AZPN - Aspen Technology: Still Sleepy After The Merger

2024-01-18 15:39:15 ET

Summary

• Aspen Technology sells process simulation software for heavy asset industries, helping them simulate different scenarios to reduce costs and waste.
• Aspen's lack of a transition to SaaS suggests it's a very sleepy business with limited growth potential.
• Aspen should prove to be a very durable business with a questionable growth curve, this makes 30x forward earnings too expensive.

There's been a number of great businesses over time conceived as a non-profit ventures, Aspen Technology ( AZPN ) is no different. Aspen Technology began as a joint venture between MIT and the Department of Energy, its name derived from the very loose original acronym, the Advanced System for Process Engineering Project.

Heritage Aspen, as it's known now, sells process simulation software. Their customers included heavy asset industries that require moving and processing raw material throughout a plant. These are extremely complex operations, and small changes can have a big impact on cost savings and reduction of waste. In the hands of chemical engineers, Aspen's software can help simulate how different scenarios might impact these metrics before a company makes the expensive investment in manipulating real-world assets.

While Aspen provides an essential tool for many chemical engineers, its customer base consists of sleepy, low-growth industrials. Aspen's financials have followed suit, until Aspen engaged in an interesting combination.

Aspen merged with a division of Emerson Electric ( EMR ) in 2022. Aspen essentially sold itself, but kept its operations the same by keeping the management team of heritage Aspen in place. Emerson contributed two businesses to the merger that constituted about 15% of revenue at the time of the merger. Emerson paid out $6B to shareholders of heritage Aspen and took a 55% stake of the new company.

The two assets Emerson contributed to the merger are OSI and Geological Simulation Software. OSI seems to offer less synergies of the two, it is a SCADA system, which stands for supervisory control and data acquisition. SCADA systems are used in nearly every industrial process . OSI is used by utilities, Aspen hopes this represents a new customer cohort to cross-sell other solutions into. GSS seems to fit well with Aspen's existing product lineup. Its portfolio of products includes subsurface simulation software. There's likely already a lot of overlap between these customers and heritage Aspen, but again, these two businesses make up a very small portion of total revenue.

Industry & Competitive Position:

It's no doubt Aspen owns interesting assets, it's comparable to Autodesk ( ADSK ) in many ways. But the underlying dynamics of the customers served should make it much easier for Autodesk to grow over Aspen.

Aspen's list of industries includes energy (mostly the entire lifecycle of oil and gas production), bulk and specialty chemicals, engineering and construction, power and utilities, metals and mining, and pharmaceuticals. Autodesk is a beneficiary of continued investment in infrastructure, Aspen is more tied to consumables in challenged industries with high levels of competition.

The one interesting note to make is that Aspen has not made the transition to software-as-a-service like many others have, including Autodesk. Aspen's revenue is derived from legacy software licenses and support contracts. This is more evidence of Aspen's structural sleepiness. SaaS is a bit of a buzzword, but it has created a lot of value for many businesses who made the transition. But in order for vendors to charge more and generate streams of reoccurring revenue, they must add more value. The primary benefit of software built in the cloud is the ease in pushing updates to users and simplifying ownership costs. I believe it's highly likely that Aspen doesn't believe it can provide enough incremental value so that a transition would be successful and well-received.

Valuation:

While headlines have been dominated by the Emerson merger, it really is not as significant as it seems. Aspen shareholders cashed out half of their stake and acquired two small businesses. But now that the merger is completed and having been fully lapped into the numbers for several quarters, management has stated their focus is now on execution and expansion:

We remain confident in our ability to deliver ACV growth of at least 11.5% and free cash flow of at least $360 million. Industry demand for greater operational efficiency coupled with higher investment levels to support sustainability goals and energy transition initiatives is driving strong demand for our innovation. Macro trends remain consistent with our expectations at the beginning of the year and we're closely monitoring the ongoing conflict in the Middle East for any potential impact on market dynamics which so far has been minimal.

This is a far different narrative from last spring when the stock cratered. The cause was pinned to a slowing chemicals market and challenges in both of the acquired businesses. The narrative might continue to be heavily influenced by the macro investment cycles of heavily cyclical industries. Another benefit of SaaS over licensing is that it smoothes out the irregularities of cyclicality.

Aspen trades a similar multiple to Autodesk:

Autodesk likely deserves a bit of a premium on Aspen because of the secular tailwinds created by the growth of infrastructure spending.

Overall, Aspen is a collection of solid assets, but has a very difficult, if not impossible, road to unlocking a significant amount of value in my view. Management has not made any egregious errors thus far, but the Emerson merger doesn't seem to have meaningfully changed the picture for shareholders. Aspen should prove to be a very durable business, but its highly uncertain growth curve makes 30x earnings way too expensive a price to pay.

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