direct competitors), also saw mild deceleration in its top-line, but
was rewarded (shares rose slightly following the report). As a result, I believe
that DATA is oversold.
• Prior to DATA's Q2, the firm traded at a premium to SPLK, which seemed
reasonable given its much stronger top line growth, superior gross margins, and
lower sales and marketing spend. This continues to be true after Q2. Yet, DATA
currently trades at a ~2x EV/sales discount to SPLK. In my view, this discount is
unwarranted, especially when one considers that there is a reason to believe
that DATA's growth outlook is likely to stabilize (or even accelerate).
• DATA's fatter gross margins and lower S&M spend implies healthy LTV/CAC
levels, which should result in massive free cash flow generation once growth
tapers off.
Ultimately, I believe DATA trading in line with SPLK is a reasonable base case,
given their striking similarities. If my thesis materializes, shares would see a 20%
upside from current levels. One can even make the case for DATA to trade at a
premium to SPLK (in which case near-term upside would be greater) as the
company is simply better in almost every metric.

Although DATA does not have significant tangible assets (PP&E is ~$60m) with the
exception of a high cash balance (~$730m or ~12% of current market cap), shares
of the firm still offer a reasonable margin of safety given the secular growth trends it
enjoys, the possible normalization of growth expectations (due to the recent selloff),
the highly recurring nature of revenues in the industry, as well as the fact that DATA
does not require continuous access to the capital markets to grow (cash continues
to grow q/q).
Given the myriad of sell-side research or otherwise publicly available analysis (here,
here, here, and here) on Tableau's business model, I will skip over explanations of
the firm's business, and instead focus on what's incremental and most meaningful to
the story.
Reasons for the opportunity - despite a solid Q2, excessive management
conservatism resulted in an unwarranted selloff
In the overwhelming majority of cases, high-growth stocks only decline sharply post-
earnings due to a few reasons. (1) Revenues fell off a cliff, (2) next quarter guidance
is weak, or (3) high expectations were not met. In Tableau's case, it is clear that the
culprit was high expectations. Revenues have continued to grow at double-digits,
while next quarter's guidance was way above consensus. Fortunately, the selloff
has created an opportunity for investors to get in on a high-growth SaaS company at
a relatively cheaper price.
Tableau's Q2 was rather solid. License revenue grew 60% y/y, while maintenance
revenues rose 76%. New customer additions remain strong, considering that the
firm signed 3,000 new accounts (up sequentially from 2,600 in Q1). Moreover, the
SaaS firm also guided strongly (but still appear conservative) - projecting Q3
revenues in the range of $153-157m (compared to a ~$150m consensus) and full-
year revenues in the range of $617-627m (compared to a ~618m consensus).
Despite a strong quarter, shares have fallen sharply since (nearly 30% since July).
Q3 guidance implies 47% y/y growth while full-year guidance implies 29% y/y
growth for Q4 revenues (assuming Q3 sales clocks in at 153m). Notably, in the prior
year, Q4 revenues jumped ~75% y/y. Effectively, the implied Q4 y/y revenue growth
rate for the current fiscal year suggests massive deceleration. Therefore, at first
sight, it seems the selloff was warranted (given the projected deceleration) but
upon closer inspection, this is not the case at all.
There are several reasons why I believe that the projected deceleration is highly
unlikely to materialize. Firstly, Tableau has a history of lowballing its guidance.

• For the prior fiscal year (FY14), the firm guided 118m-122m for Q4 revenues.
Actual Q4 revenues were 143m.
• For the current fiscal year (FY15), management guided 110m-115m for Q1
revenues. Actual revenues were 130m.
• FY15 Q2 revenue guidance was 135m-140m. Actual revenues were 150m.
In sum, Tableau has consistently "under-guided" revenues by approximately 15m-
25m each quarter. Taking the mid-point of this range, FY15 Q3 actual revenues are
likely to be ~$170m or an implied y/y growth rate of ~66%. Applying the mid-point to
Q4, revenues are likely to come in at ~$205m, or an implied y/y growth rate of
~43%.
Next, Tableau continues to ramp up hiring, especially within its sales & marketing
department - headcount within this department jumped 61% y/y. Given the industry's
extended sales cycle (new sales hires need time to get up to speed with respect to
the firm's offerings, drum up leads, etc), the revenue effects from these new hires
would likely be felt in Q4, not Q3, suggesting that Q4 y/y revenue growth rates could
be greater than ~43%.
Third, although the number of large deals (>$100,000) declined on a y/y basis to
233, management has indicated that this metric might increase substantially in the
second half of FY15. Below is the relevant excerpt (emphasis mine):

"Yes, so, the overall seasonality, as I mentioned before,
Mark, that we expect that to fluctuate and ebb and flow
on a quarter-by-quarter basis. So whether Q3 is above or
around the same ballpark, I just don't know and I wouldn't
want to guide you towards that at all. Q4 is traditionally
more of our stronger quarter, so I think overall that's
where we expect a large amount of revenues and
probably the larger amount of six figure deals will fall
into Q4. That's more of what I would give you from that
perspective."
Source: Tableau Q2 FY15 Earnings Call Transcript
Additionally, the team has announced plans to open a data center in Europe early in
July this year in order to better accommodate to demand within the region. This not
only suggests that demand trends remain resilient but also implies that revenue
from the region could inflect once the required infrastructure is in place.
Furthermore, the company also released technical support in Japanese just a few
weeks ago, which could result in acceleration in growth amongst its Japanese
customers. Although Tableau's software is intuitive and easy to use, it is likely that
the lack of technical support was a significant barrier to adoption. After all, no
enterprise in its right mind would purchase software without it being accompanied by
the associated aftermarket support. Thus, it seems likely that demand had been
relatively subdued in the area of Japan in the past - though that should no longer be
a problem given the advent of technical support.
Finally, the company is holding what seems to be the largest annual conference
(10,000 data enthusiasts are expected to participate) at Las Vegas in October. I
view of these events as low-investment/high-ROI projects - not much capital is
required to set them up while it is very possible to sign on many new clients.

Workday, another SaaS firm (though serving a different niche - HCM), has seen
great success with similar events in terms of customer acquisition. I see no reason
why Tableau wouldn't benefit as well. Below is the relevant excerpt from Workday
(emphasis mine):
"Finally, we are looking forward to Workday Rising, our
annual customer conference where we expect more than
5,000 attendees to join us in Las Vegas next month. In
addition to time with our customers, Rising is our number
one prospect event each year. In 2014, we hosted more
than 450 prospects from 200 companies at our U.S.
event, and today almost 20% of those companies are
customers. We also look forward to seeing many of you
at Workday Rising for our Analyst Day on September 29."
Source: Workday Q2 FY16 Earnings Call Transcript
Note that the event is being held in October this year, hence any new signings are
likely to result in incremental growth in Q4 revenues. In addition, management has
commented that Q4 remains a traditionally strong quarter for the company
(emphasis mine):

"So whether Q3 is above or around the same ballpark, I
just don't know and I wouldn't want to guide you towards
that at all. Q4 is traditionally more of our stronger
quarter..."
In a nutshell, it seems that Tableau's outlook (both the short- and medium-term)
remains very solid, there are many reasons to expect Q3/Q4 results to be
significantly above guidance, and it is highly likely that the following quarters would
point to a stabilization/acceleration of growth rates in the 50%-60% range. In
summary, it appears that the market has overreacted to Tableau's expected
deceleration in growth (implied by management's guidance).
As it turns out, it appears that significant incentives for conservatism and keeping
the stock price low continue to exist. Per the firm's Q2 FY15 10-Q, a significant
amount of options and non-vested RSUs remain outstanding as seen below:

Source: Tableau Q2 FY15 10-Q
Notably, the amounts that remain outstanding are in the range of hundreds of
millions (non-vested RSUs totaled ~$344m - a huge number relative to the firm's
current market cap of ~$6b).
If one digs through prior 10-Qs, they would find that the amount of RSUs tend to be
greater when the stock price is lower.
For example:
• In Q1 FY15, ~1.6m RSUs were granted at a weighted average value of $99.
Whereas in Q3 FY14, ~1.8m RSUs were granted at $78.
• In Q1 FY14, ~940k RSUs were granted at $97. In Q2 FY14, ~1.2m RSUs were
granted at $87.
Said another way, it appears that if shares of Tableau trade lower, the company's
compensation committee would compensate for that lower stock price (at the date of
the grant) by granting more RSUs. In essence, by keeping the stock price low, more
RSUs would be awarded - and these RSUs would eventually be worth way more
when shares appreciate.
I believe that this explains the continued conservatism that management has
repeatedly adopted in its guidance and also increases my conviction in my analysis
- that there existed (and continue to exist) compelling incentives for the firm
to be highly conservative with its projections.
Tableau sports superior financial metrics as compared to Splunk
Tableau's recent selloff seems even more absurd if one considers the fact that a
close comp (though not a direct competitor), Splunk, also saw a deceleration in
growth recently (from 50%-ish rates to mid-40s) Yet, this deceleration was rewarded
by the market, which pushed shares higher following the firm's Q2 earnings.
The similarities between both firms are striking. Both firms enjoy high growth rates
(and incidentally, similar revenue bases at $520m-$530m on an LTM basis), thanks
to secular tailwinds stemming from the continued explosion in data. Both have
international exposure in the mid-20%s of revenue. Both enjoy high gross margins
and spend a disproportionate amount on sales and marketing.

Given the amount of commonality that both firms share, it seems reasonable to
expect them to trade at a similar valuation. However, this is not the case.
DATA trades at an approximate 2 turn EV/sales discount to SPLK. This was not
always the case. Prior to DATA's Q2 report, the firm actually traded at a slight
premium to SPLK, and for good reason.
Source: Tableau's SEC Filings, author's calculations
Source: Splunk's SEC Filings, author's calculations
As seen above, DATA has consistently beaten SPLK in terms of revenue growth
(65%-75% vs ~47%), but more importantly, the firm possesses a higher gross
margin (~90% vs ~83%) and lower sales and marketing spending (~55% of sales vs
~78% of sales). The differential between these metrics hold true to this day,
suggesting that there is simply no reason why DATA can't trade in line or even at a
premium to SPLK (after all, it has already done so in the past).
The superiority of DATA is much clearer if we consider the customer acquisition

costs (CAC) and customer lifetime value (LTV) of both firms. As some of my readers
are probably aware, these two metrics are the strongest indicators of health in a
SaaS business (a detailed explanation why this is the case is available here,
courtesy of Andreessen Horowitz).
(click to enlarge)
Source: Tableau's SEC Filings, author's own calculations
Tableau: Incentives For Conservatism Make An Attractive Long - Tableau Software (… Page 10 of 18

Source: Splunk's SEC Filings, author's own calculations
Given that most SaaS companies (DATA and SPLK included) do not disclose CAC ,
I have sensitized the figure by assuming CAC as 60%-80% of S&M spend,
considering that it is common knowledge (at least in the SaaS space, Andreessen
Horowitz explains further in this podcast with NetSuite's CFO Ron Gill) that a
majority of S&M spend for SaaS providers is on new customer acquisition, while a
minority is dedicated towards retaining existing customers. Regardless, it is
apparent that DATA has much greater LTV/CAC levels as compared to SPLK (4.4x
to 5.8x vs 1.7x to 2.2x). As a simple rule of thumb, an LTV/CAC ratio of 3x is
considered healthy as it gives the firm enough leeway to cover operating expenses
(as LTV is based on gross margins) and still make a decent operating margin. Upon
maturity (i.e. once growth tapers off), it is crystal clear that Tableau would generate
much greater profits/cash flows as compared to Spunk, given its much higher levels
of LTV/CAC.
Relative valuation and catalysts

I understand that most value investors have an aversion in initiating long positions in
high-growth stocks. I think this aversion is misguided - there is a reason to believe
that SaaS firms would be hugely profitable if not for certain accounting rules and
continued reinvestment in growth.
Essentially, this point boils down to the key difference between traditional software
companies and SaaS companies. In the traditional software world, companies like
Oracle (NYSE:ORCL)/SAP (NYSE:SAP) conduct the majority of their business by
selling a perpetual license to their software with software upgrades as a follow-up
sale. For this model, customers pay for the software license up-front and then pay a
recurring maintenance fee in the out-years. Such a business model fits in very nicely
with accounting principles as the timing of revenue and expenses are perfectly
aligned. Once a sale is made, all the license revenue gets recognized, along with
the expenses associated with that revenue, allowing traditional software companies
to reach GAAP profitability rather quickly.
In contrast, SaaS companies adopt a different sales model. Instead of a perpetual
license, the typical SaaS firm sells its software on an on-going basis (hence the
software-as-a-service designation). Frequently, customers opt for 12-36 month
contracts, which prevents the SaaS firm from recognizing those 12-36 months worth
of fees upfront. GAAP requires revenue stemming from such contracts to be
recognized ratably over the term of the contract. Yet, the SaaS company incurs all
costs (commissions paid to salespeople, professional services implementation,
hosting the infrastructure, upgrading the software, etc) associated with that contract
upfront. To say that this depresses short-term earnings would be a huge
understatement. Consider the following (borrowed from Andreessen Horowitz):

Source: a16z
Note that the SaaS company does not achieve break-even on a single customer till
the end of year 1. Growth clearly depresses short-term earnings. The magnitude of
the depression is exponentially intensified, the faster the SaaS company acquires
new customers, as seen below (borrowed from Andreessen Horowitz):

Source: a16z
The main takeaway from this illustration is that growth worsens earnings in the
short-term - the faster the firm grows, the more costs (principally commissions paid
to salespeople) get realized right away. However, the faster the company grows, the
better the above cash flow curve will look once growth tapers off. This model applies
to Tableau and Splunk, and is the main reason why SaaS companies are inherently
profitable despite the fact that this profitability does not show up on their income
statements as a result of accounting principles.

A crude measure of "mature" profitability for SaaS companies is as follows: assume
a certain % of sales and marketing expense is tied to new customer acquisition, and
that this expense will fall off once the firm's installed base matures (to be
conservative, I assume that other expenses, especially R&D, stays the same).
If one assumes a 70% allocation of sales and marketing expense to new customer
acquisition, Tableau and Splunk would have "mature" net profit margins of 35% and
9.5% respectively (% allocation x LTM sales & marketing expense as % of sales +
current LTM net profit margins, Tableau: 70% x 54% - 2.5% = ~35% net profit
margin, Splunk: 70% x 75% - 43% = ~9.5% net profit margin). A 35% net profit
margin for Tableau translates to a LTM P/E of ~28.5 ex-cash, which seems
reasonable for a firm growing revenues by 60%-70% y/y. As a reference point, the
S&P 500 currently trades at ~20x P/E.
Tableau currently trades at ~10x LTM EV/Sales while Splunk trades at ~12x LTM
EV/Sales. In other words, if Tableau trades in line with SPLK, shares would see
20% upside. A case could be made for Tableau to trade at a premium multiple
relative to Splunk, given its superior financial metrics and far greater levels of
LTV/CAC (which ultimately drive a higher "mature" net profit margin).
Although one might want to attribute to the valuation discrepancy between DATA
and SPLK to the difference between their software offerings, this claim does not
hold merit.
Both companies are big data plays, but their products are slightly different. Briefly,
DATA provides an intuitive/easy-to-use software which allows customers to
visualize their data, whereas SPLK collects data from machines (data centers,
smartphones, etc).
While this allows SPLK to enjoy higher customer LTV (as it focuses on a niche)
compared to DATA (~$300k vs ~$99k, as seen in a prior section), SPLK has to
spend way more on sales and marketing in order to acquire customers. In fact, the
extent of the difference in sales and marketing spend is so large (as seen above,
SPLK spends ~1/4 of its customer LTV on CAC, while DATA spends ~1/2) that any
advantages from a higher customer LTV is totally wiped out by a higher CAC. As a
result, one cannot argue that SPLK should trade at a higher multiple than DATA
solely based on their software offerings (SPLK is more of a niche player while DATA
is going for the mass-market).

Given management's apparent conservatism with guidance, which clearly led to the
30% selloff since July, and considering the fact that there is a reason to believe
growth would accelerate from here on out (detailed in an earlier section), I expect
incoming Q3/Q4 results to point towards a stabilization/acceleration of top-line
growth, which would catalyze shares higher.
Risks And Conclusion
With a high-growth firm, the most relevant risk would be a sharp deceleration of
growth. However, given my earlier discussion on why growth should stabilize or
even accelerate going forward, I view this risk as minimal. Furthermore, new
versions of the firm's software have seen continued acceleration in registrations,
suggesting that near-term demand remains very strong (emphasis mine):
"Our investments in innovation are paying off with users
adopting Tableau's products at a rapid pace. In Q2, we
released Tableau 9.0, bringing big advances in analytics.
In the first few weeks after launch we experienced
78% more registrations than we did with Tableau 8.2."
Another pertinent risk that many high-growth firms face is the need to access the
capital markets to fund future growth. Tesla is one example: the company continues
to burn cash and recently closed a large equity offering in order to finance future
growth. In the context of Tableau, this risk is substantially mitigated given the firm's
huge (and growing) cash balance (~$730m as of the MRQ). DATA clearly does not
require continued access to the capital markets to finance future growth.
To conclude, despite a beat-and-raise quarter, shares of Tableau sold off sharply. It
is my view that shares were oversold. Digging deeper, it appears that an expected
deceleration in growth (implied by management guidance) was the culprit. However,

given management's history of lowballing guidance and the fact that strong
incentives to keep shares at low prices continue to be present (given the sheer
amount of options and non-vested RSUs that remain outstanding, as detailed
earlier), forward guidance is likely excessively conservative.
At current levels, shares of Tableau trade at a ~2x EV/Sales discount to close comp
Splunk, despite superior financial metrics. If Tableau trades in line with Splunk,
shares will see 20% upside - although given its stronger metrics, I see no
reason why shares can't trade higher.
Incoming Q3/Q4 results should show stabilization/acceleration in the top-line, which
would catalyze shares higher. The magnitude of the near-term upside potential
might be even greater if one considers that the selloff possibly resulted in a
normalization of market expectations. Considering its huge war chest, capital
markets risk (the risk of an inability to obtain funding) is substantially mitigated. At
current levels, shares of Tableau seem like an attractive long for the short term,
till shares re-rate to a more appropriate level (in line or at a slight premium to
Splunk).
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.

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