After filing for an IPO with a $19 to $21 range, Avalara ($AVLR) increased the range to $21 to $23 and then priced above-the-range last night at $24.

It’s not surprising because the story behind this enterprise cloud software company is a great one. It’s “astonishing” because it comes in an area that’s typically a yawner – transaction tax compliance. Sales tax is a large part of it but it also includes others like excise tax, value-added taxes and specialty taxes.

The short version of the story is that tax compliance is complicated and tedious and the correct amounts must be computed and applied at the point-of-sale which doesn’t allow a large amount of time for processing. There are over 12,000 tax jurisdictions in the US alone and knowing which rules to apply when is an almost intractable problem. It’s not just the location – it can be different depending on the buyer’s tax status, or the time of year (there are tax holidays in many jurisdictions for certain goods at certain times of the year) and it goes on and on.

What follows is a brief “story in pictures” along with some thoughts on potential risks (there are two obvious ones) and valuation.

The Story

First of all figuring out the tax is harder than you might think. There are (ever changing) tax rules, the need to geographically pinpoint the location, check sourcing rules, exemption status and tax holidays. After it’s all said and done the records have to be managed and returns must be prepared and filed by jurisdiction – there are many in the US and the problem only expands globally.

There are lots of overlapping and changing tax jurisdictions in the US alone.

Many of the processing steps must occur in near-real-time at the point of sale.

Avalara has leveraged partners to both expand their distribution and create an “Avalara inside” model where their technology can be embedded in other product and service offerings.

The overall results have been steady growth and a mostly-recurring cloud-based business model.

Potential Risks

While investors are very enthusiastic there are two areas to watch out for. The first is simply that their revenue growth has decelerated in the last year from over 30% to 25%. It’s not a flashing red light but one that suggests the growth rate could vary and investors have a tendency to overreact when deviations occur, both on the upside and the downside.

The most palpable risk for $ALVR is their growth by acquisition. They are growing organically but their strategy has been to make acquisitions and this will continue to be a key contributor to their growth. It’s likely that the pace of acquisitions might quicken with a richly-valued public currency.

Growth by acquisition raises questions about the underlying technology implementation and the ability of the company to continue to “layer on” more acquisitions and integrate them effectively. We expect the investment banks will be loving $ALVR for a long time.

Valuation

Avalara has provided their long-term model and results have been consistent with their working towards their financial targets including narrowing losses and improving cash flow.

With huge demand on the IPO the shares are likely to trade much higher when they open today in the aftermarket. However we’ve seen these types of stocks continue to run up to and often right past our IV estimates. Witness how well both Smartsheet ($SMAR) and DocuSign ($DOCU) have done in the last month.

Our IV below puts the shares at $40 in the aftermarket. If they don’t get there today then we may have a chance to start a position. This will be a good one to watch as acquisitions, lock-up expiration or changes in the growth rate could create additional opportunities.

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