ADSK - Autodesk: Signs Of Soft Demand

2023-07-20 09:37:24 ET

Summary

• Autodesk's portfolio of software solutions is well-positioned to benefit from digital transformation and AI advancements, but there are signs of weakening demand that could impact the stock in the short term.
• The company is pursuing a cloud platform strategy, with an open approach that should create network effects.
• Despite Autodesk's strong position in design, competition from adjacent markets is likely to increase over time.

Autodesk ( ADSK ) has a strong portfolio of solutions that should benefit from digital transformation initiatives and the growing capabilities of AI. Despite this long-term potential, there are signs of deteriorating demand that make the stock vulnerable in the near-term. Growth and margins are likely to remain under pressure in coming quarters, which may result in a substantial share price decline at some point.

Autodesk

Autodesk offers a range of software for use across the product lifecycle, including design, engineering, and manufacturing. This software enables end-to-end digital transformation and can provide real-time and immersive experiences. Solutions are targeted at industry verticals and are grouped under AEC, EMS and Manufacturing.

Autodesk has traditionally had a strong position in design, but the merging of design, engineering and manufacturing, as well as a convergence between industries is both expanding its opportunity and changing the basis of competition.

Autodesk is currently pursuing a cloud platform strategy to capitalize on these trends, with Autodesk Platform Services forming the basis of its cloud platform. Autodesk is utilizing an open data model, which means that changes propagate bidirectionally, enhancing collaboration between design, engineering and manufacturing. Customers and third-party developers are also able to connect to this open data model and use it to build their own applications. This should increase the functionality of Autodesk’s platform and help to create network effects. The platform also leverages common components across industrial verticals, leading to economies of scope.

Autodesk Platform Services

Interactive and concurrent workflows, which start with a 3D design and end in a digital twin, support a platform approach. Autodesk’s platform approach helps to connect data, teams and workflows. The platform also provides the basis for Autodesk’s vertical solutions:

• Autodesk Fusion - manufacturing
• Autodesk Forma - architecture, engineering and construction
• Autodesk Flow - media and entertainment

APS offers a common data model across services. This can help to reduce friction in workflows and provide insights into areas like product usage and operations.

Autodesk is also taking a relatively open approach with its platform, providing Autodesk Data Exchange to connect data between Autodesk and external products. Given Autodesk’s dominant position in the industry, an argument could be made for pursuing a closed approach, but the breadth of use cases covered in the platform makes it extremely difficult to be competitive across all areas. An open approach allows customers to standardize on Autodesk’s platform while benefitting from external best-in-class tools where needed. As Autodesk is orchestrating the overall workflow, it can do this and still maintain a strong competitive position.

As part of its platform strategy, Autodesk offers an app marketplace which increases the utility of its platform for customers. It also provides Autodesk with a scale-based advantage, as developers will only choose to create applications for a handful of the largest platforms. There are currently over 4,200 published apps and in excess of 1.3 million downloads each year.

Manufacturing

Autodesk estimates that its design and manufacturing TAM will be 42 billion USD in 2027 , with the opportunity skewing towards manufacturing applications.

Design and manufacturing software has evolved over time, with functionality expanding to encompass manufacturing operations, engineering and product lifecycle management. Autodesk's traditional strength has been CAD, but the future is a platform that can manage the entire lifecycle with an ability to seamlessly propagate data forwards and backwards through the workflow.

Generative AI and intelligent automation also promise to increase productivity. Autodesk is well positioned to capitalize on these trends with its platform and Fusion manufacturing software.

Autodesk believes that its unified approach is already beginning to yield results within CAM. Fusion had 231,000 subscribers at the end of the first quarter of FY2024.

Autodesk offers a scalable platform that is currently targeted at mid-market manufacturers. The company believes that the path of disruption is upmarket though, and in time Autodesk wants to capture more enterprise customers.

This is a misreading of disruption theory though. The marginal cost of software is essentially zero, meaning that a vendor targeting the high-end of the market should generally be able to cover the low-end of the market as well by offering a version of its software with restricted functionality. This really comes down to the sales organization as much as the product, as enterprises generally demand a higher touch service.

As part of its "disruptive" approach, Autodesk is offering Fusion at a significantly lower price point than comparable solutions. This is highly dependent on the capabilities a customer wishes to utilize though. Fusion's pricing structure is largely about trying to align pricing with the value provided to customers.

Autodesk makes heavy use of educational institutions to build product awareness and a base of users that are competent with its products. This is a fairly common strategy and is part of the reason that some companies have a strong competitive position. With the rise of no code/low code tools and generative AI to guide workflows, this type of advantage may become less relevant in the future.

Media and Entertainment

Media and entertainment is currently a relatively small opportunity, but there are a number of potential growth vectors:

• Demand for quality content
• Increasing adoption of cloud technology
• The metaverse

Competition amongst media companies is creating demand for higher quality content, which often means more VFX and 3D. As a result, the market for VFX tools is expected to grow at a healthy clip in coming years.

Autodesk believes that bigger game worlds, longer movies and more sophisticated visual effects is causing the cost of content creation to rise. In response, content creators may turn to digital tools to help manage costs.

Remote work and a growing need for collaboration and greater efficiency are also driving the adoption of cloud software for content creation.

Flow is Autodesk's cloud solution for content creation. Flow unifies workflows and data across the production lifecycle, which should enhance collaboration and enable faster content creation. AI is leveraged in flow to help studios automate manual processes and increase creativity.

Autodesk is trying to increase adoption of its creative tools through Maya Creative and Maya Indie. Maya is software for modeling, animation, and rendering, and Creative and Indie are entry level versions. Maya Indie provides freelancers, hobbyists and 3D artists a more affordable way to access Maya. There has been 49% YoY growth in 3Ds Max Indie and Maya Indie revenue.

Architecture, Engineering and Construction

Autodesk estimates that its AEC TAM will be 46 billion USD in 2027 , with the opportunity skewing towards design applications.

Government stimulus is currently driving a wave of infrastructure spending. This is temporarily offsetting generally weak demand for new infrastructure in developed countries. Digital transformation (digital twins, automation, etc.) is also currently an important trend within AEC, which is boosting demand for Autodesk's software.

Building Information Modelling tools are still underpenetrated in many countries, which should help to support long-term growth. Collaboration is also becoming more important within civil projects, and Autodesk's cloud software aims to capitalize on this. Autodesk believes that there is a large BIM Collaborate Pro opportunity as a result of demand for digital project delivery. There has been a 3x increase in Autodesk BIM Collaborate Pro users from pre-pandemic levels and 38% of Revit users globally have adopted Autodesk Collaborate Pro.

Autodesk has also introduced updates for Civil 3D and Desktop Connector which increase workload capacity and enhance cloud collaboration. Autodesk believes that these enhancements expand its target user base by approximately 51%.

Forma is Autodesk's AEC industry cloud, which aims to unify workflows across teams that design, build, and operate built environments. Forma can help clients implement projects faster and with less risk by helping companies move from linear workflows to collaboration enabled by connected data.

Autodesk also offers construction management software, which aims to bring project teams together from design to turnover.

Autodesk is trying to tightly integrate design with preconstruction, which it believes will provide a number of advantages:

• Reduced rework and material wastage
• Increased budget accuracy
• Easier conflict identification and resolution
• Greater scope definition
• Better inter-disciplinary collaboration

Autodesk's presence in design gives it a strong base from which to expand into downstream workflows.

Construction activity is still relatively robust, driven in large part by government stimulus. Although this creates a risk of weakness after the current spending boom ends.

Autodesk Construction Cloud is a cloud-based construction management solution. User growth, and in turn net revenue retention, for Autodesk Construction Cloud are currently strong.

AI

AI should provide significant benefits to CAD software, and product design and engineering more broadly. For example, generative AI could be used to help design a product's geometry. AI will also likely be used to make simulation more efficient and to optimize a product's design across a range of factors (performance, cost, manufacturability, etc.). This will also extend into areas like creating 3D objects from 2D images and artist tools to improve product renderings and content creation.

AI can also increase productivity by suggesting the next step in a workflow, like a type of autocomplete for design, or by creating scripts. Automation of documentation will also be extremely valuable. One of Autodesk’s customers that is involved in the production of large structures estimates that approximately 72% of its engineering time is dedicated to documentation rather than design.

The benefits from this should be large, but may take time to play out. It is also not currently clear how AI will impact the competitive landscape. As one of the larger companies in the market, Autodesk should have the necessary data and resources to be a winner.

Competition

Within its core markets Autodesk is a clear leader, but the convergence of adjacent markets is both creating growth opportunities and changing the basis of competition.

Autodesk has stated that it is not solely reliant on competitive displacement for growth, but given the maturity of its markets, displacement is essential for Autodesk to justify its valuation.

Autodesk's broad platform places it in competition with a wide range of companies, in areas like:

• Design Software
• Game Engines
• Additive Manufacturing Software
• Product Lifecycle Management Software
• Simulation Software

Being positioned earlier in the product lifecycle potentially gives Autodesk a strong position to expand forward. This is dependent on what parts of the lifecycle are considered the most important though. For example, it could be argued that PLM or CAE software have the opportunity to subsume CAD. Autodesk is having success with its expansion from CAD into CAM, but faces a threat from CAE software. Altair ( ALTR ) believes CAE will expand into CAD, with simulation and product design optimization converging. This trend will likely be driven by AI enabling more efficient simulation and design optimization.

Game engines are another emerging threat in areas like digital twins and media and entertainment. For example, Unity's ( U ) acquisition of Weta allows it to expand its media presence outside of gaming. Autodesk's CAD software gives it a strong position in digital twins, but the company lacks some of the capabilities of game engines. Utilization of digital assets across gaming and other types of media could give game engines an advantage in some areas. Autodesk appears to be aligning itself with Unity and Epic Games though, which gives it access to best-in-class capabilities.

Financial Analysis

Autodesk's revenue increased 12% YoY in the first quarter in constant currency. While the macro environment continues to look weak, Autodesk has suggested that its leading indicators have been consistent, with product usage growing modestly. Autodesk is also seeing more strategic partnerships, improving renewal rates, and consistent net revenue retention. A deceleration in subscriber growth was offset by an improvement in renewal rates in the first quarter.

New subscriber growth decelerated in North America and accelerated in EMEA in the first quarter. Strength in Europe is unlikely to persist though, with economic data there weakening considerably in recent months.

Revenue growth in the second quarter of FY2024 is expected to be roughly 6.7% YoY . For the full financial year Autodesk is guiding to approximately 8% revenue growth. Net revenue retention rate is expected to be in the 100-110% range at constant currency. Other revenue is expected to benefit from both offline and a large EBA renewal cohort. These EBAs last renewed three years ago at the start of the pandemic, and subsequent adoption and usage has been strong.

While Autodesk is guiding for revenue growth to stabilize or even accelerate modestly, there is evidence that the demand environment is still weakening. Survey data on technology spending expectations is extremely weak, and the number of job openings mentioning Autodesk in the job requirements has fallen significantly in recent months.

Autodesk's business has scaled well over the past decade, with the company now having consistently high margins. There is probably limited further upside though, and an argument could be made that the pandemic artificially boosted margins. Growth temporarily surged in the wake of the pandemic during a period where Autodesk was aggressively controlling costs, leading to a sharp rise in margins. Growth is now moderating while costs are rising, which may soon begin to pressure margins.

Management stated on the first quarter earnings call that it was slowing spend earlier in the year so that they have more investment flexibility later on. Hiring data suggests that the pace of investment is continuing to decline though, which again suggests softening demand.

Conclusion

As Autodesk’s valuation is high and its end markets only offer limited growth, excess returns will be dependent on either Autodesk’s ability to add new use cases to its software or strengthen its competitive position and continue to drive prices higher. While customers may not like dramatically higher costs, with enough lock-in they will have little recourse. This will be dependent on the strength of competing solutions and the ability of competitors to enable customers to switch platforms with limited friction.

Given signs of softening demand, there is a risk that growth disappoints in coming quarters, which could also lead to a decline in margins. It is hard to know how the market would react to this though, as investors appear to be willing to look through temporary issues for high quality companies at the moment.

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