ADSK - Autodesk: Too Messy In The Current Environment

2024-01-08 15:37:21 ET

Summary

• Autodesk's main product, AutoCAD, is the industry standard for design and visualization software in architecture and engineering professions.
• Autodesk's capital allocation policies and lack of clarity have been significant frustrations for investors.
• Autodesk has significant competitive advantages, but notable stock-based compensation expense and an uninteresting valuation.

Autodesk ( ADSK ) has many marks of a great business. AutoCAD is the industry standard for design, drafting, detailing and visualization software for architects and a variety of engineering professions.

Infrastructure spending should be a perpetual tailwind for Autodesk. Global Infrastructure Outlook estimates more than $2.5T is invested in global infrastructure each year . As long as the global economy continues to grow, the need for new and updated infrastructure will persist.

AutoCAD has benefited from macro growth since its release in 1982, for reference, that makes it a few years older than Microsoft ( MSFT ) Windows.

While competition exists in one form or another in every industry, AutoCAD has no serious threat for its largest, most professional customers. AutoCAD costs $1,975 per year, per user, which optically appears to be a very small tax on firms. Naturally, smaller customers with more shoestring budgets might opt for cheaper software. BricsCAD has been mentioned as a potential alternative to AutoCAD, it costs about $1,600 per year. 3rd party market share tracker sites aren't always very accurate, but they should be in the ballpark. This one pegs BricsCAD's market share in computer-aided design as basically non-existent relative to AutoCAD. This likely accurately reflects market conditions.

Autodesk has a few other interesting businesses. Additional products in the core architecture, engineering and construction segment include Revit, a 3-D modeling software that is often used in conjunction with AutoCAD's 2-D modeling. Also Autodesk Build, which competes with Procore Technologies ( PCOR ) in construction management. Other Autodesk segments also include manufacturing, highlighted by Fusion 360, a manufacturing design tool. Autodesk also has a media and entertainment segment, highlighted by Maya, a visual effects software.

Capital Allocation:

Over longer term time horizons, Autodesk has beaten the market, but not over the past 5 years. The stock has remained rangebound over the past several years:

Investors seem to have expressed a great deal of frustration with Autodesk's management and what I think is a lack of clarity surrounding capital allocation policies :

Turning to capital allocation. We continue to actively manage capital within our framework. Our strategy is underpinned by disciplined and focused capital deployment through the economic cycle. We remain vigilant during this period of macroeconomic uncertainty.

As you heard from Andrew, we continue to invest organically and through acquisitions in our capabilities and services and the cloud and platform services that underpin them. We purchased approximately 500,000 shares for $112 million, at an average price of approximately $206 per share. We will continue to offset dilution from our stock-based compensation program to opportunistically accelerate repurchases when it makes sense to do so.

There's really no clear framework for how Autodesk deploys capital in my view. Autodesk's management also purports to manage the business to the arbitrary Rule-of-40, which indicates revenue growth plus free cash flow margin should be greater than 40. Revenue growth is an extremely poor metric to assess the quality of any business. As management mentioned above, they plan to invest via acquisitions, an accelerant of growth rates that could not be adding value.

Autodesk's free cash flow includes significant stock-based compensation. It's difficult to pin excessive stock-based compensation expense on management, as it's prevalent throughout the software industry. But it has a significant impact on the tangible value being created for shareholders. Autodesk has incurred $544M of stock-based compensation year-to-date, this is a run-rate of $725M, this makes a huge difference in value accretion.

Off-setting dilution is a fairly arbitrary policy as well. And all of the free cash flow spent off-setting dilution is free cash flow that's not accruing to shareholders.

Valuation:

Businesses with competitive advantages as strong as Autodesk, but questionable capital allocation polices are difficult to value. Discount rates and exit multiples are affected by how durable a business is. If a business is built to last, it will eventually return all of its free cash flow and more. There are no imminent barriers to Autodesk's growth, thus it should demand a premium.

Historically, Autodesk's business has been affected by the cyclical construction market. The hope is moving to a SaaS model should smooth the curves out, though we haven't really experienced a significant construction downturn since this transition has occurred, so that remains to be seen. This could cause negative pressure on the multiple.

The midpoint of Autodesk's free cash flow guidance for this fiscal year is $1.23B. At the current run-rate, and as mentioned $725M is in the form of stock-based compensation. As the business transitions to multi-year billings, the approximately 40% drop in free cash flow was expected this year, but they expect to return to 35% free cash flow margins in the next 5 years. Given the business is using a good portion of that free cash flow just to offset dilution, that should be considered in its valuation.

If investors expect interest rates to remain stable and remove stock-based compensation from free cash flow, margins drop closer to 25%. At a 25x exit multiple, in-line with where 10-year treasury yields are at and where other durable businesses trade at, Autodesk would return mid-single digits at the current share price. There's excitement in the space after the rumored takeout of Ansys ( ANSS ). Ansys already trades at a large premium to Autodesk, this frankly feels quite excessive.

If we don't factor in stock-based compensation, or we accept a higher multiple, the model can be stretched to get a low double-digit return. With the amount of noise in the numbers and lack of clarity in communication, Autodesk is a tough one to own in the current environment.

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