Chit Chat Stocks - Bentley Systems (Ticker: BSY) Not So Deep Dive

Episode Date: November 15, 2022

Bentley Systems provides infrastructure engineering software solutions across the globe. For those of us that may not be engineers, the company's software provides solutions for buildings that are stationary. At the end of the month, we will publish an Arch Capital episode that will cover the company: Autodesk. Listen closely as Brett and Ryan go through the history, financials, and future prospects of Bentley Systems. Enjoy the show! ****************************** Interested in becoming a member of 7investing? Subscribe with code “MONEY” and get $100 off your annual subscription for life: https://7investing.com/checkout/ ****************************** Subscribe to our Substack to receive free show notes and charts that go along with every episode: https://chitchatmoney.substack.com/ Want updates on future shows and projects? Follow us on Twitter: https://twitter.com/chitchatmoney Contact us: [e-mail] Timestamps Company Background | (3:53) Industry | (10:36) Management & Ownership | (14:06) Earnings | (19:23)  Balance Sheet | (22:37) Valuation | (25:18) Our Analysis | (26:27) Disclosure: Chit Chat Money hosts and guests are not financial advisors, and nothing they say on this show is formal advice or a recommendation. Brett Schafer and Ryan Henderson are general partners and portfolio managers at Arch Capital. Arch Capital and its partners may hold securities discussed on this show. Learn more about your ad choices. Visit megaphone.fm/adchoices

Welcome to Chit Chat Money. On this show, hosts Ryan Henderson and Brett Schaefer interview industry experts and riff on the world of investing. As a quick reminder, Chit Chat Money is a CCM Media Group podcast. Ryan and Brett are also general partners at Arch Capital, and Arch Capital may have positions in the securities discussed in this podcast. Anything discussed on Chit Chat Money by Ryan or Brett or any other podcast guests is not formal advice or a recommendation. Now, please enjoy this episode. Welcome in. This is the Tuesday Not-So-Deep-Dive episode on Chit Chat Money. We should start saying this. My name is Brett Schaefer. I'm here along with Ryan Henderson,

the two hosts of the show. And today we're going to be talking Bentley Systems, continuing with our engineering software theme for the month of November. Previously, if you want to look at other engineering software companies, we covered Dassault Systems. and Ansys. And then upcoming, we're going to be covering Procore, which sort of engineering software, but more construction overlaps with some of the competition here. And then PTC and then Autodesk to finish out the month. It's going to be a great month for us. Second, if you're listening to this, make sure to subscribe to our free newsletter to go along with every Not So Deep Dive episode. The link will be in the show notes. It is on Substack, our Chit Chat Money

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If you don't always want to listen to these shows and you want to just read about them or you want to look at both, it's really good. And we also do a weekly recap to get everything we do on the episode. Because we know everyone doesn't listen to every show we do. If you want that recap in your inbox every Sunday, that's what you'll also get. All right. We're talking Bentley Systems. But first, let's talk about our presenting sponsor through the end of 2022.

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and even if you don't know even if you know that you're not going to sign up today we'd recommend checking out the site and just perusing they got a lot of free stuff that people can check out all right let's talk bentley systems uh that's the theme of this week's episode or the stock for this week's episode and it is infrastructure software so ryan why don't you kick it off another complicated and uh they got a lot of products let's just say that yeah you're right they do have a lot of products but to kind of consolidate it into a statement they are a leading global provider of infrastructure software so and i know that probably sounds if you've listened to the past two episodes that probably sounds quite similar to the other businesses but this is more

so ansys was really simulation you're trying to um see how a product would interact in the real world autodesk or not autodesk sorry uh to sew was really product modeling um and yeah computer design which bentley does but the so is more for manufacturers so i think aerospace and automotive has two basic examples and bentley is more infrastructure which will be civil engineers think things that transportation yeah transportation bridges structures yeah and the way even the cto described it in his interview it's stationary objects uh things well it's often really large uh infrastructure projects but they're stationary occasionally they'll have something like a big shipbuilder or something that will move but most of them are these infrastructure projects and so

the service they service fields like civil and structural engineers geoprofessionals plant engineering practitioners there's a couple of uh there's a couple of occupations i didn't know exist that they service um and then even the owners of the actual infrastructure assets so it goes beyond just the modeling of a lot of these projects and actually in some cases monitoring or examining the production of those assets as well. And the products spend, as I mentioned, a life cycle from design to construction, even the asset management side. And they group these into, I guess, three markets or three categories, and they're three

categories based on their end market. So the first one is public works slash utilities. So on the public works side, Bentley Solutions target end markets such as roads, railways, airports, wastewater networks. And on the utilities, you can probably guess they cover electric, gas, water, and even communication. So like cell towers and stuff like that. And then the second category that's industrial slash resources. So this includes like power generation, water treatment plants, oil and gas, mining facilities, offshore projects. I'm going to use the offshore one as an example. Let's think if you're modeling an offshore wind

farm. We recently had an interview with Bob Robati where he talked about Sub-C7, which is basically an offshore energy company that has wind farms. They probably use one of Bentley's different products. And so if you're modeling that offshore wind farm, you're going to need to analyze and simulate the structural performance of that project. And that includes things like the subsurface conditions, simulating water pressure, And eventually monitoring the energy production from that site. All those processes are doable within one of Bentley's offerings. Now, there are a lot of unique offerings.

So you can bundle or you can get discounted bundle when you already have one product. But you typically subscribe to an individual product and then maybe they're able to cross sell. Last segment is just commercial slash facilities. These are pretty basic. It's a commercial building. So office buildings, hospitals, school campuses, stuff like that. And they sell all the products in a couple of different ways. So they have term licenses.

So think if you're tasked with building a certain project, you might only need access to the software for a certain amount of time. So it's a duration-based project. You might subscribe to the term license. Then there's also perpetual licenses for companies who use these products day in and day out. And then they have what they call E365. I thought this was pretty interesting. with e365 subscribers get unrestricted access to all of bentley's software portfolio but they're

charged based on daily usage so it's a usage based model anyone in the unlimited user access and then they audit usage i think on a quarterly or annual basis to kind of make sure everything is in line with spending yeah and there's there's usage floors so like they have to pay a certain amount out but um it's it's kind of just a nicer way uh to really pay for what you're actually using. Especially for a large enterprise. Yeah. And then as far as history goes, there really wasn't a whole lot. It's been privately held for a long time. So not a whole lot of public information. The Bentley brothers are the founders. There's five of them. They founded the company in 1984. One brother ended up coming on later. And he's actually the CEO. So I'll talk about him

later. Yeah. They all had skills that I thought really complemented each other. There was a mechanical, chemical, and electrical engineer. Those were three of the brothers. And some of them could also, they had the software development skills to kind of build the product initially. And at the start, it was basically just simple CAD software.

And it was marketed through the name Intergraph Corp. Apparently they had some partnership with this Intergraph company. Eventually they ended up coming out of it and being able to market it as their own product. and i'm i recommend trying to read stories on them i was digging through a bunch of philadelphia small business journals um from like 10 years ago trying to get stories on these guys but a lot of them differed so um really it looks like they just steadily compounded throughout the 90s and

the 2000s and kind of grew at a healthy rate but it was never like ridiculous growth um and it wasn't until 2020 that they actually came public. So literally two years ago now. And we'll talk a little bit about the IPO and some of the transactions because I found something interesting in there, but really it's today, it's a billion dollar roughly annual revenue business. Fairly high margin, lots of employees. In 2016, Siemens, which is actually a competitor in some ways, i'm not mistaken yeah they're uh they're another they're crazy that's not a crazy conglomerate but they're conglomerate so they got their they got a ton of different products yeah they they acquired or invested into uh bentley systems and they still hold that stake today which brett will probably

talk about and they actually thought about acquiring them at one point there were rumors that siemens was going to acquire them but that still hasn't happened the stock is still up since ipo uh i think a lot of the 2020 ipos cannot say the same so good for uh good for bentley systems um that's uh i hope hopefully that covers enough of the business and the history yep all hit industry competition um these ones will all be similar for the engineering software month because a lot of the times we're looking at the competitors here but they focus on infrastructure so civil engineering plus some of those other ones that ryan mentioned is the main thing so uh bentley is say just to make it simpler say civil engineering and then if you're looking

at just so or ansys that would be more mechanical and electrical engineers however the two will overlap um and then there's also products for digital twins and then basic construction which will all overlap into general engineering and construction software again they all mix together it's kind of hard to understand uh so i guess just inverting it i think it was interesting to maybe asked the question for bentley is which do they which parts of the engineering market do they not have much exposure to and i think if we look back at the previous companies we looked at the two places they don't have that much exposure are simulation and manufacturing those are dominated by to sew and ansys and a little bit of autodesk but and of course bentley has some products for

those areas but they're they have way less market share than their core infrastructure products now When we're looking at their, Bentley's areas, infrastructure, construction, and some of those other smaller ones, it was really hard to find a total addressable market. But the global engineering software market is expected to grow by around 10% a year for the foreseeable future. And I think digital twins are expected to grow by 40% a year, that is 4-0, 40% a year. Again, always safe to do common sense analysis here of those estimates, because those projections are really hard to to make. And a lot of the times they can be wrong. But I think in this case, it makes sense. If you look at Bentley's historical growth rate, they, I believe, talked about in the annual report

how they've grown by 8% a year since something like 2001. So that's on a revenue perspective. So I think that makes sense. And then if we're looking at the digital twins, which we'll talk about in the future growth opportunities, hopefully that can keep, maybe possibly accelerate the revenue growth in the future. Now, lastly, if we look at competitors, The biggest one would be Autodesk. They overlap in civil engineering and construction management. There's also Hexagon, Trimble, Dassault with a little bit of their products. Even Oracle was mentioned.

These are all companies specifically mentioned in their annual report. If you really want to dive deep on there, they do list out explicitly the company's names. You can look at all the different products, but it's quite confusing because all of these companies have dozens of products. So mixing and matching can take a few hours. um in at least from looking at their report they have they have a good report on their ir website that basically says like what are we kind of thing and they say for the majority of their end markets

they are the the leader in terms of market share however there are a couple that uh and i want to be this big of a business if it weren't but there are a couple where autodesk or some niche players are the leaders yeah and that's kind of a self-fulfilling prophecy because they're going to focus on the ones they are the leaders in um and i'm one in uh and yeah so bentley has a ton of different products again the main competitor is going to be autodesk we'll probably look at them when we cover autodesk in a little bit of the light of comparing them to bentley and who maybe has a better competitive uh positioning within the infrastructure market uh but yeah bentley doesn't you know the leader in the space number one in infrastructure similar to how ansys

was number one in simulation. Let's move to management and ownership. Bentley Systems was founded by the Bentley brothers, like Ryan mentioned, and they're still family run and controlled today. So they have a dual class share structure. They have full control of the business. In the newsletter, you'll be able to look at the ownership table that we have out here. If we look at the, say, this kind of encapsulates, pretty much encapsulates the family ownership. All executive officers and directors of the board have 57.5% voting power as of the proxy statement. So full control by the insiders here. Now, the CEO is Greg Bentley. He's one of the brothers. He actually wasn't the founder, but he joined them in 1991. He's also the chairperson of the board.

The CTO that Ryan mentioned is Keith Bentley. He is one of the founders and the principal architect for the company, Software. He is running the technology strategy for this business. We'll link this in the newsletter. There is a good podcast interview where he goes over what does as the cto of bentley pretty down to earth really focuses on the technology uh no not really anything with financials and stuff like that it's just pure uh tech side of things tech side software all that good stuff uh if we move to the board of directors they have four of the seven board members that are bentley family members and they're allowed to do this because they are a family controlled business so under the u.s regulations you're supposed to have a more

independent board members but they don't have to have that so this makes this even a more controlled family business than other dual class companies like say meta platforms with zuckerberg having that controlling stake with the dual class structure even here the board wouldn't be able to vote them out because they have the four members um and i think that's important to note yeah yeah because the brothers could vote each other out if they well they could have they could have been fighting. I guess that is true. They haven't had that for 40 years, but I guess that is right. It is not impossible for that to happen. Moving to compensation, executive comp in 2021 was $37.9 million or 5% of gross profit. That is kind of on the high end of

what we would call the reasonable range when looking at a business. So I mean, it's not high for executive team in America, but I think it's important to watch for this company because once you get that 5% of gross profit that can eat into your margins quite a bit if it goes up even further. It's also a 5% of gross profit is, I would definitely consider that on the higher end of the reasonable range is given how much they already own the business. I am going to talk about that. Yes. So if we look at say the CEO and CTO, they both own, and this isn't voting power, this is ownership. So kind of their economic interest. CEO, Greg Bentley owns 3.1%, and the CTO, Keith Bentley, owns 6.5%.

When we look at the size of this business, those are really big chunks. Yeah, and look at the board compensation, less than $1 million, so not consequential. Now, the most important thing, and I think we're going to spend a lot of time on the proxy today just because it was probably the biggest low light or the biggest concern when looking at the stock. There were a few yellow flags I saw when reading their 2021 proxy statement. First, they have a complicated, what they call bonus pool compensation scheme where executives can get paid up to 20% of adjusted operating income each year.

I'll repeat that, up to 20% of adjusted operating income. This is especially concerning considering they already own a huge chunk of Bentley stock. So why do they need the salary at all? If the business does well, the stock will go up and they will do well. It just feels a bit greedy to me. Second, the other executives who are not part of this bonus pool can get performance stock units based on adjusted EBITDA targets. The use of adjusted EBITDA is a concern here because the performance stock units are then

adjusted out of the earnings and you kind of have this self-fulfilling cycle where you can be profitable and just give people a lot of stock. Third, and this is a small one, but I think it reads a bit into a culture concern, executives get reimbursed $12,500 a year for fitness memberships and $25,000 a year for family members to accompany them on business trips. This is not going to impact their bottom line, but I think it's self-explanatory how you might be a bit peeved reading that. And you say, oh, you question as an outside shareholder, the ethics of this executive team. I mean, what gym are they going to?

Oh, yeah. 12,500. They're all at the Equinox. All these software engineers are going to the Equinox. Fourth, there are, and this isn't terrible. I know companies like maybe Liberty or other complicated entities do things like this. But there are almost 10 million, what they call phantom shares of stock that are held by executives that can be converted to, quote, real shares under their deferred compensation structure. I think they did this for tax reasons, but I find it unnecessarily complicated and it

can be used to mislead shareholders if they really want it to. I don't think they are doing with that because I give out some great explanations on how this works. But again, make sure to look at that. Don't look at the wrong share count when looking at this company. And then I said I had the Siemens part. So we're going to look at that. All right.

Earnings, Ryan, less complicated. Let's go through that. Yeah, fairly straightforward. I'll go through 2021 first, so that was their last full year, $965 million in revenue, so almost a billion-dollar revenue business. That was growing 20% from the year prior, 78% gross margins, typical of your engineering software companies to have such high margins, and then only $93 million in earnings before taxes or about a 10% EBT margin, but they had a $95 million one time, and I say one

time because sometimes we just talked about this uh sometimes it'll help them sometimes it'll hurt them um and they had a 95 million dollar one-time deferred compensation expense i believe part of that was connected to the ipo because that was way larger than they typically had uh in their previous financial statements so um yeah we'll hope that's not as big of a deal in the coming years. Yeah. All the other numbers are around 20% earnings before taxes margins. So in 2020, they had about, it was 21% earnings before taxes margins. So typically more in the high teens to 20% range, as opposed to the 10% they saw in 2021. As for operating cashflow, almost $300 million. So you're looking at potentially 30% operating cashflow margins. And then they do have some

stock-based compensation expense and that's probably the leading uh difference there between uh cash flow and your gap earnings don't forget yeah and don't forget to track deferred revenue with this type of business as well right and then i most recently just focus on arr is probably the best way to go um and explain for any what that is that is annual recurring revenue so they're just taking their recurring revenue figure from the current quarter and extrapolating it out for next nine months right so it'll be the current quarter annualized so 12 12 months not nine yeah but it includes the existing quarter oh sure yeah yeah you're annualizing the the recurring revenue from the existing quarter and so in the most recent quarter they're looking at about 984

million dollars in annual recurring revenue now keep in mind that might seem like limited growth But there's a part of the top line that comes from professional services, so like helping their customers implement the software and stuff like that. So that doesn't get really lumped in to the recurring revenue, at least not all of it, I don't believe. So that is really just their recurring revenue figure. Their ARR was growing at about 14% in constant currency. They did have some big foreign exchange headwinds this quarter. But all in all, it seems like they continue to grow at about a mid-teens percentage growth rate. And they're accelerating, yeah, from the last decade.

Yeah. Now some of that may be inorganic because they recently had some big acquisitions, but 99% account retention rate. So very little logo churn here. That's pretty impressive. Yeah. And then 47 million in EBT this quarter. So 18% EBT margin.

It's just that earnings before taxes that I mentioned. Keep in mind, I do include interest there. So I'm not using EBIT on this occasion because they have a lot of interest expense and that moves kind of right into the balance sheet. On the liability side, this is a business that uses a ton of debt to finance growth, primarily their acquisitions. So $1.8 billion in long-term debt and basically $1.7 billion in net debt. So really almost no cash. And here's how it kind of shakes out. So 540 million of that 1.8 is in a bank credit facility. This is ultimate. It's comprised of two things. There's a term loan and then there's like this revolving facility, but

it's variable rate debt. And the weighted average rate was around 3% between the, both the term loan and the revolving facility. And then there's two other tranches of senior notes, or two different sets of senior notes, I should say. $700 million worth of 2026 convertible notes, that's a 0.125% rate and a conversion price of $64 a share, which is 63% higher than today's price. So if they get to that price by 2026, it's convertible into stock as opposed to paying that down debt. They also have a 2027 convertible senior note. That price is $83.23 a share. That's double today's price, but it's a slightly higher rate at 3.75%. Basically, all this is to say they are certainly a heavily indebted company and they've used these

for their big acquisitions because only $73 million in cash. However, it's 360 roughly million in adjusted EBITDA. They're getting probably close to $400 million in adjusted EBITDA. And their credit agreement states that they can't exceed a net leverage ratio of three and a half to one. And net leverage is just their net debt divided by that adjusted EBITDA figure. I think there must've been an amendment because right now they've got 1.7 billion in net debt, 362 million in last whole month adjusted EBITDA. So their net leverage ratio is 4.7 times as opposed to the yeah maybe maybe they don't count convertibles there could be something in there yeah i guess just the way i the main takeaway here is that they like to push the limits on

on how much debt they can use i like the convertibles though pretty smart yeah good good convertibles and they seem like they're good conversion prices as well not too much of meatballs for the uh yeah and it's a good uh it seems like a good target where like that can you know it's achievable yeah where you know it's it aligns with shareholders all right i'll hit valuation keep it quick here let's get the sheet up um because we track in real time all right market cap is about 12 billion dollars add back the debt we're about an enterprise value of 13.6 billion dollars and the stock is quite expensive i think this is going to be the most expensive stock we look at here from a trailing multiple basis. EV to sales, 14. EV to gross profit, 16.

And EV to operating cash flow of 43. And those are all trailing 12-month from Q3. Again, sales ratio, 14. Operating cash flow ratio, 43. That's pretty expensive, especially in today's market. We're looking at probably a double of what Autodesk is going to be at. We're probably looking at, I mean, ANSYS even was at 30, and they have traded a premium multiple for a while. And all these growth rates are not that different. No, that is the thing. All these companies are growing at very similar growth rates. Now, you could argue, and we'll talk about this in the future growth opportunities, that Bentley Systems has just a fantastic industry tailwind that's going to be coming this decade, but

um just the starting multiples are high here okay anecdotal evidence ryan this has been a tough month for anecdotal evidence but what do you think well just kind of looking at management and and maybe the way they communicate with investors how long they stayed private and and reading about um the founder letter yeah reading the founder letter and reading stories of the written about the family it feels like this is a business that's very much focused on engineers and employees first there was an interview talking about their ipo with greg bentley and he said that we like he was talking about how how much we care about our employees and he said we made an extraordinary stock grant to our employees right before they went right before it went public so that they

owned a third of the company when it did it was good then maybe spc can be lower now i think they actually said they said that on a conference call so that could be it could be a positive but yeah it's definitely a sign that they're not afraid to focus on employees first yeah which is good it's not that's not bad but yeah you know it's something to factor in and whether they're going to care about margins too much and stuff like that yeah um yeah i think the founder who is the cto uh he has that uh interview on that podcast that again we'll link in the newsletter make sure to check that out uh he seems very dedicated to bentley's mission he's been there uh just as a reminder since 1984 um and he gives a great pitch for the long-term growth of digital

twins which that leads into the future growth opportunities um that's gonna be mine but ryan won't you start with yours yeah he seems pretty fixated on that one uh so that that kind of seems like the big one at least he's not the ceo where it's like again we talked about zuckerberg already so it's on my mind with the dual class share structure at least he's not the ceo and they didn't change their name to i digital twins or whatever yeah and the ceo is focused on that i'm glad it's the guy in charge of their products. Yeah. So growth opportunities for me, I'm going to go with some of the recent acquisitions that they've made. And it's worth noting that this is very much an acquisitive business. They explicitly state that they want this to be a part of their

strategy. There's even a quote here from the 10K. They say, since our founding, we have purposefully pursued a strategy of regularly acquiring and integrating specialized infrastructure, engineering, software businesses. So much so, in fact, they bought 33 companies in the last five years and two really big ones so sequent was a billion dollar acquisition that was in 2021 i believe it was 2021 and then power line systems was recently that was this year more recent 700 million so pretty much all of their net debt um worth of these two acquisitions and they bought them also here's the part that i'll i'll maybe save that for my low lights but it's potential concern who they're kind of buying them from and and stating that as your strategy it makes me

worry that maybe you're not getting the best prices but let's let's look at sequent which is the global leader in 3d modeling software for geosciences apparently a lot of people use this um it's one of the leader in one of the leaders in subsurface yeah oil boom back with the oil boom back excuse me i can't talk you know could have been good timing here yeah and this apparently added 10 to bentley's arr uh so basically it looks like they paid 10 times sales for the business hard to know what the margins will be but uh it's yeah it's okay that's okay it's not terrible if they especially if they can if they can bundle it that's the key is if they can accelerate the growth all right what about you um yeah just i'll mention power line systems just look them up and

this is going to be big for the uh when we talk about later kind of the infrastructure bill so power line systems develop cells and support software for the design of overhead electric power transmission distribution and communication lines and their structures so again classic infrastructure company but mine is going to be infrastructure digital twins keith bentley like i mentioned before thinks that digital twins are the next big revolution that bentley systems is working on since the original computer-aided design boom in the 1980s so that's a big the computer-aided design boom in the 1980s is was huge you had autodesk you had uh Josh, Ansys, Bentley, and a few others really take hold in the 1980s and become the giant

businesses in the engineering software industry. So when he says digital twins, he is saying that it's the same as CAD. He's being really optimistic about this, and he thinks it's a multi-decade tailwind for them. So some people may know what a digital twin is, but it is a digital representation of a real physical asset which can be analyzed and managed in real time through the connection of internet of things sensors and computer chips so just say you got a bridge you have some maybe sensors on it you have uh that are connected to your say cad file and updates continuously with say stress loads stuff like that and can help an engineer or whoever manages the bridge you know make it more efficient uh safer for the people that are driving on it

and just apply that to any other infrastructure asset out there um yeah so benley systems is investing heavily in this industry they have its i-twin platform which they want to lay on top of its existing design and management software so again how that would potentially work against its early stages so they're really trying to build this out is you have say the software design thing for trains let's say it's trains and you can layer on the i-twin what railroads or trains is moving oh oh sure yeah the rail excuse me yeah the rail you're making the bridges across all that when you have the digital twin capabilities you can layer that on the uh the software and instead of just the design phase it's also in the management phase and hopefully that i think

i i said that uh well enough but they're they're really optimistic about this they're investing heavily. Keith said that he is spending almost all of his time on this. So I think that was really important. That was probably my biggest takeaway from the interview is that he's spending all his time on this. So if you're going to invest in Bentley, it's important to look at digital twins. Lastly, oh, I should have linked to Bentley's website. Oh, well, okay. That's in the newsletter. They have a $100 million venture fund specifically earmarked to invest in digital twins. So again, they're investing heavily into this. All right, let's move into highlights on lives ryan what'd you like and dislike about deadly systems uh likes i think they're well

first of all they're the leading software provider in a lot of their end markets so it's not like they're fighting some uphill battle um and they serve a really critical function for a lot of their customers which i think generally leads to pricing power um and you can probably see that in the dollar based net revenue retention figure that they reported last quarter 110 pretty solid that's pretty much in line with Autodesk of the world. Also, having the bundling potential between your products, I think that makes it harder to disrupt. One competitor comes along,

you're not probably going to lose as many customers to something like that when they're relying on more than one of your products. And then the last one, and this is really probably the largest one by a mile. Now, commodity inflation is really good for this business when if the whole thesis plays out the high prices or the cure for high prices and people are going to invest in a bunch of assets to mine whatever the goods are, infrastructure-based assets for oil, infrastructure-based assets for, I don't know, coal. They talk about mining plants as one of their end markets. lithium for renewables all yeah all these i mean all the end markets uh if there's going

to be more investment there because the prices are higher and your theoretical return if you invent if you work to uh produce them is uh if your theoretical return is higher then you're going to spend more money on things like bentley systems so all that is to say i think there's going to be more spending on infrastructure-based assets this probably next five years. And Bentley is a critical part of that. Yeah. And more of the spending will probably be going to software. And just as another example for that, the renewable benefits of the infrastructure bill in the United States are well-known. It's not political on this at all, but it's there and it's approved as of today. There is going to be a huge influx of capital that are tax-free. We

need to go through the details for a lot of these companies whether it's nuclear solar wind uh geothermal other research technologies they're going to be using bentley type systems and to transmit on the power lines to build these smart grids they're also going to be using the management software like power line systems and stuff like that so again the infrastructure bills um the infrastructure spending is just going to be very very beneficial along with the the renewable, uh, transition that a lot of the Western world or the whole world is trying to make, um, low life rent for you. They do have a lot of debt. Um, a big chunk of it is also variable rate debt. So rising rates potentially, uh, more money's going to go towards their debt

holders. Um, and then I generally don't like it when companies have acquisitions as a part of their stated growth strategy, because it means you're probably getting worse deals when everyone knows that you're trying to meet a certain amount of acquisitions. They're buying these a lot of the time from private equity businesses who aren't going to just relinquish their stake on some scummy deal. They're trying to probably sell it for a premium. So I worry about what they're paying on a lot of these acquisitions. And then the last one for me is throughout a lot of their annual report

and their financial statements, it looks like they're paying a ton of money to investment banks. They've amended their credit agreement like three times in the last three years with a whole bunch of fees going to the investment banks. They're paying investment banks

for consulting on acquisitions. And when they raise convertibles as well, I think the raising convertibles is the right thing to do, but I just worry how much money they continue to shell out to investment banks. I mean, yeah, just compared to another software acquisition companies, Constellation Software, have any of those, you know, culture or spending lowlights? No, none of those. So, yeah, I think that's a valid concern. And then on the acquisition front, they did explicitly mention that they're looking first for technology and talent in an acquisition. So, yeah, that's that I think your concern could be valid. All right. My highlights. I think the durability and focus of the family led business for multiple decades is highly impressive. From what I can read into, they are mostly non frivolous. And since we can't read into them, then, you know, I think that helps confirm that where they're not on CNBC all the time or going to the, you know, constantly going to getting in front of the TV screen.

And really, they just want to build the best software they can for their infrastructure customers. Second, digital twins for a few reasons. First, these new products give them new revenue opportunities, plain and simple. Second, it widens the moat by increasing the switching costs of leaving Bentley systems. If you're not only doing the design, but also the management and the tracking of all your assets through Bentley, the switching costs, I think, are self-explanatory there. Third, it allows them to ride the technological innovations of other companies and other

industries that make digital twins more viable. And these can include, say, cloud computing, mobile devices, semiconductor advances with Internet of Things. As those get better and better and other companies are investing in that, that makes it much easier to manage something through a digital twin. Third, the government infrastructure bills. Ryan talked about that one so we don't need to hit it again. Lowlights for me, we talked about not having a great ROIC framework on acquisitions. Other lowlight, we already talked about it though, is the greedy compensation plans. It just doesn't make me feel good, especially when you combine that with bonuses being based on adjusted metrics. Because when they're based on adjusted metrics and you have

an acquisition strategy, it's just a tough combo because there's always going to be the adjustments in that. And I worry about true free cash flow generation. Third one, we haven't mentioned this yet, but exposure to China. China is a huge infrastructure spender, has been the last two decades. And they explicitly mentioned in the last conference call, and not even just the last conference call, that China is a big negative as of late. 19% of the revenue is from APAC, which is Asia Pacific. And then China is likely the largest piece of that. However, on the last conference call, they did mention they're getting a big pickup from India, which is balancing that out. But the China part does make me nervous. Decent exposure there. And we don't have the

issues that they've had recently with tightening up foreign investment and all that stuff that makes outside investors and outside companies concerned. All right. Bull case. Bull case and bear case have been fairly simple for these software businesses. But Ryan, what do you think? Because valuation is a bit expensive here. Yeah. I feel like I'm kind of repeating myself, But in this case, the valuation, when I look at it, it's honestly a little wild of a premium. You're looking at potentially 40 times adjusted EBITDA, which is really not the true free cash flow of the business. Is it, what, 50 times free cash flow trailing? Oh, I don't know about, I did operating, but 43 times operating.

I'm sure, well, it's an acquisition strategy, so you're probably going to want to include the acquisitions on that. So I'm sure, yeah, 50 sounds reasonable. I mean, to get to 10% returns from here, I think a lot needs to go right. You're probably going to be fighting multiple compression along the way. So I'd argue you need at least a teens percentage annual growth rate on the top line and then some margin expansion as well over the next five years. the uh maybe they maybe the infrastructure spending is so strong the growth in infrastructure spending across not only the u.s but just internationally over the next five years that it just doesn't matter and they get 20 percent top line growth for the next three

if that happens yeah you're probably going to have good returns but feels like there's some risk in that yeah and remember historically they've grown at eight percent a year with a heavy acquisition strategy. Again, my bull case, when looking at this, you have a premium valuation and it should be handicapped even further because it's an acquisition-heavy strategy. So I think you need to expect durable 10% growth for the next decade. It's not going to be hyper growth because it's infrastructure. It moves slow. Government is in there a lot of the time. So it's not going to be one year we get this software program for whatever and it's not like they're sending this to VC backed startups that are moving rapidly and stuff

like that. So it's not going to be one year. Oh, they're growing 40% like crazy. It's going to be durable growth, which is fine. It's actually better, but I think we, you need to expect 10% growth for probably a decade. You think of it? Well, for a decade. Yeah. But like, you think if they, let's put 8% revenue growth on it for the next 10 years, do you think you get good returns from here? Oh, that depends what margins look like.

I think right where they are now, 20%. Oh, no, probably not. Probably not. But I think this still deserves a premium valuation given how low the churn is on all their, with their customers. It deserves a slight premium valuation. But again, we're at a really, really premium multiple here. But I kind of think they have a chance of doing this, of hitting 10% plus growth because

you have the combination of the government infrastructure plans. And I guess this is a little bit, the second part's a little bit more speculative, the commercialization of digital twins, which are projected to grow at 40% a year. Bentley is one of the leaders here, and I think that can help them out a ton. Now let's move to the bear case,

and this one will be simple for both of us, and that's multiple compression. Yeah, I have a couple. Multiple compression's one that could lead to underwhelming performance. Overpaying for acquisitions is another. And then increasing debt payments, they have a lot of net debt right now.

Right, low cash position, less than $100 million, right? Yeah. I think there's maybe a good chance that they'll have to roll that debt. If rates rise, they're going to have to roll that debt at higher rates. That's just a recipe for higher interest expense, which is kind of difficult. I think the business is really, really sound. I think this software is going to be just as relevant in 10 years, maybe probably more relevant,

but I don't necessarily know if shareholders are going to make out that well over the next five, 10 years. Yeah. Yeah. I think, yeah, my bear case has got to be the same. It's pretty simple. You start with the high earnings multiple and you kind of have an ownership and management structure. I'll reiterate this family controlled. They've been there forever and they have full control of the board. And they talk about a lot how they focus on technology.

There's no talk about free cash flow per share. There's no talk about all that good stuff. So it seems like the ownership and management structure is worried about business durability over generating cash for shareholders, which is they can do that. But you, I think, have to handicap that as a potential investor here. and that could be a bear case just because they might not care about optimizing cash flow. I swear.

And I say not even in the short run, I'm not talking about juicing cash flow in three-year time. I'm talking about long-term focusing on cash flow generation versus durability, versus just the durability

of their position in the industry. Whether it takes a lot of acquisitions through stock, a lot of acquisitions through debt, whatever. Yeah, it feels like in listening to that, I know it was the CTO,

but it feels like they go, wow that that tech looks cool it's better than ours let's let's go out can we buy it and then they say what price do you guys want all right we'll try to see if we can get the debt to finance it that's not a great acquisition strategy in terms of generating returns yeah but and you said it they care most about tech and talent not roi yeah and that's fine when they're small acquisitions uh which i think it can be great if it's kind of acquiring some really smart people for $10 million, but $500 million, no. All right.

More or less interested, Ryan? I am more interested just because I think there's that big tail end. I'd like to see them be public for a little bit longer, I think. That's a good point, yeah. And let's get the stock cut in half. Yeah. I mean, the valuation's just definitely not at this price. It really is a sound business.

I feel like we're saying that with all these engineering software companies, but these are businesses that have been around for a long time, have gotten bigger over time, gotten better over time. Yeah. Well, if we're going to rank durability, Bentley is probably number one here just because the industry is so much more stable than, say, Ansys. Yeah, they have so much potential, but a lot of the stuff is industries that could lose R&D budgets. Yeah. I think, yeah, this has more customer applications. Yeah. And just, you know, that there's going to be spending year and year out more government focus. Yeah. I'm more interested, you know, I'm not going to buy something like a slow grower at 40 times cashflow. It's just not going to happen. And I think you, I said earlier that

a business like this deserves a premium, but I think you might have to balance that back because of the management and proxy statement concerns. And maybe uh i would just be waiting for a multiple that is below the market average and that might never come for mentally systems but uh i guess that's the price you have to pay to be patient all right stock for next week is going to be pro core not exactly engineering software but if i'm looking at coif in here uh i guess they're growing quicker so maybe we can kind of look and maybe balance someone who's growing at more than 20 a year but it's another one trading at more than 10 times sales so uh that's what it's going to be for these software companies um all right

anything else ryan no we're good i guess for the pro core if you want a little bit of a precursor we've interviewed the ceo twice now that is true very very interesting man uh built this business from scratch yeah uh very cool he's ceo and founder we'll try to give our his his is uh i mean he obviously has a better understanding of the business than we do but we're going to try give our sort of candid uh thoughts on the stock today and obviously talk about the business as well but uh yeah we'll see if we'll see if they're in uh how it relates to our interviews with them yep all right well that's going to do it for this episode remember uh check out seven investing code money get 100 off your annual subscription for life sign up for the newsletter give the show

notes and charts we are not financial advisors anything we say on the show is not formal advice forward recommendation. We are general partners at Arch Capital and clients may hold securities discussed in this podcast. Thank you all for listening. We will see you next time.