Chit Chat Stocks - Avalara (AVLR) | Deep Dive

Episode Date: February 18, 2021

Avalara is a tax software focused on e-commerce. For many small businesses, a sales tax must be collected at the time of purchase. Is the tax based on where the customer is or where the merchant is? Clearly, taxes can cause enormous headaches for small businesses and Avalara wants to be the solution. As always enjoy the show! Subscribe to 7 Investing with the code "CCM": https://7investing.com/subscribe/ Follow Ian and check out his work on Twitter: https://twitter.com/IanGrayLive Follow us on Twitter: https://twitter.com/chitchatmoney Subscribe to our Youtube Channel: https://www.youtube.com/channel/UCG5Ni-SI-jyrEsoNUhqftNQ Email us: [e-mail] Timestamps Company Background | (2:29) Industry | (5:52) Management & Ownership | (9:03) Valuation | (11:53) Earnings | (12:57) Balance Sheet | (14:58) Our Analysis | (19:14) Disclosure: Chit Chat Money hosts and guests are not financial advisors, and nothing they say on this show is formal advice or a recommendation. Brett Schafer and Ryan Henderson are general partners and portfolio managers at Arch Capital. Arch Capital and its partners may hold securities discussed on this show. Learn more about your ad choices. Visit megaphone.fm/adchoices Learn more about your ad choices. Visit megaphone.fm/adchoices

Welcome to Chit Chat Money. On this show, host Ryan Henderson and Brett Schaefer interview industry experts and riff on the world of investing. As a quick reminder, Chit Chat Money is a CCM Media Group podcast. Ryan and Brett are also general partners at Arch Capital, and Arch Capital may have positions in the securities discussed in this podcast. Anything discussed on Chit Chat Money by Ryan or Brett or any other podcast guests is not formal advice or a recommendation. Now, please enjoy this episode. Okay, welcome in. This is the Thursday Deep Dive episode. My name is Brett Schaefer. I'm here with Ian Gray on Zoom and Ryan Henderson. As always, we're going to be talking Avalara today,

a software as a service company that does tax compliance. Very boring, but everyone knows we love software as a service, so we can pay infinite valuation for it. But no, we know we can't do that. But before we get started, I don't know, it's been 13F season. We saw that Berkshire Hathaway has been buying a Verizon. I don't know. Do you guys follow 13Fs at all? I like the screenshots on Twitter. Yeah, I'll go to Whale Wisdom occasionally.

The problem is I always see the number one holding, and I always think, like, gosh, that's a good idea. Like, maybe I'll look into it more. And that's always the one that's, like, run up. That's why it's, like, the number one for them. Yeah. Ian, do you pay attention to the 13Fs? I don't pay attention to them too much in the moment. Every once in a while, I like to see what historic,

what firms have been doing historically, because I think that gives a little bit of insight into maybe how to, how to find some of these ideas. Like where did they, you know, why did that become their number one position or things like that? But in the moment, I don't pay too much attention to them. We just copied Berkshire Hathaway, right? But no, we'll let Ryan, Ryan, why don't you get started and talk about what Avalara does? well before uh use our code oh use our code ccm at seven investing because we're salesmen now so

uh ten dollars off first month at seven investing so it only costs you seven bucks great a great amount of picks what what else running they're getting their new advisor soon yeah and what how many days until we're only halfway through the month so i guess a few more days until march yeah they're their new picks but we do look forward to their picks pretty much every time there's always one or two you can nitpick and kind of uh add or look at for your own portfolio but i'll get into avalara so is it hold on it's avalara or avalara i heard them on a podcast advertising uh so come on ours if you want but the it's avalara avalara is a software as a service tax compliance company so merchants that still sell stuff on the internet this is

kind of the customer value proposition there's merchants and they sell stuff on the internet or they sell in multiple states or something like that and they have to pay various different types of taxes so there's sales tax use tax value-added tax which i believe is like uh sort of placed on the supply chain essentially and then uh excise taxes in some cases and there's a bunch more and the problem is every state and jurisdiction has not only different rates but in some case different taxes altogether so it's hard for them i mean almost impossible for the merchants to keep up with all of that. And then they're supposed to pay or remit those taxes at the end of the year, or they have to pass along certain taxes to the consumer at the time of the purchase.

And so this is where Avalara comes in, Avalara, and they have a bunch of different products that basically clean it all up for you. So you can calculate your required taxes, you can automate your returns, your reporting, you can simplify the registration process, a bunch of that kind of stuff. And it's really, there is a lot of terminology. If you're looking this company that might be difficult to understand i recommend kind of just going one by one and looking up a bunch of the different words because there were a bunch of the different taxes that i didn't quite understand um but basically that is their customer value proposition is this is such a hard time consuming yeah for merchants it's time consuming it's not what they want to be doing uh

and it can be pretty intimidating for a lot of merchants so they're that's really where they just kind of fit in. And so there were three founders initially. There was Rory Rawlings, Scott McFarlane, and Jared Vogt. Sorry if I'm pronouncing that wrong, but I believe Rory was the first one to actually come up with the idea in 2004. And this was based in Seattle, Washington, so close to our home. So we might have a little home bias here, but I've got a quote from the CEO, Scott McFarlane. He said, it's not just, oh, I'm going to make a calculations. Sales tax is a lot harder than just rates. Rory had this idea about taking a geospatial information, combining it with rates, combining it with all the sourcing and taxability rules, and combining it into one

engine that could speak to every accounting package, every e-commerce package, do it in sub one second, store that information, then report on that information and create a return to the right jurisdiction and then remit your money. It's complicated, long, but basically They packaged all this into one so that it's easy for these businesses to just integrate it and take care of essentially all their tax compliance. And Rory actually left. Rory was sort of the one that came up with the initial idea. He left in 2016 to start some hemp and cannabis thing in Virginia. That's where the ideas guys are now.

I guess. Hemp cannabis, crypto. It was a little strange. I looked at his LinkedIn profile. It was just weed in the background of his profile picture, but whatever. And then Jared still works at Avalara and Rory is the CEO. So that's kind of background on the business. Am I missing anything? I don't think so. I'll get into the industry landscape competition. Management talks about there's a $4 billion opportunity for mid-market companies, $2 billion for small market companies, and then $2 billion for enterprise in the United

States. Sort of revenue. Yeah, that's their kind of revenue opportunity for them. For tax compliance, that's kind of the industry they're going after in the United States. And they probably say that you can multiply it by more than two for their opportunity abroad. So when we look at, we'll look at the earnings numbers when Ryan talks about them, but they're not really coming up with any market saturation anytime soon. Because that's kind of something you would worry about with Avalara is it seems niche. So are they going to have all these customers to actually go after for the next few years? Number one competitor would be, according to them, manual filings. So people that are still doing the legacy stuff, all on the analog stuff instead

of using a software service to automate it. Sorry, I'm going to interrupt there, but it feels like that is going to become an increasingly smaller parts of merchants as e-commerce becomes so ubiquitous. Yeah, over the next decade. I mean, if you're going into multiple jurisdictions or selling into different locations, it makes it so much harder. Yeah. And that's the big market opportunity to talk about because I think it's 70% of people still

use manual. So it feels like that's going to entirely go to a concept like Avalara over the next decade. But they have competitors. So there's Vertex, which is a software competitor, very similar to them. They just went public. They also work on tax compliance for businesses. They're the largest public direct competitor.

But there's also Thomson Reuters, who does tax accounting software. And then just for Vertex, I believe they're more enterprise-focused because they brag that 50% of the Fortune 500 uses Vertex. But Avalara is kind of going after that mid-market and small market, although they are trying to go after the large market as well. There's other ones. There's one Ryan was mentioning to me called Tax Jar. They're a little bit smaller, but still relevant. And there's a bunch of other smaller players because it's not something that's super hard to copy.

But, you know, like there's just not a code that's super fun. You have to take the tax codes as inputs and essentially be able to run it at a fast speed, right? So as soon as they give you the locations, you cross-reference it from the maybe I'm talking ahead but you're referencing it based on all these different tax codes from all these different areas that you hopefully have in one place and it can hopefully be done quickly yeah yeah there's taxify also tax cloud I think but those are more for like small kind of yeah like maybe an individual entrepreneur on Amazon or Etsy

marketplace or Etsy Shopify something like that but Avalara tries to go I think they mentioned that their core market is someone above 20 employees. So that's who they're going after. So it's a little different. And then the industry overall is projected to grow at a double-digit rate over the next seven years. So good tailwind overall for them. Ian, I'll let you talk about management and ownership.

Yeah, so the CEO and co-founder, as Ryan mentioned, is Scott McFarlane, not to be mistaken for Seth McFarlane, as I accidentally Googled today, looking for the Avalara CEO and found some different stuff. So anyways, this is just a little bit of a fun fact, a little bit personal, but he went to Claremont McKenna, which is a college in Southern California. It's actually where my parents met and went to school and I was very close to going there. So it's a really good school. So anyways, that was kind of a cool little connection, but he used to be the COO and looks to have quite a bit operating experience. He also seems like he's kind of a serial entrepreneur right out of college.

He started, um, life cycle, which was, they made exercise equipment. And I think they said it became like the largest exercise bike, um, provider in the country at the time. Uh, he ran that for like six or eight years, somewhere in there. So, you know, he was kind of Peloton before Peloton, I guess that was back in like the seventies or eighties. Um, so anyway, it's kind of some, a little bit of an interesting history. Uh, as far as the ownership structure institutions own over eight, 90% classic kind of software as a service, um, you know, ownership structure there, uh, T-Row price, Vanguard and BlackRock are the top three shareholders. So some pretty, some pretty big names there. I think their positions are all about 10%, eight to 10%.

Um, insiders own just under 5% of the company. So, you know, a good stake, but nothing, nothing crazy. They don't have crazy. Yeah. Yeah. It's not like 20% of the company or anything like that. And then the CEO owns just under 1%. So again, a little less than I sometimes like to see, but I think that, uh, I think he has like $130 million wrapped up in the business. So he should be aligned with shareholder interests. Okay. Yeah. That's not bad, man. I did like, now you've got Seth MacFarlane stuck in my head, but, uh, MacFarlane, they did an interview with, i think all three founders it's up on the avalera website um and scott mcfarland seemed very competent very much sort of like a business operator and almost a little salesy uh but he

was very convincing uh worth going and taking a look at yeah and i was reading an interview transcript and it said something along the lines of the employee said that you know scott mcfarland was very passionate about the project but i think it's a plus and that people respected him but like he wasn't a people weren't scared of him so it seemed like they the culture around there at least that he kind of brings in was strong uh but that was just one anecdote and i guess we all go to their headquarters are in a great building in a great building yeah it's overlooking the stadium in seattle so yeah oh that's cool that's a that's a buy signal that is a true buy signal yeah those lease costs are that's definitely coming right to the operating margin but i'll hit the valuation

enterprise value, $14 billion, ticker AVLR. I'll just hit some quick numbers here. Don't want to overwhelm people, but EV to sales of 28, that's pretty high. EV to gross profit of 39, it's also high. EV to operating cashflow of 324, also very high, but they're still right around operating cashflow breaking. They're kind of in growth mode. So I wouldn't say don't buy this because the operating cashflow multiple is that high. They can probably get higher margins over time, but that EV to sales number is very high. No dividend as you probably expect.

And the shares outstanding are likely going to rise a bit with the software business culture where you got one, the sales reps in your team that are getting stock options for closing deals and stuff like that. And then two, developers historically get a lot of stock. So that's part of the, I don't know, that's part of the company.

like it's just this type of company you're probably gonna get some share conclusion probably won't expect that all right ryan you get earnings yeah i'll talk earnings uh 2020 revenue was 500.6 million so they crossed the half a billion dollar mark uh and that was up 31 percent year over year uh more than 90 of that is subscription revenue and the rest is basically big managed accounts so there's some stuff that maybe people or cus companies tried to use Avalara, but then they're like, this is just too complex. It doesn't quite

fit it. Can you guys just outright manage this? I assume that's sort of what's baked into that portion of the revenue. They had 71% gross margins in 2020, which was in line with the prior year. Operating cashflow was $42.6 million for the year, about double last year's number. So it was about operating cashflow margin of 9%. They had negative 62 million in operating income, with $48 million in stock-based compensation. So stock-based compensation did outnumber cash flow. That's one of the big add-backs. The other one was deferred revenue.

So some of these contracts are a little longer. That's why companies like this have such, I'd say, hefty deferred revenue line items. And then they ended the year with almost 15,000 core customers, up 23% year-over-year. And they bought four companies this year. And so apparently they did a big secondary raise in 2019, which put a whole bunch of cash on their balance sheet and they used a whole, like almost a ton of it to buy these four companies. And apparently it's just like an aggressive expansion plan. They're trying to take over as much of the market as they can. Some of it was international adjacent type companies.

And then some were… One was enterprise focused. Yeah, one was more designed for enterprise customers, might be blanking on some of the other ones. Some of them might have just been very similar products that they just bought for the customers. But yeah, that's pretty much it for the earnings. Ian, you want to hit balance sheet? Yep. So on the last report of balance sheet, they have cash at about $675 million, which is due in part to, it's up from last year due to that equity raise they did. no debt, really. They have $68 million in long-term leases. So depending on how you treat

those, there's arguably some debt on the balance sheet. That's still an over $600 million net cash position. So a very good-looking balance sheet from that point of view. About a third of its assets is Goodwill, which is due to these acquisitions that Ryan just mentioned. Again, Goodwill is the premium that you pay over the book value for some of these companies. And so should be fine. Like I said, about a third of assets. So it's a little bit high. That'll go down over time as their asset base increases. And if some of the acquisitions are unsuccessful, then you could see some write downs that would lead to poor earnings. But they don't have a bunch of leverage on the balance sheet. So it's not a big red flag for me,

but just something to be aware of. One other thing I want to point out is their days sales outstanding, which basically says how long it takes from the time they make a sale to the time they get the cash. Um, it's up from 44 days to 47 days. So that's less than a 10% increase, but it means they are having to extend a bit more terms probably to close these deals. And so, uh, you know, maybe a little discount upfront, don't have to pay for the first month, things of that nature. Um, which like we were talking about the stock-based compensation for these sales teams at Avalara. It's, you know, things like they're always trying to hit sales targets. And so that could show that demand may have been a little bit weak in the last most

recent quarter in the most recent year compared to historical numbers. Like I said, it's not a huge deal because it's a less than 10% increase. But if that number were to continue to rise, it might show that demand is weakening and that competitors may be taking a little bit of market share. The other thing you can pair with that is look at the SG&A margin just to say, okay, are they having to spend more on sales and marketing as well to make these sales? And you can kind of look at those two things in tandem. In this case, the margins did improve in the last year, but I would say that's largely attributable to the operating leverage in the model that as their revenues grow significantly, their fixed cost base becomes a lower and lower

percentage of, of revenue. So anyways, but you can look at those two numbers in tandem a little bit to get an idea if, uh, if demand is weakening, it looks like it is a little bit, but not, not, not too much. Yeah. For a B2B software business, I think a key metric to always look at is sales and marketing for sure. Yeah. I am starting to see a lot of the sales, uh, the payback periods extend and that a lot of that might be due just to, uh, companies struggling out of the pandemic. um the other thing i would say is the the contracts are all year-long contracts so uh the lifetime i guess everyone it feels like companies always overestimate their lifetime value but i can't imagine there's a whole bunch of companies that are switching in between and in and out of

tax compliance softwares because it is probably a pain in the ass to uh figure it out um and so once you've kind of bolted onto something, I'd be surprised if you're switching in between. Yeah. I think the key metric for that is the net revenue retention rate. I'm not sure there's one that takes into account. Sure. And I'm not sure which one they use, but theirs has been in between a hundred and 110%, which is pretty strong. Yeah. It has been trending in the right direction as well. So that's probably the best number to look out for, for customers leaving. If it stays above a hundred percent or keeps going higher, that's a really good sign that the customer is sticking around seeing the value in the business yeah and you don't want to you don't want to mortgage

those relationships with your customers by like overpricing too much but the longer that they're with you the more pricing power you essentially have because the the more those employees are used to that system so i would not be surprised if overall in aggregate the net revenue retention rate at least tipped up a little bit over time yeah all right we're going to take an ad break here and then we'll be back and talk about you know competitive advantages all the good stuff in the second half of the show. security must be enabled in the Panoramic Wi-Fi app. Restrictions apply. All right. Welcome back in. Next up is going to be competitive advantages. We'll start with Ian. As always, what do you have

here? Yep. So this one's a little bit of a weak competitive advantage, at least compared to the other tax compliance software. But I'm going to take this in a little bit of a different direction and say this is a competitive advantage relative to other software investments you might make. And the competitive advantage is government. There's always going to be taxes and the market it really isn't going anywhere. You're going to have to, you know, it's kind of a problem and depending on how you look at it, but tax compliance is a big industry and it's pretty much guaranteed to be there and it may morph and shift over time, but they don't have to worry about growing their market. It's more about capturing the market. The market's going to be there. And so it kind of

provides a little bit of focus for the business to really, like I said, capture the market rather and then worry about sales to grow the market. Okay, Ryan, what do you got? Yeah, it's hard for me to know because I always have a hard time grasping competitive advantages when I have like no experience with the product and especially when I can't try out

any of the other competitors' products. But the Shopify Plus partnership seems like a pretty big deal that is, and I know that's part of your growth opportunities, But apparently you can choose one of two things as a Shopify Plus user. I was watching one of those like Shopify Plus promo YouTube videos, you know, the ones you always get ads for. But either their in-house solution or the AvaTax engine. And so there's no other third parties that have that partnership.

If you wanted to use TaxJar or Taxify or something like that, you'd have to go out independently, get it and integrate it, if I'm not mistaken. So they kind of have a leg up in that regard. That was the only one I could really identify. Yeah, that seems like a competitive advantage because if they can basically be the default plugin like Twilio is or Stripe is, just kind of like, I mean, I know it's different than just being an API like that,

but if they can be similar to one of those, that is a big competitive advantage where you're just plugging in if you're using these merchant services. Those integrations do seem like a big deal, but I'll talk about mine. I do think scale matters with some of these offerings. So if Avalara has essentially rolled up all these tax offerings for compliance for sellers of goods, I know that's their bread and butter, but they do a lot of other things.

I think it is going to be tough to compete with because, I mean, if you only have 10 developers working on something or even 30 or 40 versus Avalara with 500, it's just tough to do well. It's tough to repeat that. But I think the likelihood of someone switching is also low, which is a competitive advantage. It's kind of the huge lock-in you have, you know, with the software as a service business. I don't think there's any data lock-in like with another business. I guess a comparison would be someone like Snowflake or MongoDB reporting all that data or even someone like AWS, I guess, at the cloud level where you're having all that data that kind of locks you in with that customer relationship.

It would seem a little harder to switch because Avalara is just a one-year process. Right. You know, each year it ends and then you start up again. It seems like once that happens, you kind of have a year to switch to another provider. So that may be a little weaker for Avalara. I don't know. What do you guys think about that? Yeah.

I mean, there is, the people are using it for one reason. It's not like they're, this isn't really, maybe I'm wrong, but this is not core to core or data. This is not core to their day-to-day operations. It's not something like Autodesk where they're stuck to the software forever. It's something that they've learned and they're going to stick with it. They can track stuff day to day, but you're not doing the filings are once a year. Yes. Right. So it's kind of got that into it. Seasonality, if you will. I don't know. I

looked at the year over year numbers, didn't really look at the quarter numbers. And I'm not sure when, if they have any seasonality, but people are really depending on it for that one taxes. Well, you still get the compliance is done continuously, but yeah, you file once a year. So like commerce business, you're tracking everything, you know, each month or, you know, right, right in. Is that correct? Yeah. And for certain businesses, you actually have to make quarterly. And I think there are even some businesses that make monthly filings because if their tax bill is big enough, the IRS wants to make sure that you're actually going to pay your taxes. So they don't want you just paying at the end of the year. You have to, you have to

make filings throughout the year. And so, you know, it does have some stuff, but I think, i think kind of to your question the it's a little bit less sticky than some of the other ones because it just has that it's it seems like it's not there's all these competitors out there it seems like the type of thing that's very easy to plug into platforms and so whether it's you know shopify and i know they have the shopify plus partnership which you're going to talk about a little bit more in a second brett but um you know that platforms like that can really just integrate within the platform, even something like the Instagram, um, what are they calling it? Instagram buy or whatever they're calling it. Like, it seems like that's, that wouldn't be too hard to

integrate into that platform as well. They have all the location data that you wouldn't really need additional software on top of it. It just seems like the type of thing that's really a tuck in, um, type piece of software into many of the e-commerce platforms. Yeah. And it is vital to a business like an e-commerce business. This, an Avalara or competitor is vital to keeping your business running but i don't know i kind of lean back and forth you you would think that someone like stripe or twilio would be beatable right but there's a reason why they have kind of reached that economies of scale i think that because right those you could argue are you know copyable but there's a reason why they've succeeded maybe there's something a little underlying

on the layer of why they've been able to grow for so long yeah but i guess maybe let me give like a scenario if you were one of these merchants and you had 15 or 20 employees and avalaris continued to like like one year they gave you a bill that was just way too much um wouldn't you look for alternatives it's not like you're stuck to that one platform i mean yeah but that's like with any it's not i don't that's not really the that's not the point i'm making though it's more of like the software itself the technology being able to copy it's not more of the pricing power Yeah, I don't think a lot of the businesses are switching away because Avalara has bad technology. I think if there was anything, it's because there'd be a cheaper alternative.

That's true. I think that's probably true. And like I said, I think it's that platform integration things. Because if we go to your example of Stripe or Twilio, those are things that are really adding functionality, making apps do the things they're supposed to do. Whereas like Avalara, it's really providing an additional service to the customer that the customer didn't know about. And so the platforms like the Shopify, and we'll talk about this in just a second, but the Shopify Plus, you know, allowing, giving more functionality to the user. Whereas something like Twilio or Stripe doesn't really, in the same way, give more functionality to the user. It's more making the thing actually work.

right it's making whatever your app is trying to do work whereas like this can be a value add for some of these platforms to come in and say you know i can i can start including this tax compliance thing and then it either becomes a more of a competitive advantage for me because more people want to go with you know shopify plus rather than instagram buy because it has tax compliance built in or or you can even charge you know these companies these platforms could charge something for tax compliance. So, you know, it, it's similar. I'd say it's a little bit different than those, those things though. Yeah. Yeah. The price, yeah. The pricing power might be a bit, yeah. Concern for Avalara, um, future growth opportunities. Uh, what do you got Ian?

Yep. So we've touched on this earlier. It's my future growth opportunities, international expansion. Um, they have a large presence in Brazil. It looks like, um, just made a, an acquisition, um, of a German company called Imposia. Uh, it looks like that's kind of the way they're growing internationally is doing, buying these smaller companies that, um, you know, it's kind of their R and D budget really just buying up these smaller companies using acquisitions, um, and kind of expanding the market. Presumably they have all the tax codes built in there already. And so then they can get going real fast. Um, I think they'll continue to probably do that over the next few years. That makes sense. Do you think that's the easier way to go is to

just acquire the the foreign companies because i it can't be as easy as just like seeing the tax codes uploading it to a database like i'm sure there has to be some there's some benefit to being native to a country right for yeah and i think there's also the the trust factor i think these companies like if you just see some random american company come in and say yeah we can do your taxes for you in your country like there's probably i don't know because I don't run a business in another country. But I would imagine that if you're there, you're thinking, you know,

what do these people know about my taxes? It's something that people are fairly connected to. Like they don't want it to get messed up. No one wants to go to prison because of taxes. And so knowing that there's a company in your home country that does it probably provides you a little more assurance rather than just the big multinational.

And so if they've already built these relationships there with these companies that they've acquired, then i think that may may help with some some trust issues potentially and ideally it's probably just a tiny one like a 10 million dollar acquisition or something you know give them the foothold and then you use the appalera business model to expand but international seems like i mean that's kind of what they talk about on investor presentations that's where they think their next decade of growth is mainly going to come from the run that you have Yeah. So I read an interview with a transcript of one of the old directors of sales. And so he said the big thing, their mid-market customers are not businesses that are on like QuickBooks. It's not businesses that are really doing it in-house. It's people that are on ERPs like NetSuite or Microsoft.

What's an ERP? uh and it's enterprise resource planning solution so i believe that's basically the platform that manages day-to-day stuff unless i'm getting that wrong and then kind of managing like do managing like yeah like managing gna like general administrative yeah all that stuff uh hr accounting solutions um like payroll that type of stuff kind of and so he said if there was a way to partner with either microsoft or oracle or something like that where they could give like a referral from their ERP to just be like, oh yeah,

just use AvaTax or something like that. He said it would just make it much, much easier for customer acquisition because their businesses wouldn't shop around. They would just probably go with whatever the recommended one was. And even if they have to give some sort of generous kickback to Microsoft or Oracle,

I don't know, it seems like it'd be worth it if you think the lifetime value of your customers is high enough. Yeah, and that's been a big method of growth for one of the other companies we looked at a couple months back, Blackline. They partnered with SAP and became one of their preferred solutions, which SAP is another ERP. And so a lot too many acronyms, but that's been a big thing for them where they get a lot of their sales now come from SAP who gets a kickback. but now all of sap's sales staff is selling black line as well so it kind of you know you lose a little margin but you gain some volume so um that's that's definitely an interesting growth avenue yeah and i thought i saw that avalara i was going to say that's good news for you around because i thought i saw avalara announced a recent partnership with net suite but it looks like they

just kind of talk about them a lot they don't have like a direct integration yet where it's like all right you sell net suite add this on real quick like maybe there's maybe like vertex or other maybe other tax filing entities have tried that as well so maybe it's more competitive than we think and oracle and microsoft are kind of like hey we're not gonna sit here and give someone a special deal yeah so maybe they're less inclined to do it than we think but yeah i don't know i thought i saw something on partnership with netsuite but i'll just i'll get into mine but that is right that that would help them a ton um yeah we talked about this before the integration Shopify Plus, I think it's huge. We all know the growth of Shopify, the merchants on that platform.

And then if you're a Shopify Plus subscriber, I mean, AvaTax just seems like, I mean, it's an automatic add-on if it works. It automatically calculates your seller taxes for you. Riding that growth of Shopify could be very beneficial to Avalara. I just think that's a huge tailwind. Their partnership with BigCommerce too, which is like the second tier for Shopify but yeah it's very simple but I think that's a great partnership to have do you think it's out of the question to have

either an ERP provider or an e-commerce company like Shopify acquire them I think Shopify should probably I think it would be very smart because if you're a Shopify I mean if you're Shopify your goal is to reduce friction as much as you can for your

sellers this is like the biggest like this reduces it as much as anything else maybe other than logistics but oh yeah i think shopify should require have a layer like yeah definitely what do you think it might be too big yeah well i think that the fact that they're already integrated on the platform and there's no other system that is shows gives a little bit of hint of a hint that maybe they're thinking about it um and that they're kind of kicking it around and seeing how much value it's really adding because otherwise it would seem to be, you know, it would be taking away a little bit from their

own platform if they could charge for the service. And so, you know, I think they see it as a value add. And if this goes well and people really enjoy using the Avalara tax solution on Shopify, I think it's a potential acquisition for sure. Okay. Highlights and lowlights. Ian, check things up yep so for my highlights um you know it's a necessary product you have to use for most for the majority of you know mid-sized businesses at least you're going to want to use some version of this whether it's avalera or one of their competitors so that provides a stable market they've had strong revenue growth improving margins for the most part um a good balance sheet um so you know just it's a solid business um on the low lights the recent net revenue retention

for this last past year was actually at 104 percent which we mentioned earlier how it has been fairly steady for most years and that has been true it's been you know 110 111 113 kind of in that neighborhood it dropped this year to 104 so um you know it could be one time because Yeah, that's the question. Is it one time because of COVID, you know, they've had a little bit of pressure on the business. Management says they've been kind of talking about it for the last couple of quarters, kind of letting people know this is going to come in a little weaker. They probably weren't, I don't know, I didn't look into this exactly, but I assume they weren't making big price increases or like putting extra pressure on companies that, you know, that were already

their customers. They didn't want to raise prices on these companies that were potentially struggling so um still impressive revenue numbers uh but definitely want to keep an eye on that net revenue retention number to make sure it gets back up to that you know 110 111 level could the could it be that the acquisitions may have brought that number down like the acquisitions might have had a net revenue retention rate that was much lower than avatax or something like that potentially that's yeah that's a good point because uh that ttr i forget the name of the company acquisition was quite large 300 million dollars uh so yeah but yeah that's definitely uh i didn't know it had dropped like that yeah it did tick down but ryan what are your

highlights uh same as ian's the customer value proposition is very apparent uh they thrive on fear uncertainty and doubt the fd um people if you don't know what you have to pay it's daunting and very discouraging. And most, I mean, most merchants are not tax experts. So they can probably charge a lot for that. And the CEO is also solid, I thought. The low life for me is sort of the intuit situation. And so we talked about this.

It feels somewhat predatory and maybe it's less predatory because it's in across multiple jurisdictions. But don't you think taxes as a whole should be more intuitive? That's why Intuit calls themselves that. Shouldn't the government make it more intuitive? Like you're paying to pay. I hate that. I agree.

I agree. But businesses are a little different than individuals because each are unique. But they're not all that unique. Individuals, I definitely agree with that. But I don't know. I mean, that is a concern relying on the government. All right. what about you? I mean, great economics, like I said, I think lifetime value of a large customer

is there. We were seeing with those retention rates that are strong. And I think the one thing that kind of got me interested, at least the most interested, is that I do believe there's a high predictability with the sales growth. It seems like you can forecast, I mean, I hate to forecast over like a five-year period, but I mean, it seems highly predictable, 15% to 20% sales growth the next five years. They got a lot of tailwinds going for them. Minimal realistic competition. Now we did talk about a lot of the competitors. Vertex seems pretty good. You know, there's Taxstar, a bunch of other smaller ones, but it feels like it's coming down to a two horse race. Could be wrong on that. I'm not exactly sure on that, but I don't know. Also CEO is great.

Like Ryan said, low lights though, you are relying on the tax code and the complication of the tax code. I think we can expect the tax code to stay complicated, but you're relying on someone else's decision for Avalara's success. That seems, I don't know, that's hard to take into account. Also, they have 70% post-growth margins and that looks great, but it feels like a business that's going to be spending a good amount of their sales on sales and marketing. I don't think that's going to drop below. It feels like it has to stay high. because you have to have the maintenance customer support, all that stuff. So, yeah, I don't know.

Well, let's wrap things up, though. More or less interested, what do you guys think? I'm thinking a little bit less interested. I've seen this one tossed around a few times and have taken just a little look at it. I never really dove deep on it, but I hate to say it, but it seems like just another SaaS company, kind of. um and that there's more there's there's companies that have um a little stronger value propositions

in my mind and a little bit better competitive positioning against um either the incumbents or the people who are rising up so yeah it just doesn't quite it doesn't quite get me there okay ryan yeah honestly i kind of throw this in the too hard pile uh i know we just went through whole deep dive on it but i don't understand the nature of tax software um and if something were to change i'd be much slower to being able to identify what it means um so it might be out of my circle of competence also i hate to be a perma bear but 28 times sales is not cheap um no and that makes it that much easier to discard for me yeah i think for me i'm not less interested mainly because of the valuation. I mean, at 10 times sales maybe this thing gets interesting, but

that's a huge haircut from here. I do like the business a lot. I really like management. Yeah, management seems good, but it's just the valuation that's just getting in the way. I don't know, like if I had, yeah, if I understood enough and I could assume a higher growth rate because I knew the business really, really well and it was like this thing's going to grow and uh for 30 in perpetuity then well yeah i'd have no problem buying that yeah but they're not i can't assume that yeah i mean at 28 times sales it feels like and 30 is different than like 15 which or 10 that's a huge difference uh it feels like they have you know conservatively they could probably go 10 to 15 for the next five years right at least sales wise but at 28 times sales

isn't that all priced in i don't know right i feel like it is or at least you just have to have you have to be confident like super confident that 15 will be there for the next 10 years i mean even if so what are they gonna it'd be like compressing the sales ratio to in between 10 15. I mean, there are margins here, but yeah, I don't know. All right. I guess what's the stock for next week? What's the next deep dive?

I'm thinking that we just had some recent news this week. Some earnings come out. So I'm thinking maybe Palantir next week. Okay. That's a hot name. It's a hot name. We got to keep with the times, you know? Yeah. And we're kind of government heavy right now, too. Going from

Avalara to Palantir, you know, should be interesting. Plus the bond villain CEO, right? They do have the villain, Alex Clark. All right. We all good? Anything else to close out? That's it. All right. That's going to do it for this episode. As always, remember that Ryan and I are general partners at Arch Capital. Clients of Arch Capital may have interests or hold securities in the stocks talk on this podcast. Remember, we are not financial advisors. Anything we say on the show is not formal advice or recommendation. Thank you all for listening. I'll see you next week.

don't you wish you could just hit skip on the worst parts of your life you know the same way you can skip an ad i get it i'm siaya and i live in ice cove i've made some questionable decisions that didn't end up the way i planned and today i'm still figuring it out somehow things usually get worse before they get better. Apparently that's how I roll. So bundle up and come along for the bumpy ride. Stream a new episode of North of North Tuesdays on CBC Gem.