Autodesk Designs for the Future

Autodesk's transition to a subscription business model remains largely on track, although its financial performance remains hard to determine, given the many puts and takes between perpetual licenses and subscriptions, along with an array of timing differences related to when subscriptions will be enforced between products. Autodesk will host an investor day next month, and we hope to hear a more refined transition plan then. For now, we reiterate our $60 fair value estimate and wide economic moat rating. We think Autodesk looks moderately undervalued and would recommend the stock to investors willing to accept lumpy midterm financial performance as the firm transitions to a ratable revenue model.

For the quarter, revenue fell 4% to $610 million year over year (flat in constant currency). In the architecture, engineering, and construction segments, building information modeling and commercial construction helped fuel 7% revenue growth. In manufacturing, the automotive sector drove modest revenue growth, with Delcam helping to solidify Autodesk's increasing presence in the industry. From a geographical standpoint, Japan continues to weigh on the company's results, and we do not see this reversing any time soon. Non-GAAP operating margins were depressed, a trend we expect to remain over the short term, given the business model transition.

Market Leader for the Long Term Autodesk is positioning itself to protect and extend its market leadership in computer-aided design. We believe the firm will remain a market leader over the long term, given its commitment to evolve to changing market trends, and its recent investments in mobile, social, suites, and cloud technology exemplify this. Autodesk also aims to expand into adjacent markets such as product lifecycle management and simulation and increase its presence in the underpenetrated government and construction sectors. As a result of its strong position and encouraging growth trends, we forecast healthy low-double-digit revenue growth.

We believe Autodesk's long-term growth depends on its ability to provide more value per customer and attract subscribers to its platforms. It has moved aggressively into the mobile and social markets through acquisitions like Socialcam, Instructables, and Pixlr. In addition, it has been an early mover into the cloud market, relative to close competitors, through its Autodesk 360 platform. The company's key growth enablers will include desktop rental, cloud services, and consumption-based pricing models. Given the premium placed on agility and the use of all-digital processes, we expect Autodesk's products to resonate well with current and future clients. Key growth segments will include simulation, consumers, and PLM. In these segments, we think Autodesk has the opportunity to disrupt incumbents with its relatively cheap and easily deployable products such as Sim 360 and PLM 360. With management's new onus on driving recurring revenue, it expects 70% of group revenue to be recurring by fiscal 2018 (from about 40% today). Financially, the recurring revenue model is attractive, as it provides more long-term revenue, financial predictability, and flexibility.

By fiscal 2018, management expects billings to grow 12% on average per year, customer value to rise 20%, subscribers to increase 50%, and non-GAAP operating margins to reach more than 30% (from about 25% today). We believe these expectations are attainable and think the company's early adoption of mobile, social, and cloud technology has positioned it aptly.

Switching Costs Are High Autodesk's wide economic moat stems from its customers' high switching costs and a large network of users. We believe the company's clients are averse to switching because of the time it takes to learn a new platform, the downtime risk to current operations, and the monetary cost associated with implementing a new CAD solution. Furthermore, Autodesk has developed a very large customer base over the past 30 years that is unlikely to deteriorate, given the aforementioned switching costs. This large network is expected to sustain Autodesk's competitive advantage over the long term. In addition, the firm actively provides educational institutions and instructors with its software, so future users are trained on its tools at an early stage. In fact, the company sponsors high school programs that combine Autodesk's 3-D animation and visual effects tools with math, science, and arts courses. This grassroots approach reinforces the company's long-term relevance and appeal in the CAD industry.

Entering New Markets Could Be Difficult While Autodesk is well positioned in the CAD industry, it does face risks. Even though the company's move into adjacent markets presents a growth opportunity, breaking into the simulation and PLM markets may be difficult. The barriers that keep others from entering Autodesk's traditional markets, such as architecture, engineering, and construction, may also prevent the firm from gaining meaningful share. For example, the dominant simulation provider, Ansys ANSS, is likely to offer stiff competition. Meanwhile, PLM providers like Dassault DASTY, SAP SAP, IBM IBM, and Siemens SIEGY will provide fierce competition, too. Consolidation among its value-added resellers is another trend that could negatively affect Autodesk even though it is moving increasingly to a direct distribution model. To highlight this, Tech Data, the firm's largest distributor, acquired Mensch und Maschine, Autodesk's largest distributor in Europe/Middle East/Africa. Such a move could lead to greater bargaining power for Autodesk's distributors and create a situation where it becomes increasingly reliant on a few large distributors to generate revenue. Lastly, perceived or actual technical issues with products may damage Autodesk's reputation. Maintaining a trusted brand is vital to the company's commercial success.

Acquisitions Boost Portfolio During fiscal 2013, Autodesk issued $750 million of debt in order to boost its U.S. cash balance, since the majority (80%-85%) of its cash is offshore. The funds will be used to pay off the company's existing lines of credit (approximately $100 million), provide the firm with further flexibility for future bolt-on acquisitions, and support share buybacks. Autodesk's share-buyback program is used to return excess cash to stockholders and offset option dilution. However, the company pays no dividend and does not expect to pay one in the foreseeable future.

When compelling opportunities present themselves, Autodesk will pursue acquisitions of products, technology, and businesses. Acquisitions are made to strengthen or expand the company's broad portfolio of software and service offerings, which entrenches its position in the market. Recent acquisitions such as Firehole Composites, Tinker CAD, Delcam, and Creative Market exemplify this. Although the desktop PC market remains an important part of the business, Autodesk will continue to invest capital toward cloud, mobile, and social computing. Significant resources are being allocated toward these growth areas as the company aims to lead the industry transition. The development of this business is expected to be an important growth driver into the future, and we believe it will cement Autodesk's market-leading position for many years to come.