– AVLR SaaS is leveraged to some of the same e-commerce catalysts as AMZN

– US Supreme Court 2018 decision on states sales tax likely increasing customer base

– Major barriers to entry; inexorable growth of online retailing can boost stock

These are unusual times, but it seems the market still sees a bright future for online commerce, even two decades on, to go by Amazon’s (AMZN) 40% stock rise in the past five weeks.  It is hardly a value play, and many simply can’t bring themselves to buy it after such a ferocious run.

If that describes you, perhaps take a look instead at Avalara (AVLR), which is a much smaller and lesser known company, but one that also could benefit from similar e-commerce catalysts and one uniquely its own.  Before we get too far, there is one thing to note:  I’m assuming that the U.S. and global economies get back to some semblance of normal after COVID19 fades. I don’t know when but that’s my working thesis. If you don’t, then you should likely be in cash or gold.  

There remain two things you can always count on in this world, death and taxes. Avalara’s business model doesn’t address the former but does the latter, a fundamental characteristic that could drive the stock for years.  Through the use of cloud-computing and software as a service (SAAS), AVLR provides a tax compliance platform to midsized firms, with a database of sales tax content and technology for executing compliance across thousands of tax jurisdictions, like states and municipalities. Currently, many such firms accomplish this function internally and sometimes even manually. I see this as an essential service that isn’t going away.

I like Avalara because it should benefit from some of the same e-commerce tailwinds that help AMZN, particularly in a post-COVID-19 world. Avalara has a first mover advantage in a business where there are relatively high barriers to entry.

American consumers spent $602 billion online in 2019, up 14.9% from the prior year, according to the U.S. Dept. of Commerce. Moreover, while e-commerce growth rates had been slowly declining from very high levels, in 2019 the rate rose and was higher than the 13.6% seen in 2018. According to www.eMarketer.com, e-commerce sales should almost double worldwide to $6.5 trillion in 2023 from 2019. (See chart below.) You can bet taxes will be collected on that. And that’s where Avalara comes in.

When someone buys something online, increasingly they will have to pay sales tax in the U.S.  That comes from a 2018 Supreme Court ruling that states can mandate businesses without a physical presence in that state collect sales taxes on transactions in the state.

“That unleashed the ability of states and municipalities to look at their respective tax codes and collect,” says Craig Giventer, a portfolio manager at Financial Partners Capital Management, which owns shares for its clients.

This suggests that more tax jurisdictions will be moving to collect sales tax where they hadn’t before. Indeed, according to a mid-2019 report from Vertex, a private competitor to AVLR, there were 335 standard sales tax rate changes in the first half of 2019, a 5% increase from the same period in 2018. In addition, the report says there have been 6,230 new and changed standard sales and use tax rates over the past 10 years. Companies need to deal with that, and outsourcing to an expert is one way to accomplish it efficiently.

Secondly, this thicket of tax rules and changes will not be something many firms will want to spend resources on. As a bullish Giventer adds, collecting the sales tax isn’t necessarily the retailers biggest concern. The “horror,” he adds, is that they will have to navigate a tax compliance labyrinth of hundreds if not thousands of government entities all wanting their tax portion of the sale and many regularly changing their rules. The software compliance that Avalara provides must remain fresh and updated.

Another of AVLR’s appealing characteristics is that it uses a subscription model, which helps to maintain a recurring revenue stream. As of the end of 2019, 2018, and 2017, AVLR had 11,960, 9,070, and 7,490 core customers, respectively, representing less than 50% of the total and 80% of total revenue. In 2019, AVLR posted $382 million in sales, up 40% from $272.1 million in 2018, in turn up 27% from $213 million in 2017.

The biggest negative is that AVLR is not profitable. It posted a loss of $50 million or 68 cents per share in 2019, down from red ink of $69 million or 94 cents in 2018 and $76 million or $1.95 in 2017, but the trend is going in the right direction.

Nevertheless, it sports SaaS type 70% gross margins.  The losses come from reinvesting almost 60% of revenue back into the business for sales and marketing, as well as in research and development.  As it continues to grow net margins should improve when it captures more share.  The company, which has roughly a single-digit percentage market share, estimates the U.S. addressable midsize market at $8 billion, so there’s room to grow. An investor buying AVLR is purchasing a potential multi-year growth period in the future.

Currently, it supplies mostly small and midsize businesses, as larger retailers tend to do their tax collecting in house, or in concert with their accounting firms, typically the big four, PricewaterhouseCoopers, Deloitte Touche Tohmatsu, Ernst & Young, and KPMG. Giventer says that over the long-term Avalara has a shot at the big market cap retailers.

Using a mix of potential scenarios, Giventer’s discounted cash flow (DCF) valuation of AVLR is $135, some two-thirds above the current $82 price.

There is also potential from ALVR’s international business, where it’s expanding in the European Union and Brazil, among other places, but it is early days yet. However, the same catalysts apply and it could turn out to be a significant part of AVLR’s future value. 

Where I could be wrong:  The stock could fall if a competitor, some of them much larger, takes a large share of the market or AVLR makes a misstep in its software.

Bottom Line:  Retailers will increasingly have to be more tax compliant on their online sales in the future.  If online commerce is growing and more governments are trying to collect sales tax, that should be a natural boost for Avalara.

Prior “Signals”