UDMY - Autodesk: The Next A.I. Winner

2023-07-21 08:56:43 ET

Summary

• Autodesk is well-positioned to capitalize on the AI-driven design market, with potential to revolutionize industries.
• ADSK has demonstrated robust revenue growth and strong profitability over the past five years, and its focus on generative design could lead to continued profitable expansion.
• Despite potential competition from startups, Autodesk's global reach and award-winning design stack should enable continued top-line pickup and deepen entrenchment of its products among professionals worldwide.

In a recent article titled " Udemy: An Overlooked AI Winner With Huge Potential Upside ", we laid out the bull case for Udemy ( UDMY ), an online learning platform that stands to benefit from a potential wave of AI-displaced workers that need to re-skill in order to remain competitive in the job market.

While the article touched on Udemy's business in particular, we also did some analysis more broadly about which industries could see the biggest impact from the introduction of AI solutions. Our comments covered industries like Legal Services, Healthcare, Retail, and Entertainment:

First, AI has the potential to disrupt legal services by automating document analysis and contract review processes, saving time and improving accuracy. [...]

Second, AI could disrupt healthcare by leveraging machine learning to improve diagnostics accuracy, assist in patient monitoring, accelerate drug discovery and development processes, and enable personalized medicine through genetic analysis and precision treatments. [...]

Third, AI has the potential to disrupt retail by optimizing inventory management and demand forecasting, streamlining supply chain operations, and facilitating frictionless cashier-less checkout systems through technologies like computer vision and natural language processing. [...]

Finally, AI has the potential to impact the entertainment industry. AI can automate video editing and post-production processes, generate virtual actors and influencers, enhance content generation and curation, and enable immersive experiences through technologies like augmented reality.

However, three important industries that we failed to mention were Construction, Product Design and Manufacturing.

Players in these businesses will likely see big changes over the coming decade as AI makes a big impact on overall efficiency and employee workflow. This means that there's big opportunity for the company that's going to sell next-gen, AI powered tools to the architects, designers, and engineers of tomorrow.

We think that company will be Autodesk ( ADSK ).

Today, we'll be taking a deeper look at Autodesk, and why we think the company is in the perfect position to capitalize on this fantastic opportunity.

If things go as planned and the company continues to execute as they have been, we see significant upside for Autodesk stock over the next 5 years or so.

Financial Results

As usual, we'll begin with some info about the company and its recent financial results.

In case you're unfamiliar, Autodesk is a software company that produces 87 distinct software products & applications that serve three end business use cases:

• AEC: Architecture, Engineering & Construction
• MFG: Product Design & Manufacturing
• M&E: Media & Entertainment

The company's largest products include big brand names that you may have heard of, like AutoCAD, Fusion 360, and Maya.

An easy way to think about Autodesk is that it's similar to Adobe ( ADBE ) in a lot of ways. Both companies sell subscriptions to customers in return for access to packaged software products that boost professional productivity.

The main difference is who they sell to; Adobe's products cater to a broad range of customers, including individual designers, creative professionals, photographers, video editors, web developers, and marketers. Autodesk, on the other hand, primarily targets professionals in architecture, engineering, construction, manufacturing, and the entertainment industry.

ADSK products are essential for professionals dealing with 3D modeling, rendering, and simulation.

The company's products have become the industry standard in many of the end market Autodesk serves, which has led to extremely robust TTM revenue growth over the last 5 years:

Since mid-2018, Autodesk has grown revenue from $2.24 billion to over $5 billion, unbelievable growth of more than 120% in the span of just 5 years. This growth has been the result of a buy-and-build strategy that the company has used to build its product portfolio in double-quick time :

Our strategy includes improving our product functionality and expanding our product offerings through internal development as well as through the acquisition of products, technology, and businesses. Acquisitions often increase the speed at which we can deliver product functionality to our customers; however, they entail cost and integration challenges and may, in certain instances, negatively impact our operating margins. We continually review these factors in making decisions regarding acquisitions. We anticipate that we will continue to acquire products, technology, and businesses as compelling opportunities become available.

Clearly, the strategy is working, as customers are happy with the product. In Q1 2023, as well as the period a year earlier, Autodesk saw net revenue retention of 100-110%, which indicates strong user stickiness and satisfaction. Considering that recurring subscription revenue counts for nearly all of Autodesk's revenue, it's an incredibly encouraging sign:

Also encouraging is the company's strong business mix and geographical diversification.

Autodesk has several strong lines of business that all contribute meaningfully to the top line, including the aforementioned AEC, Manufacturing, and Media & Entertainment, along with AutoCAD which it breaks out manually:

Sure, M&E may end up being a bit weaker than the other segments due to the strong competition with the aforementioned Adobe, there are still a few niche entertainment markets where Autodesk retains some share.

Geographically, the company also has a truly global reach:

This reach is to the companies benefit, as it will, in many parts of the world, become the "go-to" firm for AI-powered design products, as we will discuss a bit further on.

The company's revenue profile is strong and robust. But what about profitability?

As it turns out, profitability has been extremely strong as well. In the same 5-year period as above, Autodesk has taken TTM free cash flow from basically zero to over $2.35 billion:

The company now produces more profit than it did in total sales just 5 years ago(!!).

This growth also shows how much margins have improved; from breakeven, to more than 40% in that same span of time.

The increase in profit margin has come from strong cost control. Autodesk's G&A costs have grown much more slowly over the years than revenue, which shows that the company has been incredibly efficient with headcount:

R&D has also grown, but due to the aforementioned buy-and-build approach, it's grown less quickly than perhaps otherwise expected.

Lastly, touching on liquidity, Autodesk remains in an enviable position. Since the firm has acquired a LOT of companies over the years, one might expect that Autodesk has piled up a significant amount of debt. In reality, the company maintains a cash & equivalents position of $2.13 billion, and a total debt pile (of almost exclusively long-term debt) of $2.28 billion.

Clearly, a liquidity crunch is not in the cards, especially given the company's strong profitability profile.

Even if there wasn't an opportunity for Autodesk to become the go-to AI-powered construction and design software, the business's overall traits look incredibly appealing.

However, as we've discussed, Autodesk has a unique opportunity.

The AI Opportunity

Consider the following example for a moment:

Imagine you're planning the interior of an office building. In one scenario, your first step is to define the design parameters by describing the amount of light you want for desks depending on the season, the desired views for conference rooms, and the maximum amount you want to spend for construction. After you define the criteria, your design tools generate all the best possible outcomes with a single analysis and evaluate the alternatives. This all takes place in a fraction of the time that it normally takes you to manually arrive at one or two best-guess approximations.

In the other scenario, you sit down and manually calculate how your design parameters impact other aspects of the office, building like energy loads and construction costs. You tediously go through the hundreds of location variables—kitchens, bathrooms, desks, or communal space placements—produced by your choices as the design develops.

This entire process takes days or weeks as you review the options. How might it change the way you design if, like in the first scenario, your software could help discover the implications of the goals you define instead?

Now think about a typical construction project and shifting your approach to the actual procedure of building—and not just what you’re building, but how it's built. Cost overruns and waste are always the enemies of construction. What if you could mitigate these potential risk factors with better recommendations on materials or by scheduling and sequencing job site work? What is the right strategy for placing precast concrete panels? Or the optimum placement of a crane? A software algorithm can test numerous scenarios for potential solutions to find the best one.

This is the goal of Generative Design.

In short, advances in AI will allow designers to leverage computation in order to efficiently explore, optimize, and make choices when faced with intricate design challenges.

In the same way that ChatGPT can write a poem about [anything] in the style of [anything], generative design tools will allow designers, architects and engineers to create designs and building plans that seem otherworldly to us now, yet that are unbelievably efficient.

However you look at it, this is an incredibly powerful concept that could revolutionize the built environment, improve the environmental friendliness of everyday products, and lead to shakeups in lots of different sectors.

Need a 10-story building to be structurally sound but only made out of CLT (cross laminated timber) with a budget of $15 million? Generative design tools will be able to help you plan everything from A to Z.

Not just any generative tools, mind you; Autodesk's generative tools:

As you can see, Autodesk is already aware of the potential here and is pivoting its award-winning tools and design stack for this future.

Given the company's already-global reach, staying on top of this evolving AI use-case should allow Autodesk to continue growing revenues for the foreseeable future, and deepen entrenchment of the company's products in the eyes of professionals all over the world.

Valuation

So; AI is set to revolutionize design by making it easier to design, engineer, and create things, and Autodesk will be the one making the software that everyone else needs to "make it happen".

What is that opportunity currently selling for in the market?

As it turns out, a fair price - in our view.

Right now, Autodesk is trading at a ~9x revenue multiple, and a ~19.6x free cash flow multiple:

While a 9x revenue multiple looks a bit elevated when compared to industry peers, a 19.6x free cash flow looks downright attractive, both when compared to where Autodesk has traded historically, as well as the broader market on the whole.

Sure, our view conflicts with Seeking Alpha's Quant Rating System that currently rates the valuation at a "D+":

However, we don't think that Price/Book is a relevant metric for a company like ADSK, and removing that would skew the results likely back into "C" territory, which is where we think Autodesk should sit. It's not a great value, but it's also not overly expensive at the current moment. It reminds us of what we said about Opera , right before the stock ran 30%+:

As Warren Buffett is fond of saying: It's far better to buy a wonderful company at a fair price than a fair company at a wonderful price.

We couldn't agree more, especially given the opportunity set available to Autodesk.

Risks

The main risk here is competition from scrappy startups. While Autodesk does maintain a strong global reach and solid brand recognition among professionals, there's always a chance that an up-and-coming company could begin winning market share, like Figma did with Adobe. Adobe ultimately resolved that competition, but they did it by spending $20 billion; clearly a sub-optimal outcome.

Right now, there are a few companies like Monolith that are getting their toes wet with generative design, but there doesn't appear to be much in the way of traction, yet. It's something we plan on monitoring.

Summary

In conclusion, Autodesk is a contender for the crown in the AI-driven design market, with the potential to revolutionize the architecture, engineering, construction, and manufacturing industries.

The company's robust revenue growth and strong profitability over the past five years demonstrate its solid platform, and with the company's increasing focus on generative design, we think the stock is set to soar on the back of continued profitable growth.

Despite potential competition from startups, the company's already-global reach and award-winning design stack should enable continued top line growth and deepen entrenchment of its products among professionals worldwide.

Taken together, the reasonable valuation makes Autodesk a compelling choice for investors looking for an under-explored AI winner with significant upside potential over the next few years.

We initiate coverage on ADSK with a "Strong Buy" rating.

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