Autodesk builds on its competitive advantage

When architects and engineers put their heads together to create buildings, they used to do so exclusively around huge blueprints and endless reams of paper. Now, they can also draw up 3D images of their visions digitally, creating the relevant paperwork in real-time. That is, if they are using Autodesk (US:ADSK) products. 

In its words, the California-based company “makes software for people who make things”. Its clients work mostly in the architecture, engineering and construction (AEC) industries, as well as manufacturing, media and entertainment. Its cloud-based products are built to streamline design, building and data management processes. They have become so embedded in the industry that universities teach architecture and engineering students how to use them. 

The company’s huge market share and reputation for quality make it a popular holding for funds with a focus on long-term growth opportunities in the tech sector. “We have held Autodesk in our portfolio since early 2018, and it’s a classic example of the sort of company we like to own,” says Stephen Yiu, lead manager at LF Blue Whale Growth (GB00BD6PG563), which counts Autodesk as a top 10 holding. “It has a market-leading position in digital design and is able to sustainably reinvest capital at high rates of return by digitising the rest of the construction and architecture industry.” Indeed, Autodesk’s return on capital employed, which measures how effectively money invested in a business is turned into profit, sat at a chunky 24.5 per cent in its last fiscal year. 

A slow transition to SaaS

But the company has been late off the mark in transitioning to the software-as-a-service (SaaS) model that became the industry standard over the course of the 2010s. Autodesk only discontinued the sale of its new commercial licences (one-off purchases for perpetual access to a product) in its 2016 financial year. Its transitional “maintenance-to-subscription” strategy kicked off just three years ago. Compare that with software peer Adobe (US:ADBE), which pioneered the model back in 2013. 

It has taken some time, but Autodesk’s results have been fruitful so far. In the fiscal year ended in January 2021, recurring revenue accounted for 97 per cent of the net total. More than a quarter of that was derived from subscriptions. Growth here is already improving the quality of Autodesk’s revenue streams: in its most recent quarter, remaining performance obligations (RPO), which represent revenue yet to be recognised under existing contracts, increased by more than a fifth to $4.2bn (£3bn). 

A subscription plan will tick the missing box in Autodesk’s software business model. It is already highly cash-generative, with a free cash conversion rate of 111 per cent last year. The company also boasts a high gross margin, which has averaged 90 per cent over the past three years.

Autodesk looks as though it is using this cash wisely. In its most recent quarter, the group acquired Innovyze, a software analytics company for the water utility and management industry, for $1bn, as well as product lifecycle management start-up Upchain for an undisclosed amount. Both purchases will increase the group’s exposure to the infrastructure market. The former could be a significant beneficiary of President Biden’s proposed $2.3tn infrastructure bill, if it passes. The spending plan includes $111bn in investment in water infrastructure. 

Just this week, the group also placed a $3.9bn bid for Altium (AUS:ALU), an Australian software company that helps engineers design printed circuit boards. Altium’s board quickly turned down the offer, arguing that it significantly undervalued its prospects and therefore “rejects the proposal at the current price” – but if Autodesk is willing to bump up its bid, a takeover could still be on the cards. 

Autodesk’s core AEC and manufacturing markets are growing well, too, as industry activity starts to recover from the impact of the coronavirus outbreak last year. Investors should be minded that the group’s reliance on construction and manufacturing activity does introduce some cyclical risk.

The multi-speed nature of the global recovery so far, and Autodesk’s geographic diversity, meant that trading has remained relatively unaffected during the pandemic, overall. The group did extend payment terms for its customers to 60 days until early August last year and deferred a 20 per cent maintenance price increase from May to August to give more time to consider a subscription agreement. But last month the group noted that usage was above pre-Covid levels in most of Asia Pacific and Continental Europe. The US and the UK are still behind, but a rebound in US construction activity bodes well for the year ahead. 

Cutting out the middlemen

When you Google Autodesk, the search engine immediately throws up an alternative question: “Why is Autodesk so expensive?” It seems a common complaint, given that the software company recognises 12m non-compliant (non-paying) users. These pirate copies of Autodesk products do not generate any revenue, which might trigger alarm bells for potential investors. But they also represent a huge pool of possible customers who have a need for Autodesk software – and the more Autodesk updates its products, the wider the quality gap between the paid version and the pirated version becomes. 

Management has implemented a specific strategy to convert non-compliant users to paying users and so far it appears to be yielding results. The company does not break out specific figures for the project, but chief executive Andrew Anagnost said in a recent analyst call that revenue from converting non-compliant users had almost doubled year on year in the first quarter. 

Autodesk is clearly in a period of transition into a more modern SaaS business, which will unlock the value of owning the intellectual property of a highly sought after product. In the short term, however, it could lead to some disruption in relationships with its resellers. Its largest partner, Tech Data, accounted for 37 per cent of Autodesk’s total net revenue last year, and 35 per cent in the two years prior. Its second-largest, Ingram Micro, has historically accounted for around a tenth. As Autodesk pursues the direct SaaS subscription model, the role of the middlemen will inevitably begin to look redundant. The company has openly admitted that it anticipates its largest accounts will move towards its direct-only business. It has also hinted that its agreements with the likes of Tech Data may be terminated in the future, but ultimately the company’s end-users will simply become direct clients or seek out other distributors. 

Quality tech without hype

While Autodesk has not always been a top 10 holding at LF Blue Whale growth, Yiu says that its existing position reflects the fund’s view that “companies with pricing power can do well in an inflationary environment – Autodesk is one of them and raises its price every year roughly in line with inflation.” 

It is rare that a high-quality tech name such as Autodesk comes cheap. But the group’s improving business model, high margins and ongoing introduction of newer technology such as artificial intelligence into the world of construction and manufacturing together look promising for its long-term prospects. On that basis, we think that broker Berenberg’s forecast free cash flow (FCF) yield of 3 per cent for 2023 makes Autodesk look appealing.