Sleuthing out RiskHedge’s “Amazon Killer Tollbooth”

by Travis Johnson, Stock Gumshoe | November 19, 2020 1:01 am

What's Stephen McBride calling "Amazon's Kryptonite" in ads for Disruption Investor?

This article was originally published on June 16, 2020. The ad is circulating again now, and seems unchanged from when we first covered it, so we’re re-posting it here to help answer reader questions. What follows has not been updated or revised since June, as of today the stock has risen in value by about 25% in the interim.

The pitch is for Disruption Investor ($99/yr), Stephen McBride’s “entry level” newsletter for RiskHedge that seeks out, well, disruptive companies that can generate outsize returns… and it’s a technology-focused newsletter for the most part, so I imagine the picks have probably done really well over the last year or two as the “cloud” revolution has disrupted the world of software and driven SaaS companies dramatically higher.

This particular stock is pitched as an “Amazon Killer,” here’s a little taste from the tease:

“Most folks don’t know this, but Amazon owes a lot of its success to an obscure tax ruling from 1992 called Quill.

“Quill forbade governments from taxing online transactions in most cases.

“Keep in mind, these were the early days of the internet. Amazon didn’t exist yet. Lawmakers were clueless about the coming explosion in online shopping.

“But Amazon exploited this outdated ruling to pay ZERO sales taxes!

“Forbes[1] called it an unbelievably unfair tax advantage.”

But now that unfair tax advantage has disappeared, thanks to a Supreme Court decision…

“… South Dakota vs. Wayfair.

“Tax experts call it the case of the millennium.

“Because effective immediately…

“It closes the internet tax loophole…

“And opens a new opportunity to make quick 200% gains… and overall gains of 1,000% or more… in the Amazon Killer tollbooth stock.”

That creates a sense of urgency in our minds, right? We think this decision just came down and this “tollbooth” stock that’s about to kill Amazon is going to surge right now, right?

Well, that may or may not be true… but the news itself is pretty old now. You’ve probably noticed that you’re being charged sales tax online much more often these days than in the past, and that’s because that Supreme Court decision[2] came down almost exactly two years ago, getting rid of much of the “tax shelter” that internet retailers (and before them, catalog retailers) enjoyed.

So that’s where we see the problem emerge — it’s not just Amazon and Wayfair that have to pay local state sales taxes, which differ in every state, it’s also much smaller retailers who have to navigate these myriad rules and regulations and file the proper forms and make the proper payments to different states and municipalities.

Which leads right to the stock McBride is teasing, a company that’s trying to solve this problem for retailers. Here’s a bit more from the tease:

“… authorities have effectively hired the Amazon Killer to create and run this new nationwide system.

“Using its unique, patent-protected technology, it’s created a new internet tollbooth that all online transactions can pass through.

“With the blessing of US tax authorities, 10 billion transactions already pass through its tollbooth.

“It gets paid a small cut for each one.

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“And it’s adding millions more transactions a day!

“Which is why the Amazon Killer’s revenue growth has accelerated for six straight quarters…”

Accelerating revenue growth, when your revenue doesn’t just keep rising but continues to rise at a faster rate, is a huge indicator for growth-focused investors… and it doesn’t come along very often for larger companies, so that piques my interest. What else?

“Shopify… Etsy… Wix…

“They ALL use the Amazon Killer’s tollbooth.

“So do hundreds of big businesses like The New York Times, Pinterest, Converse, 3M, Adidas, and Reebok.

“In fact, even Amazon has an agreement in place with the Amazon Killer!”

OK, so it’s probably not really an Amazon killer if they’re also partnering with Amazon… but when you’re trying to sell a newsletter, you want the “winner take all” imagery of a “killer” to be in your customer’s mind.

What exactly does this company do? More from the ad:

“… it has the only artificial intelligence-powered gateway for online commerce.

“Billions of transactions pass through its special tollbooth software. Within milliseconds, the AI combs through over 16 million lines of code to apply and collect the right taxes.

“Keep in mind, there are 12,000 sales tax jurisdictions in the US.

“In the old days, a business simply paid the taxes based on the town where it was located.

“But online businesses are different because they sell everywhere.

“So thanks to that new Supreme Court ruling—online businesses suddenly have to comply with the tax codes of every small town in America!”

And McBride also drops some hints in explaining why this stock is unknown…

“I believe there are only two reasons why this stock is undiscovered by 99% of investors.

“One, taxes are boring. Most folks won’t put in the time to understand what’s really going on here….

“Two, the Amazon Killer is a new stock.

“It went public just days before the Supreme Court ruling.

“So it’s still under the radar.”

We also get the usual spiel about big institutions who own the stock, which is usually meaningless but does help us throw some more clues to the Thinkolator…

“Renaissance Technologies, known as one of the most secretive and successful hedge funds[3] on earth, loaded up on 2.5 million shares.

“BlackRock, the world’s richest money manager, now owns 3.3 million shares.

“And Vanguard bought a whopping 5.7 million shares.”

And an oblique clue about the size of the company:

“In 2019, internet retail sales in the US totaled $602 billion.

“The average sales tax rate in the US is 6.5%.

“That works out to $39 billion… which is five times the Amazon Killer’s current size!”

So it’s got roughly an $8 billion market cap, we presume. And that’s really all we need in the way of clues… so the Thinkolator had short work on this one, chugging along for just a few moments before telling us that McBride is teasing… Avalara (AVLR).

Avalara is an interesting company, and it is indeed still relatively small, with revenue of about $400 million and a market cap of now about $9 billion — and yes, as you’d expect, at first glance it surely trades at a lofty “cloud growth” valuation (roughly 20X sales), and it’s unprofitable. I hadn’t dug deep into the shares before today, though when a reader asked about the stock a couple months ago I noted that “betting on the tax system continuing to get more complex has usually been a pretty safe bet” (and yes, I should have bought it back then… but “should have” is rarely a helpful thought to obsess over in investing).

Here’s how the company describes itself:

“Avalara helps businesses of all sizes get tax compliance right. In partnership with leading ERP, accounting, ecommerce, and other financial management system providers, Avalara delivers cloud-based compliance solutions for various transaction taxes, including sales and use, VAT, GST, excise, communications, lodging, and other indirect tax types. Headquartered in Seattle, Avalara has offices across the U.S. and around the world in Canada[4], the U.K., Belgium, Brazil[5], and India[6].”

So if you’re an Amazon Marketplace seller, for example, you can sign up for $20 a month to have Avalara TrustFile track your sales tax obligations and provide you with the information you need to file with different states, including info about which Amazon warehouses your inventory is in and what the sales are in each state… or once you get larger or more complicated you can upgrade to $350/month and Avalara will actually do the monthly filings for each state for you.

That’s just an example, Avalara appears to be very partnership-focused, since being easy to use in the platforms that their customers depend on would presumably be critical — so they have a variety of tax and compliance-related services they can offer, and they integrate with big platforms like Shopify and Magento but also payment processors and accounting systems like Stripe and QuickBooks.

The company did go public on June 15, 2018, just a few days before that Supreme Court decision, and they had a bumpy road for a while… including a big secondary offering last summer that helped to keep the stock a bit depressed for a while, but the shares have indeed taken off this year. And as I noted, they’ve risen quite a bit since this teaser ad started circulating, I first saw the ad on May 28 and the shares are up more than 20% since then.

And that seems to be a bet on the future, not on the present. The company is growing, but not dramatically at this point — so the question is whether the growth is going to accelerate or decelerate, and while it did accelerate into the end of last year, as McBride teased, lately it’s been decelerating a little (for a few quarters revenue growth topped 40%, but last quarter it dipped down to 31%). It’s still growing nicely, but you want high revenue growth to justify a 20X sales valuation… so is it high enough now?

The thing that appeals to me about Avalara is similar to what appeals about DocuSign or The Trade Desk, both of which also trade at silly valuations and aren’t really profitable yet — it is not really burning a lot of cash, they’re close to break-even so don’t need funding to pay for their current growth plans (unlike Shopify, for example, which has far larger ambitions and burns through a lot of cash because of their firm eye on the future prize)… and the size of the potential market, that “compliance” layer for global tax obligations, is very large.

The current estimate from analysts is that they’ll grow revenues from $382 million in 2019 to $565 million in 2021, so that’s roughly a 20% growth rate, and they expect AVLR to be cash-flow positive next year and to earn a penny a share. You wouldn’t want to base your investment on earning one cent a share when you’re talking about a company trading at $117 (yes, that’s a PE of 11,700), but breaking even while growing revenues at 20% a year, and presumably becoming a little more efficient each year after that, could create a strong earnings growth story within a few years. There are a few analysts who go all the way out to 2022, and while those seem to be the more optimistic ones it’s interesting that they see 29 cents per share in earnings for that year, and revenue growth accelerating to above 30%. They’ll probably be wrong, of course, analysts usually are and nobody knows what the world will look like in 2022, but there’s at least some rational modeling that creates accelerated growth potential from here.

I must admit that after reading through some of their materials, I love the business if it’s as good as they say they are — having the ability to manage sales tax and other odd tax terms across jurisdictions is huge, that’s a major headache for online retailers… and online retail is certainly growing, so I really see some value in what they call their “vision,” to be “the global cloud compliance platform.” That’s the kind of boring and complicated work that, if it can be made easy and seamless, would be a great use of Artificial Intelligence and could be truly valuable to a large number of businesses… and eminently scalable, since the work done to set up one business would make their next customer’s integration cheaper.

Avalara had a well-received quarter when they last reported, with a loss that was smaller than expected in Q1 and 31% year over year revenue growth, but they also did lower their guidance for the year instead of just abandoning the annual guidance like many companies have done. I don’t know if that’s because they’re being conservative, with worries about a slowing economy, or if they really think that they’ll be losing momentum.

The stock is at all-time highs again after the coronavirus[7] crash and recovery, probably largely because e-commerce is hot right now as Amazon and Shopify set new records… but it’s “only” up 60% this year, not 100% like Shopify, so I guess it’s possible that they could bounce higher still if they get more investor attention… particularly if the company begins to talk more optimistically about growth. I can easily imagine a world in which local, state and special-use taxes grow ever more complicated as municipalities are either incentivizing local businesses to remain, or trying to rebuild public finances after this cataclysmic Spring of shutdowns. And that increasing complexity, and perhaps an increasing tax burden, provides a ripe environment in which to sell a “we’ve got you covered” solution.

So… what’s to like? It’s a very sticky subscription business (once you get a sales tax system integrated, you’re not going to want to switch to a different provider and do it all over again, and almost all of their revenue is either from subscriptions or from recurring filing fees), and at least some of their products seem to be scaled, so revenue should rise as their customers’ revenue rises. Revenue retention has been around 110% lately, meaning that increased spending by existing customers more than makes up for the small number of customers they lose, and they grew their “core customer” base by 31% year over year, exactly the same pace at which they grew revenue this past quarter[8]. And it’s a problem solver in an area where problems are becoming more complex. They’re growing nicely and have strong retention, and good gross margins that are likely to ease them into profitability by next year — and they’re effectively self-funding now, with no debt and with plenty of cash.

What’s not to like? There are meaningful competitors, firms like Vertex, SpeedTax and TaxJar, but they aren’t generally publicly traded companies so it’s hard to have a handle on the competitive landscape (Avalara in some ways reminds me of DocuSign (DOCU)[9] — it might be the leading or highest-profile publicly-traded provider of a particular service, but there are other pretty strong providers out there as well… SpeedTax, for example, is hidden within Wolters Kluwer (WTKWY), but might also benefit from that company’s huge customer base, while DocuSign competes with add-on offerings from Adobe or Microsoft).

And the stock is clearly expensive at more than 20X sales, and is growing strongly but not as dramatically as real highfliers like Shopify — analysts estimate that they’ll be growing revenue by only about 20% this year and next (that’s great growth in the abstract, but not really up to par with other “20X+ sales” cloud stocks). And really, for many people it’s just hard to buy a stock that has risen so quickly… even if that kind of momentum can often stay with a stock for a long time, as we’ve seen plenty of times with the cloud stock “winners.” There’s a little bit of a disconnect between Avalara backpedaling on their forecast for the year, yet investors continuing to bid the shares higher.

But really, at this point I’d say the risk is mostly market-related — if the market stays enthused about recovery and continues to value cloud software stocks richly, Avalara should be fine… if the market collapses, these richly-valued stocks could easily fall twice as fast as the broader market. The prime issue is not whether the growth in any given quarter is going to be 21% or 25% or 32%, it’s whether investors decide the value the stock at 10X sales or 25X sales — and, of course, investor sentiment changes can be driven by company-specific news or by external factors in the broader economy or markets, and sentiment changes a lot faster than numbers do.

This looks like a pretty clearly excellent business with a recently stretched valuation — though not as wildly stretched as some of the higher-profile names in e-commerce. They’re not going to kill Amazon… I expect, in fact, that they’ll have little to no impact on Amazon’s results either way… but they could certainly help e-commerce providers to play in the big leagues more easily (which also benefits Amazon, as a marketplace provider who would love to push all the inventory and tax headaches off to other sellers and just charge a fee for facilitating and logistics). I’m inclined to take a little bite here and watch it, so that’s what I’ve done today, even though the price is a little hard to swallow at these all-time highs — if I own a few shares here, I’m far more likely to follow it closely and perhaps take a larger position if we get a meaningful dip in the price or my understanding of the company changes, but on this first read-through I do really like the business.

That’s just my take, though — it’s your money, so you have to invest for your vision of the future. Do you see Avalara’s business catching up with this valuation over the next few years? Think they’ll be hit more by the recession than investors are expecting right now? Expect competitors like TaxJar to come public and steal some of their thunder? Let us know with a comment below.

Disclosure: Of the companies mentioned above I own shares of and/or call options[10] on Amazon, Shopify, DocuSign, Avalara, EverArc Holdings and The Trade Desk. I will not trade in any covered stock for at least three days after publication, per Stock Gumshoe’s trading rules.

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