Autodesk: Industry Standard For Over 30 Years

A theme that has done very well for investors is finding and investing in companies that produce "industry standard" digital tools.

Countless companies rely on these to get work done every day. Investing in them has proven out very well over the years. Take a look:

Adobe (ADBE) creates and sells industry standard tools in several digital creative industries, like Photoshop for digital photography, or Illustrator for digital art. It has annihilated the S&P 500 over the last 20 years, posting a 2,560% gain vs. the market's 350% return.

Or how about Synopsys (SNPS), a company that sells industry standard digital tools for semiconductor design? That stock has appreciated 1,311% since 2002, crushing the market.

Perhaps the granddaddy of all industry standard digital software, Microsoft (MSFT), has been no slouch, either. With its dominance in business operating systems and productivity software, its 849% return over the last 20 years has more than doubled the S&P 500.

Today's company fits right in with this theme. Autodesk (ADSK) creates tools that are THE standard in computer-aided design (CAD) for the architecture, construction, civil engineering, manufacturing, and media/entertainment industries.

Oh... and its stock performance fits nicely in this group as well. In fact, it LEADS this group! Autodesk is up over 2,615% since 2002.

Let's take a look...

Autodesk's Software Suite

Autodesk provides key design, test, and simulation tools for a number of industries.

The largest (60% of sales) is architecture, engineering, and construction (AEC). Here, the company's tools provide the core modeling solutions for building everything from houses to skyscrapers to bridges and dams.

Manufacturing is about 30% of sales. Autodesk's software solutions are used to plan out manufacturing strategies, assembly lines, product design, and much more. They also help connect the various parts of the manufacturing process together into one command-and-control system for operations.

Finally, about 10% of sales come from the media and entertainment space. You know how a lot of environments, objects, and even living things in movies and TV are not actually real nowadays? Well, Autodesk's software is what movie makers use to create these realistic, 3D digital models.

Traditionally, Autodesk has provided desktop-based software packages. AutoCAD and Revit are its main offerings for AEC. Maya (for movies) and 3ds Max (for gaming) cover the media and entertainment space. And a variety of tools are offered for manufacturing, collected into its Fusion 360 offering.

Up until recently, Autodesk has utilized a traditional "license-and-maintenance" model for its software sales. Customers would pay the company for a "perpetual license key" and ongoing maintenance contracts, allowing for minor software upgrades. To access major upgrades, a new license would be required.

While software has always been a high margin business, the license-and-maintenance model set up a very "lumpy" revenue graph. Firms - including Autodesk - would experience flattening or even declining growth in between major releases, with large sales increases after a major update.

Additionally, on-premises desktop software is a piracy-ridden model. License keys are stolen or programs are illegally patched to not require them. Autodesk estimated at one point that almost 12 million people were using pirated copies of its software. That's a lot of lost sales, considering the company is only reporting about 5 million subscribers at present!

In response, and following industry trends, Autodesk set off on a strategy to move its software to cloud-based subscriptions. Today, the transition is essentially complete - over 98% of sales are recurring revenue, 90% of it cloud subscriptions.

Just recently, the company announced a new product strategy. It appears to be based largely off of Salesforce's or Adobe's model of providing "clouds" targeted at certain customer cohorts. For Autodesk, the Forma Cloud will be for AEC customers, Fusion Cloud for the manufacturing space, and Flow Cloud for media and entertainment. The goal is to integrate all relevant tools for these different clients into one of these 3 clouds.

The Revenue Model

We covered a good bit of the revenue model above. With virtually all of the company's sales from subscription access or legacy maintenance contracts, sales are nearly 100% recurring. That's just what we want!

Now, let's turn to growth potential.

Since moving to a subscription based model about 6 years ago, Autodesk has delivered solid compound annual revenue growth of 19%. It has slowed to 16% over the past few years, and management expects a few more percentage points of weakness next year due to recession fears.

Still, there is plenty of room for Autodesk to maintain 10%+ growth rates for the foreseeable future. Management estimates a $62 billion addressable market at present, growing at 6% annually to reach $78 billion by 2026. That represents over 15 times the current revenue run rate of $5 billion.

AEC is still not a fully digitized industry. One growth driver for Autodesk is the growth of building information model, or BIM, across the industry. The BIM standard is that all physical assets must have corresponding realistic digital 3D models. Revit (a part of Forma Cloud) is the #1 BIM tool worldwide. As more and more countries move towards a BIM standard (most are less than 50% today), Autodesk will benefit.

Another part of the construction industry that has not been widely "digitally transformed" is the project management side. There are some nascent entrants in this space (Procore (PCOR) is one), but Autodesk's Construction Cloud offering has big potential here. It gives the various construction crews a way to communicate, share documents, plan schedules, and monitor worksites digitally, instead of through pen-and-paper solutions.

Add to these catalysts strong pricing power for subscription increases, and you have a recipe for satisfactory growth going forward.

Competitive Advantages

Autodesk benefits from two key long-term competitive advantages: HIGH SWITCHING COSTS and NETWORK EFFECTS.

Many architects, manufacturing engineers, and digital artists spend their entire days inside of Autodesk tooling. Learning basic skills in a complex CAD tool can take over 6 months, proficiency takes a year, and mastery 3 years or more. This isn't something anyone off the street can come in and learn quickly.

Combine that with the fact that Autodesk's tools are mission critical to their customer's projects, and you can see how strong its switching costs are! You can't just decide to replace AutoCAD or 3ds Max even if you wanted to... it would take your employees quite a long time to come up to productivity on a new tool, costing you a lot of business in the process.

Autodesk's net revenue retention is generally in the 110-115% range. This means that not only does it not lose customers, but customers increase their spend 10-15% annually.

This industry standard nature also leads to network effects. With their ubiquity (AutoCAD has nearly 4x the market share of its nearest competitor), the company's tools are used to train students in secondary and trade schools. Employers (the demand side of the network) standardize on Autodesk because the worker base is trained on it, and workers (the supply side) learn it because that is what employers want.

This is a hard cycle to break. Indeed, Autodesk tools have held their industry standard perch for many decades running now.

There are some competitors. Dassault's Solidworks and CATIA, and PTC's OnShape, among others, compete in various categories. In the wider CAD space, though, Autodesk dominates. It claims 5 of the top 7 programs in CAD software worldwide.

Management and Financials

The CEO is Andrew Anagnost, who was elevated to the top seat in June 2017. He's been with Autodesk for 25 years, serving in various roles including Chief Marketing Officer and SVP of Business Strategy & Marketing. It was in the latter role that he architected Autodesk's transition from a traditional software vendor to a SaaS model.

It is hard to complain about the firm's results under Anagnost. He has delivered compound annual revenue growth over 20%. Gross margins have increased over 500 basis points to 90%. Autodesk has moved from being cash flow negative in 2018 to generating a free cash margin over 37% last year. The cloud transition was bumpy, but has put the firm on very strong footing. Autodesk is generating cash flow margins comparable to companies like Adobe. That was achieved under Anagnost's leadership.

One thing that is a bit disappointing is insider ownership. Despite 25 years with the firm and 6 years as CEO, Anagnost still has a meager stake in the company. He owns just 50k shares, worth about $10 million. It would be nice to see a little more "skin in the game".

On the other hand, a strategy I like is Autodesk's willingness to buy back shares when the stock price is unusually low (like now). The company recently announced a $5 billion buyback plan. That amounts to 12% of market cap at current prices. This is a good use of cash flow for such an established firm, and certainly better than making a "transformative" acquisition that rarely works out.

In all, I feel comfortable that Autodesk is well-led, and the company's financial profile matches that of some of the strongest cloud software providers out there.

Risks

The primary client base for Autodesk are firms in architecture, construction, engineering, and manufacturing.

Consequently, these firms are particularly sensitive to economic downturns. Large construction projects are often put on hold when there are worries about the economy, and manufacturing slows down in these times as well. With a recession widely predicted in 2023, the potential for short-term revenue weakness exists. With a P/S ratio near 9, investors are still expecting good growth from Autodesk - a failure to deliver that will cause stock price declines.

All of the typical risks apply: global economic downswings or turmoil, ridiculous acquisitions, technological upheaval, competitive pressures, and so forth.

That said, the company has survived a number of these before and would likely survive any in the future. In the context of the entire stock universe, Autodesk is clearly a company with lower-than-average business risk.

Conclusion

Autodesk is a textbook "industry standard" digital tools provider, a cohort that has performed fabulously for investors in the past. It has all the earmarks we look for: recurring revenue, growth potential, strong competitive advantages, and proven leadership. It's also priced very attractively at present. We will "buy" immediately and add it to the Buy List!