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Investors' High Expectations Are Making Anaplan a Risky Bet

Investors often tend to believe that investing in a fundamentally solid, fast-growing company has significantly lower chances of value destruction in the long term. Moreover, if it happens to be a tech company that has historically performed well and is operating in a fast-growing market, the investor's confidence goes a notch higher and they often tend to overlook the huge underlying risk associated with the sheer overoptimism of the market. One of the best examples in today's market is California-based software-as-a-service player Anaplan Inc. (NYSE:PLAN).

Strong revenue model, excellent results and promising new launches

Anaplan provides a cloud-based connected planning platform for online analytical processing, data storage, calculations and various forms of functionality required by businesses across areas like finance, sales, marketing, operations management, human resources and more. It operates on a subscription-based revenue model and earns over 90% of its top line through recurring sales from a global base of over 1,250 customers. It is easily one of the fastest-growing companies within the space.

The company delivered solid third-quarter earnings last week. Of $89.4 million in total revenue, $79.7 million was from subscription sales. Incidentally, both these numbers grew by more than 40% from the prior-year quarter. The company managed to beat the consensus estimate of $86.47 million yet again and also outperformed on the earnings front.

Its non-GAAP loss of 8 cents per share was a significant improvement over the 18 cents per share loss in the year-ago quarter and was well below the expected loss of 13 cents per share forecasted by analysts.

Anaplan's guidance for 2020 fiscal is even better. It expects total revenue between $346 million and $347 million (an increase from the previous forecast of between $339 million and $343 million) and a lower negative margin of negative 17% to 18%.

In terms of new product development, CEO Frank Calderoni said the company released an updated platform user experience and a new mobile app known as Connected Planning Xperience (CPX), which provides a significant improvement in terms of design and customizability of reports. Anaplan's move toward multi-device accessibility to enable better planning for businesses across desktops, tablets and mobile phones is an attempt to help companies generate real-time insights and enable management to make decisions quickly. With such innovations, the company is certainly investing a fair bit in the future and is well-equipped in its race with rivals like Workday (NASDAQ:WDAY) and Microsoft (NASDAQ:MSFT).

Why is Anaplan valued so high?

The enterprise value-to-revenue multiple of Anaplan is a classic example of a SaaS company trading at high valuations, but there is a strong rationale behind it. The company's subscription revenue has been growing at a phenomenal rate of more than 40% for the past several years. There is visible growth in quarterly subscriptions, which come from companies based in the U.S. as well as other large global economies such as France, Germany, India, Japan, Australia, Russia, Singapore, Sweden, Switzerland and the U.K. The $91 million in subscription revenue recorded in fiscal 2017 grew 57% to $144 million in 2018 and to $209 million in 2019.

Subscription growth is strong despite the fact that Anaplan's financial planning products face stiff competition from Workday and Microsoft. While its features may be vastly different, Anaplan's Connected Planning offerings eventually look to replace Microsoft Excel and its related tools within organizations. It is evident that organizations are seeing tremendous value in the products, which is why Anaplan's subscriptions are increasing so rapidly. This has a direct positive impact on profitability. While the company continues to be loss-making, its margin of losses is contracting fast with its increasing revenues as the company's costs are not growing proportionately.

The multiples expansion is much more than Anaplan's revenue growth

Anaplan's valuation is a different story altogether. The stock is currently trading close to its 52-week high, after beating analyst expectations five times in a row. The stock has more than tripled from its listing price of $17 in October 2018.

The company's revenue has increased by more than 40% since its debut, but its enterprise value-to-revenue multiple has expanded from around 10 to as much as 23, which is the reason for this phenomenal price growth. This multiple expansion is the result of nothing but investor optimism and enthusiasm, which can be dampened by something as small as one mediocre result or one negative rumor. It implies a significantly high underlying risk resulting from very high price sensitivity to Anaplan's financial performance as well as general market conditions.

Key takeaways

Investors who purchased the stock during its initial public offering and have held it to date are certainly rejoicing. However, they must be aware of the underlying risk associated with the highly positive investor perception. Since the expectations of investors and analysts are high, the margin for error for management is very low. A slight change in the business environment could affect this perception and bring the stock crashing down to its earlier enterprise value-to-revenue levels of around 10 or even lower. While this might not be a reason to sell the stock, it is certainly important for investors to be cautious to avoid any kind of value destruction.

Disclosure: No positions.

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This article first appeared on GuruFocus.