2023-06-21 04:25:20 ET
Summary
- Altair Engineering's business model is poised for growth due to the adoption of AI technologies, but the stock price's upside potential is limited.
- ALTR faces risks from competitors, M&A, and a potential slowdown in customer and partnership growth.
- Two case scenarios show a fair price range between $58 and $85 per share, making it less attractive for investment at the current price.
Altair Engineering Inc. ( ALTR ) recently reported an interesting survey about the adoption of AI technologies, so I continue to believe that the business model is poised for further growth. Having said so, I am a bit less optimistic about the current stock price mainly because some guidance figures deteriorated. Using two case scenarios, I obtained results showing that the upside potential does not appear as large as in my last article. Considering the M&A risks and risks from competitors, less partnerships, and customer growth, I would not be buying at this point in time.
Altair Engineering
Altair Engineering is an internationally positioned company dedicated to computer science and artificial intelligence, offering its clients a service of high technological value that allows decisions to be made based on a large amount of collected data and information. The company's services are provided through software and cloud solutions in the area of ??simulations, high performance computing, data analysis, and artificial intelligence.
With regard to artificial intelligence, the integration of this type of technology into the company's previous infrastructure is what makes the difference in this regard. The integration of artificial intelligence into the previous programs allows an expansion of productive capacities, a greater flow of data interpretation, and optimizations in the order of information processing through machine learning programs developed by the company itself.
These artificial intelligence programs play a fundamental role since they allow the company to expand the portfolio of offers to its clients and delve into the effectiveness of the service and the knowledge to carry it out. The company, which has been present in the computational solution for almost 40 years, has managed, through the integration of artificial intelligence, to offer high-standard design services that include the simulation of thermal and electromagnetic fluids, structures, and system modeling.
Currently, its operations are divided into two segments: software and customer engineering. The first of these segments include all the products in the company's portfolio, marketed through annual subscription licenses. The second segment refers to specific and customized services to provide support, advice, training, and technical services to its customers.
Statistics show that 39% of billings were made to companies in the automotive and aerospace industries, including in both cases 10 of the leading companies in each sector.
Other markets to which the company's clients belong are energy, rail and ship design, government institutions, and life or earth sciences. In recent years, the trend shows that between 30% and 40% of sales were made to companies in the United States. No client represented more than 2% of sales for the year 2022, demonstrating the diversification that Altair has in this regard.
One last comment in this section is to emphasize that although the contracts are not long-term, and there are no commercial renewal obligations, the company, through its artificial intelligence services and innovations, manages to become part of the production and operational chains of its clients. This means that the continuity of the service in most cases is ensured by this trend.
Guidance Included More 2023 Net Losses
Even if we assume that the current valuation may fail to represent the true value of Altair, in my opinion, it is worth noting that the numbers reported in Q1 2023 were beneficial. Management noted that the figures reported exceeded largely the expectations of the company. As shown in the lines below, the company sees a continuation of the momentum seen in 2022.
Q1 exceeded our expectations and represents an all-time high for revenue to continue our good momentum from 2022. Demand for our products continues to be strong and we're seeing the investments we've made in product development and our approach to our customers' success paying off. Source: Quarterly Press Release
I believe that the guidance given for the full year 2023 continues to be optimistic, however, I did not really see new improvements as compared to my previous post about Altair. I believe that the net income expectations were lowered in this new quarter.
Altair believes that for full year 2023, it could deliver total sales close to $614 million-$624 million and a net loss of about -$19 million and -$10 million. With that about the net losses, management expects to deliver 2023 EBITDA of $120-$130 million and FCF of $108-$116. These numbers were approximately the same reported in the last report.
Source: Quarterly Release
If we look at the numbers expected by other market analysts, we can see a decline in the 2025 EBITDA expectations and 2025 FCF. Market analysts expect 2025 net sales close to $731 million, with 2025 EBITDA of $188 million, 2025 operating profit of $181 million, and 2025 operating margin close to 24.7%. Also, with a net income of $23 million, 2025 free cash flow would be close to $173 million, and the FCF / Sales ratio would stand at 23%.
Considering that the expectations from both management and market analysts deteriorated, it appears interesting that the stock price increased as compared to the price market reported a few months ago.
Liquidity Is Not An Issue
As of March 31, 2023, the company reported cash and cash equivalents worth $378 million , accounts receivable of about $130 million, and total current assets close to $548 million. Current assets stand at a level that is significantly higher than the total amount of current liabilities. Liquidity will most likely not be a problem for Altair.
The company also reported property and equipment worth $38 million, with operating lease rights of use assets of about $33 million, goodwill worth $451 million, and total assets of close to $1.226 billion.
Source: 10-Q
Under the list of liabilities, I found accrued compensation and benefits worth $30 million, the current portion of operating lease liabilities of $9 million, and deferred revenue of $114 million. Management also reported 2024 convertible senior notes close to $81 million, deferred revenue non-current of $27 million, 2027 convertible senior notes of about $225 million, and total liabilities of about $619 million.
Source: 10-Q
DCF Model Under A Bearish Case Scenario
Under my bearish case scenario, I assumed that failed pricing strategies and failed business growth may lead to lower net sales growth than expected. As a result, I believe that investors may sell shares, and the cost of capital could increase. In sum, I would expect a lower fair price.
Our revenue growth could decline over time as a result of a number of factors, including increasing competition from smaller entities and well-established, larger organizations, limited ability to, or our decision not to, increase pricing, contraction of our overall market, the manner in which the markets for our products, including our data analytics products, evolve or our failure to capitalize on growth opportunities. Source: 10-k
There are many competitors out there with a lot of financial resources, including IBM (IBM), Dassault Systèmes (DASTY), Siemens (SIEGY), Ansys (ANSS), and Alteryx (AYX). There are also a significant number of competitors, which may offer their own systems, and may affect the FCF margin reported by Altair. In the worst-case scenario, lower free cash flow would lead to lower stock valuation.
We may also face competition from participants in adjacent markets, including two-dimensional, or 2D, and three-dimensional, or 3D, CAD, and broader PLM competitors and others that may enter our markets by leveraging related technologies and partnering with or acquiring other companies. Source: 10-k
I also assumed that the number of users may not grow as expected, and management may not be able to find new partners, which would most likely limit the ability to bring further net sales. Altair talked about its partners, user growth, and risks related in the last annual report.
If we fail to increase the number of customers or users and/or application usage among existing users of our software and the software of our APA partners, our ability to license additional software will be adversely affected, which would harm our operating results and financial condition. Source: 10-k
Considering the total amount of goodwill, I also took into account that some of the mergers signed recently would not work as expected. As a result, goodwill impairments may lead to lower book value per share. In the worst case scenario, I believe that investors may expect lower future net sales growth than expected, which may affect the fair price.
Under the previous conditions, I included 2033 net loss of -$219 million, 2033 depreciation and amortization worth $107 million, stock-based compensation expense of about $449 million, expense on the repurchase of convertible senior notes worth $123 million, changes in accounts receivable of -$175 million, changes in prepaid expenses and other current assets close to $34 million, and changes in accounts payable of $43 million.
Finally, with changes in other accrued expenses and current liabilities of about -$480 million and a change in deferred revenue of $247 million, 2033 CFO would be close to $68 million.
If we also assume 2033 capital expenditures of -$30 million, 2033 FCF would be close to $39 million. With an EV/ FCF of 250x and a WACC of 7.5%, the implied enterprise value would be $4.648 billion. If we add cash and cash equivalents worth $378 million, and subtract 2024 convertible senior notes of about $81 million and 2027 convertible senior notes of $225 million, equity value would be $4.721 billion. Finally, the implied price would stand at about $58 per share.
DCF Model Under A Beneficial Case Scenario
In my view, if the company really becomes part of the basic operating infrastructure of its clients, in my opinion, many clients will remain with Altari in the future. Under this scenario, I also assumed that the exponential application of technologies related to artificial intelligence and the great transformations that it may generate in the commercial, financial, and labor markets will most likely bring further net sales growth in the coming years. Considering the expectations about future global artificial intelligence market growth, I believe that Altair could benefit significantly from the target market growth.
The global artificial intelligence market size was valued at USD 136.55 billion in 2022 and is projected to expand at a compound annual growth rate of 37.3% from 2023 to 2030. Source: Artificial Intelligence Market Size & Share Analysis Report 2030
In addition, under this case scenario, I assumed a successful acquisition strategy mainly because management showed many acquisitions in the past. These were 48 acquisitions since 1996, 23 of them in the last five years alone. Only during 2022, Altair acquired RapidMiner, Cassini, PowerSim, Gen3D, and Concept Engineering, all companies in the industry 4.0 sector, being able to expand its services, its knowledge of technological processes, and cloud storage services. I assumed that the know-how acquired from these companies will likely bring future net sales growth.
Finally, under this case scenario, I would also be optimistic about the future adoption of new emerging AI strategies. In my view, if clients continue to adopt higher levels of AI strategies in their organization, even organizational, technological, and financial frictions may not represent a large problem. In this regard, I would invite readers to have a look at the recent adoption rates described by Altair.
Altair released results from an international survey which revealed high rates of adoption and implementation of organizational data and AI strategies globally. The survey also revealed that project successes suffer due to three main types of friction: organizational, technological, and financial. Source: Altair Global Survey Reveals Significant Opportunities to Improve Efficiency, Scale, and Success of Enterprise AI and Data Projects
Under the previous assumptions, I included 2033 net loss of -$200 million, 2033 depreciation and amortization of $108 million, and stock-based compensation expense of $452 million. Also, with deferred income taxes close to $18 million, 2033 expense on repurchase of convertible senior notes worth $124 million, and changes in accounts receivable close to -$172 million, prepaid expenses and other current assets would be $33 million.
Now, with changes in accounts payable worth $42 million, 2033 accrued compensation and benefits of -$20 million, and changes in other accrued expenses and current liabilities of about -$452 million, the net cash provided by operating activities would be $72 million.
I also assumed 2033 capital expenditures of about -$30 million, 2033 FCF of $43 million, and an exit multiple of EV/ 2033 FCF of 260x. My results included 2033 terminal FCF of $11.203 billion, and with an optimistic WACC of 5% million, the implied enterprise value would be $6.787 billion. Adding cash and cash equivalents of about $378 million, and subtracting 2024 convertible senior notes of $81 million and 2027 convertible senior notes close to $225 million, the implied equity value would be $6.859 million, and the fair price would stand at $85 per share.
Other Risks
First, in terms of business, Altair has experienced steady annual earnings growth in recent years, and there is no assurance that this growth will continue at the same level. In addition, the inability to attract new customers or innovate in its services mean a possible risk for Altair.
To this we can add the difficulty to project future statistics due to the length of the sales cycles in this type of services and the percentage net sales to the automotive sector. A drop in the generation of this sector would logically be a drop in the company's income.
Besides, I do believe that the company is heavily dependent on hiring high-level professionals and maintaining a work team that has extensive experience in the sector as well as a capacity for innovation and improvement. If Altair cannot hire at competitive prices, I believe that FCF margins would most likely not grow.
Conclusion
Altair engineering continues to see adoption of AI technologies, even though there are certain organizational, technological, and financial frictions. I am quite optimistic about the business model, however I did not really see that the upside potential in the stock price is that large. Like other analysts, I lowered my expectations about the future a bit, so I cannot maintain the buying attitude that I had in my previous article. M&A risks, competitors, or risks about lower net sales growth from lower user growth are my largest concerns.
For further details see:
Altair Engineering: Optimistic AI Adoption, But Less Optimistic About Valuation