Description

Pitch:

Autodesk (ADSK) is a compelling long because it is a best in class design software business with "must have" customer applications that is in the middle innings of a transition from perpetual license to recurring revenue subscription contracts.  Management is also opening up large new market opportunies in the Construction and Manufacturing industries that could further position the business for strong organic growth long term.  These newer markets have a tremendous opportunity for workflow improvement with the adoption of Autodesk software and tools.  You'll likely want to own ADSK well after the model conversion. 

Why now?  Autodesk trades at a discount to peers, and has an attractive valuation on full conversion FCF per share and could continue to have strong growth beyond 2023.  Execution the last 2 to 3 years has been strong, allowing investors to have greater confidence into management's long-term guidance presented at the FY18 analyst day.  There is potential that management's guide is too conservative if the economy remains resiliant. 

Reward/Risk:

Base case ADSK appears to trade at ~24x 14 month forward FCF and ~12.5x Jan 2023 FCF per share, but should trade for at least 21x in the out years and peers who are further along in the transition trade at 23-27x.  Using management's FY23 (Jan 23') FCF guidance of $2.4B on a slightly reduced share base from current levels due to repurchases along the way ADSK could earn $11.50 in recurring FCF per share on Jan 2023 and receive a 21x 12 month forward multiple at Jan 2022 creating 66% gross upside to ~$240 per share and an 18% IRR over 38 months.  It's worth noting that this only uses management's FCF guidance, which has proven conservative, historically.  In FY15 management was guiding FY20 FCF to be ~1B and at the recent investor day this is now 1.4B for 2020.  If management continues to execute against their plan and the economy is holding up well I believe the market may pull forward the return with a higher multiple as confidence in the plan increases. 

Upside case - FCF could exceed management's plan due to higher average revenue per subscriber, higher paying subscriber levels, and greater share count reduction along the way to result in $13.00 Jan 2023 FCF per share.  A 24x forward multiple, in-line with other best in class software applications who have transitioned their model like Adobe or Aspen Software, would yield a $312 target, 116% upside, and a 28% IRR. 

Bear case - management could miss their plan due to slower conversion of subs and lose some subs with a lower base of overall employment levels in their customer industries due to a recession.  In this scenario it's reasonable to assume ADSK may produce $9 of FCF per share in Jan 2023 and receive a 17x forward multiple for a $153 target creating 6% upside, and a 2% IRR over this time frame.  Considering the ample run-way ahead of them, unless the market is trading for 12x or something, 17x is likelyt too low and the co. would shift to far more share repurchases.  Importantly, I believe investors should frame the conversion of active legacy subs mostly as a "when" not "if" scenario given the mission critical nature of the software suites in their businesses.  This is before factoring in the pirating users outlined below, which is considerable upside.  

Since these numbers are far into the future it's worth noting the business is currently at a point in the transition phase where FCF production is set to explode.  On management #s FY Jan 2020 is expected to produce 1.4B in FCF or ~$6 per share.  Shares currently trade at ~24x 14 month forward FCF, which is lower to in-line with Adobe and Aspen yet ADSK has higher 2-3 year FCF growth than each of these and very attractive post conversion organic growth rates as well (ADBE / AZPN are near or already fully converted to the subscription model).  This is a great business and should trade at a significant premium to the market given the long-term growth profile and competitive advantages.    

Regarding management's guidance.  They describe it as a combination of organic and inorganic to get their however with the recent acquisition of PlanGrid set to close soon much of the inorganic activity is likely complete.   

Great business, irreplaceable products, high pricing power:

Autodesk is a global leader in design software applications and has been around for > 35 years with ~150 product offerings built organically and inorganically.  Its products are essential to the customer's workflow and often tie into shared workflows between customer, vendor, owner and other key consituents of the design and service ecosystem.  Much like other software suites that are this ingrained into the customer workflows Autodesk's products on average have tremendous pricing power.  They represent a very small part of the overall budget at less than 2.5% of the user's annual salary (2 or 1.5K subscription vs. 90K or 70K salary).  The implied ROI varies by industry and project, but it's safe to say that ADSK is likely pricing their product at fraction of the value it creates for the end user.  Much of the users have trained on the software since their college/graduate studies.  It's very difficult to swith to other vendors even if you wanted to go through the hassle of ensuring you knew the new software and had all of your old workflows properly sync'd into the new systems.  On top of this, the limited # of alternative prodviders who have good products already have higher effective pricing by 2 or 3x + versus Autodesk's current subscription pricing, based on some list price estimates, so I'm not sure the incentive is even there from a price perspective.         

Understanding the model transition and opportunity to convert users:

This is actually a pretty simply story.  The transition to subscription models from perpetual license has become relatively common in legacy software businesses.  Adobe, Aspen, Microsoft, and Cadence Design are good examples.  ADSK is converting the base to recurring revenue, raising the effective price through subscription, and controlling cost through a variety of initiatives so that revenue will expand dramatically while Opex grows much more slowly and FCF can be allocated to share acquisitions and share repurchases.  Sales of the perpetual licenses was discontinued in 2016.  Beginning in June 2017 an incentive program began to further transition maintence customers to subscriptions including better promotions that lock in pricing for a few years.  On certain promotions ADSK is also agreeing to not raise price till FY19/FY20 at which point annual price increases can go up between 0 and 20% per annum for the next few years, which gives management considerable room to hit their targets on these subs.  

Large opportunity to convert non-paying legacy users & pirated users:

ADSK currently has ~4MM active paying subscribers, but there are ~2MM estimated active users ("legacy") who are not paying for ongoing maintenance on top of the original license they purchased.  About 1.2MM of these are using the last 5 releases of ADSK software and an estimated 0.8MM are using software that are 6 releases back, or older.  In addition, the company estimates there are 12MM non-paying users worldwide with 4MM of these in mature markets that are considerated pirated versions of the software.  

To believe management's #s for FY2023 one has to assume all of these 2MM active but non-paying subscribers on the legacy perpetual become subscription license paying due to various feature sunsetting, compatability interferance, access to support, and other "conversion tools" ADSK will roll-out to create conversion along with a 4% CAGR in the underlying base to arrive at the 7MM paying subsribers in their 2023 guidance (before the acquisition of PlanGrid).  Or, one can assume 50% of the 2MM converts and 1MM of the pirates etc plus a 4% CAGR in the underlying brand new users base.  Since it's very hard to pirate cloud software there is also a % of new subs each year who came in through the pirated software route that will have a harder time as the pirated software becomes less up to date.    

Management is doing things to help alert the pirating or non-valid users that they have not paid, nor certified the software for genuine use (various on screen alerts while using plus many other techniques longer term etc.)  In addition, it simply won't function that well as the years go by.  They are being very prudent in the management of this non-valid user conversion because they don't want to immediately cut these users off and disrupt workflow, but they want to increasingly "bump" them into becoming paying subs.  Management has commented that at least 1MM of the 12MM in the "pirate" bucket actually sit inside large clients, so, they think that these may be legit cases of "we didn't know" users whereas the rest of the base may be true pirates.  They addressed this at a recent conference. 

Given the large number of active users who are not paying for maintenace, and large number of users who have been active in the past and may be on pirated software, it's not hard to see how at 2023 and well beyond 2023 there is ample room for ADSK to grow the paying subscriber base.  I think this is an underappreciated dynamic along with the underlying market growth for their products.        

ADSK markets are CAGR'ing at 8% out to 2020E:

In addition to managments effort to convert the sub base ADSK has a tailwind from its markets growing at GDP plus plus like rates due to increasing usage of their software and digitized workflows in new and established settings.  Management has further bolstered it's positioning via acquistions in Construction such as PlanGrid which is expected to close in the next few months that help increase the TAM by an additional 10B.  Construction represents one of the least digitized fields in the market and productivity is set to increase dramatically as a result of these initiatives.  

Conclusion:

Very high quality business.  High pricing power they are starting to realize.  Conversion to subscription creates resiliant pro-forma model.  FCF generation from capital light model allows for significant share repurchases or acquisitions long-term.  Could run with more leverage post conversion.  Early days in the construction and manufacturing markets + good adoption in legacy markets for Autodesk Cloud software creates strong organic growth run-way post sub base conversion in 2023.     

Disclosure:

We and our affiliates are long Autodesk (ADSK) and may buy additional shares or sell some or all of our securities at any time.  We have no obligation to inform anybody of any changes in our views of ADSK.  This is not a recommendation to buy or sell securities.  Our research should not be taken for certainty.  Please conduct your own research and reach your own conclusion.  

Catalyst

Achieving guidance and showing the market ample run-way for growth in the out years.