This article is a reprint of my February 8, 2008 RealMone y column
One of my favorite investment themes is engineering and infrastructure software, which I think combines the high margins and cash flow stability of a software investment with the positive long-term trends in global infrastructure development. I think investors can profit handsomely from a potential 64% rise in Autodesk, the leading player in this market.
In November I wrote bullishly about Dassault (DASTY) and Ansys (ANSS), which I bought in January . Since those columns were written the stocks have performed in-line with the market, which is a nicer-sounding euphemism for saying they have gone down. I was more bearish about Parametric (PMTC), which has indeed turned in the worst performance of the three.
Long term, however, I still think the space has tremendous opportunity and think the overall market downturn is providing additional opportunities – most notably that of industry leader Autodesk (ADSK). Autodesk is best known for its AutoCAD software, a customizable and extendable computer aided design (CAD) application for 2D drafting, detailing, functional design documentation and basic 3D model-based design.
A common misperception is that AutoCAD is focused on architectural markets, and that a slowdown in construction activity could be disproportionately harmful. However, the largest end market is manufacturing (product design) and the civil engineering/infrastructure market is nearly as meaningful as construction.
The shares were downgraded by an analyst at Jeffries in January, who cited “anecdotal channel evidence of slowing manufacturing demand in Europe” and a “decent chance” that spending on computer-aided design software and related technologies will slow in both North America and in 2008. Yet his less-than-2% trims to his EPS estimates, which simply brought them in line with the rest of the crowd, are more than reflected in the 25% decline in the share price since the December.
At any rate, Autodesk continues to meet or exceed earnings estimates and has seen modest positive revisions to estimates over the last month. Since its products are used in the early stages of the construction process, if the potential slowdown doesn’t show up soon it likely won’t show up at all.
Furthermore, with more of its customers migrating to a subscription-based model some of the uncertainty surrounding upgrade adoption has been mitigated and revenue growth and stability are more transparent. Subscription revenues are growing at twice the rate of license sales. Deferred revenues have grown 12% in the last nine months, including an 18% increase in long-term deferred revenues. All of this lends to greater confidence in the level of sales and earnings over the next year.
Autodesk generated $640 million in free cash flow over the last 12 months, which amounts to a free cash flow yield approaching 8% of enterprise value. With a 500-basis point advantage over Treasuries and a long-term expected growth rate of 16% (which is more than justified by the company’s high return on equity ) the stock looks very attractive here.
If Autodesk grows in line with estimates and narrows the spread between its cash flow yield and the Treasury yield to a still-attractive 100%, its shares could rise to $63, for a potential return of 64%. The shares offered a similar spread to Treasuries as recently as December, when the shares were trading above $51. Meanwhile, short of a considerable decline from the existing level of sales and cash flow it is hard to see significant further downside.
Disclosures: Long Ansys (ANSS)
William Trent currently holds a short position in put options related to Ansys (ANSS).
$38.7 (02/15/08)
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