Chit Chat Stocks - Brian Feroldi | Autodesk (ADSK)

Episode Date: December 2, 2020

On the 2nd day of Christmas Brian Feroldi gives to you, Autodesk the engineering software that almost every engineer uses. The Chit Chat Money team dives into how Autodesk is valued compared to its possible growth opportunites. Visit our website: https://www.chitchatmoney.com/ Subscribe to 7 Investing with the code "CCM": https://7investing.com/subscribe/ Follow Chit Chat Money on Twitter: https://twitter.com/chitchatmoney Learn more about your ad choices. Visit megaphone.fm/adchoices Learn more about your ad choices. Visit megaphone.fm/adchoices

Welcome to 25 Stocks of Christmas presented by Chit Chat Money. Today we have an episode with Brian Feroldi and we're talking Autodesk. I really enjoyed it but before we get to that we have a word from our sponsors 7invest partners really and you want to give the sales pitch here? Sure so you get using our code CCM you all probably know this already you can get $10 off your first month at 7investing. It's a great way to get started with their program. You get 7 stock picks a month from advisors that are very smart uh simon's the head guy there but you know all of them they've been on their show before they will be on this 25 stocks of christmas program so look forward to that in the coming episodes all i can say is yeah it's a great

deal and we'd love for people to subscribe okay here you go welcome to chit chat money on this show host ryan henderson and brett shaffer interview industry experts, and riff on the world of investment. As a quick reminder, Chit Chat Money is a CCM Media Group podcast. Ryan and Brett are not financial advisors. Anything discussed on Chit Chat Money by Ryan or Brett or any other podcast guest is not formal advice or a recommendation. Now, please enjoy this episode. Today, we are welcomed by Brian Feroldi, writer and contributor, Motley Fool personality, and today I believe you're talking Autodesk but this is the second time you've been on the show

so it's been a while. How have you been? I've been fantastic. Things going pretty good all things considered. We've survived 2020 just fine. The most important things for me is that my kids are back in school and are in school still so if you guys aren't parents it's hard to express how important that is. That is good news. That is good news. Yeah. So how did you find Autodesk as an investment? I think I first heard it on a podcast, most likely Motley Fool Money. At the end of every podcast, somebody pitches a stock and I'd heard it pitched a couple of times, maybe years and years ago. And I was always just like, oh, okay, that's interesting. But I never gave it a hard look because for whatever reason, it just was never represented in any of the Motley Fool's

services. However, once I dug in and ran it through my checklist, I became really excited about owning this company. So I hear of stocks from a number of different sources. The Motley Fool is definitely number one. Twitter has definitely become number two. But I always take them and start with, here's an idea. How does it stack up against my criteria? And if it stacks up really well, that's when I get excited. Okay. And then can you explain what Autodesk does? Because it's not something a lot of consumers are really familiar with. Yeah. Autodesk, their most popular or most well-known product is called AutoCAD. Now CAD is C-A-D, stands for computer aided design. Autodesk essentially helps anybody in the architecture, engineering, construction,

design, manufacturing, or even media and entertainment to design and build real world products. The design used to be done with pencils and paper, and Autodesk is the pioneer that helped to bring that to using computers and obviously there's a tremendous number of benefits to using computers to do so. So Autodesk has essentially won the category. It's been selling its software for almost 40 years and in many ways it is the industry standard in the same way that Windows is the industry standard operating system and Adobe's products are the industry standard for creativity and media. Autodesk similarly dominates its industries, which again are architecture, engineering, and construction. And it now sells dozens of software products

that's used for a huge number of use cases. More recently, they've been pushing hard to transition their business to a software as a service model. If you guys know anything about that, it's a really painful transition for companies, for legacy companies to go through because they have to give up huge amounts of revenue in the short term to make the transition. Once the transition is complete, it's a gift that keeps on giving to investors because it usually leads to increased margins, steady recurring revenue, and a much longer term and durable growth trajectory that allows companies like this to grow even in the face of sessions and so we went through ansys with jason uh we were talking about this before the show and

i think ansys was more correct me if i'm wrong brett but it was more for like it was like a flow tool so you'd see how things moved i guess or yeah it's different yeah there's there's flow analysis like for complex things that ansys does but um brian you probably know this too autodesk is more of a broader platform that more than just those highly complex and you know things would use for someone like a PhD or something may be using ANSYS, but a bunch of undergrads or construction management people would be using Autodesk. Yeah, I can't speak too intelligently about ANSYS and how it differs from Autodesk. However, the number of use cases for Autodesk's products is astoundingly large. And to your point, this is the kind of software that is taught in design

schools, engineers that are up and coming through learning how to use this or build construction products or manufacturing products, use Autodesk's products to do that. Okay. And I know there's been, I was just reading through the third quarter conference call, and I think there was a management change going on. The CFO was leaving or something like that. So what do you think about management and the executive team as a whole? Yeah, it's always a bit of a head scratcher, something worth noting when a major executive announces their departure. It's just something that happens on occasion. I'm not too concerned with that happening at Autodesk because the company is at a stage of its maturity where its business model is already intact. I'm personally

much more concerned about an executive leaving if it's very early on in the company's growth stage. this to me would be like if an executive was living at Microsoft. Would you guys have any concerns that Microsoft was in trouble if one of its executives left? No, because the thesis isn't so much about any key executives. Now, when it comes to executives, the CEO here, and I'm going to butcher his last name, but it's Andrew Anagnost, something like that. I always read the conference calls. I never hear them, so I never hear how they're actually pronounced. But he is exactly the kind of executive that I like to bet on. He's not the founder of this business. It would be really hard to have this be found to run because again, it's almost 40 years old.

But he has been with Autodesk since 1997. So he's going on essentially 23 years of working at this company. He took over as CEO in 2017. And he has been a major part of the spearhead of the movement to switch from the licensing model to the software as a service model. I really like that. But when it comes to judging CEOs, I always like to let the employees do the judging for me. So I always go right to Glassdoor. And here's what I see. I see 4.1 stars out of 5 for the company as a whole. That's really good. And I see a 94% CEO approval rating of the CEO. Those are outstanding numbers in general. So when you combine that with his tenure and what the stock has done under his leadership, I'm very comfortable with this management team. Yeah. I mean,

that Glassdoor rating is really strong. All right. Let's get to that. Ryan, do you have anything? I was just going to say, sometimes Glassdoor ratings on smaller companies can be a little misleading because there's probably less data, but Autodesk is a bigger company. So that's pretty validating of the management team. Yes. I always look at the number of reviews. And in this case, there's over 500. So that's a number that's really hard to game. To your point, if there's under 10, I mean, how can you put any emphasis on that? Given that the people that go to Glassdoor and give reviews are typically extremely happy or extremely upset. So these things always require, you know, context to put around. But when I see hundreds upon hundreds

reviews, it gives me confidence that this number is accurate. Right. That makes sense. Okay. Now this is the crux of the episode. We want to, you know, talk about why you like Autodesk as an investment going forward. Maybe give some info on your time horizon. I know, and maybe some parts about valuation. What kind of parts can they grow with? Are there any new business lines? You know, why do you like Autodesk for the next few years here or longer? So my favorite type of investments are basically this awesome company is going to stay awesome for a long time. Like that's my favorite thesis. When it comes to Autodesk, there's no doubt in my mind that it is an awesome company. If you bought this stock at any point in its history, you have done phenomenally well. It has been a wealth creation machine. And as I said before, it is the industry standard for what it does.

That provides both switching costs as well as some loose network effects. Because if you want to communicate with other engineers or other design professionals, you're using their platform to do so. You're emailing each other files. It's the same way that Microsoft products and Excel have lock-in effects. Isn't it hard to communicate with somebody if they don't have Excel and you want to send them a spreadsheet? very similar dynamics at play with Autodesk. But the thing that really jumped off the page to me

when I was researching this company is that its growth trajectory, I think, is extremely predictable and very low risk. As I said before, they made a transition from a licensing model to a software as a service model. In the beginning, a lot of customers complained about that, as they often do when they have to go to a monthly recurring fee. But there are about 17 million people out there that are actively using Autodesk's products. The majority of them are using legacy products. Of that 17 million people that are active users of Autodesk products, only 5 million are paying subscribers. That means that there's 12 million people out there that are using older versions of Autodesk's products

and have yet to make the transition to SaaS. A big part of the reason I like this is because the growth thesis for this company is those people that are using this product but aren't paying will eventually pay. That's it. If you are actively using it, and for a lot of people,

they can't do their job without this kind of software. They're just using legacy products that are on a machine. Once that machine dies or once the company decides it's time to transition, that just turns a non-paying legacy client into one that's going to be monetized essentially indefinitely. So I really like that because it doesn't require them to go out and grab new customers, although I think they will. It just requires them to monetize the two-thirds of customers that aren't monetized yet. Okay. And then what kind of margins does Autodesk get? Because I know people look at it, I think they look at it first and like, whoa, like the sales ratio, it's 15, how this thing might be expensive, but do they have strong free cashflow and profit

margins? So their margins are a little bit wonky right now, because again, they just went through the transition process. However, their current gross margin, their gross margin has more than fully recovered. Their current gross margin is 91%. That's extraordinarily high. And it's risen substantially over the last few years, as again, the SaaS transition has taken place. I don't see a ton of upside for that particular number, but man, when you have a 90% gross margin, holy cow, is it easy to create wealth for your shareholders. The rest of their, or the rest of the income statement is going to continue to produce tremendous operating leverage from here as those users are monetized and the revenue number goes up. That's one reason why I absolutely love

investing in software companies is because their revenue is so predictable and so high margin that the management team, if they're focused on generating above average profit growth, It's just a matter of planning out their investments on a schedule and it almost automatically leads to profit growth. So this is a company that I think is more than capable of producing a ton of operating leverage over the next five plus years. When you throw in a modest top line growth rate, and by modest, I mean the low double digit, probably mintines, I could easily see this company growing its free cashflow and its gap net income at a 20% clip for the next five plus years. Now it is expensive, as you pointed out, although the price to sales ratio, I don't think is a great metric here because again, 90% gross margin, like 90%, holy cow, is that high.

companies like that deserve a really high price to sales ratio the stock is trading at about 53 times next year's earnings estimate but again earnings are artificially depressed because it's not yet optimized for profit i don't i'm not going to go out and say this is a screaming buy right now but if you want a low risk high probability double digit return for the next 10 years, I think this is an excellent choice. And I, yeah, we, we definitely like the business as well. Um, a concern that I think might come up is the idea of like maturity. Like they sort of have, um, you know, they have a lot of customers, but how much more can they grow? Uh, you briefly answered that, but does that ever worry you at all that they've sort of hit saturation?

So when you are the top dog and you are the industry standard, that's of course going to naturally slow your growth. They, I think, can continue to grow by adding on new features, new services, and pushing through regular price increases. When you combine that with the huge tailwind of just monetizing the customers that already exist, I think that the chances of double-digit revenue growth are highly likely to occur. You have a question on here about their low revenue retention rate, which I think is perfectly fair. They do target a revenue retention rate of existing customers between 100 and 110%, which if you're a SaaS investor and you're comparing that to Twilio or Datadog or Snowflake, you're like, holy cow, is that low? Why would you

ever buy this company? But you have to compare it to what it should be compared to. High growth SaaS companies that are literally creating brand new industries or attacking brand new opportunities such as Snowflake, such as Datadog, of course, they're going to be able to grow their sales per customer at a much, much faster clip than a company like Autodesk. I'm extremely impressed that Autodesk can have this number above 100. I'm just happy with that. That means not only are they hanging on to their customers, but they're getting more and more revenue out of each existing customer. You can't compare their growth rate, their same customer growth rate to those high growth companies, a better comparison would be to a company like Microsoft or Adobe, which don't

provide this metric. I think on that comparison, it would look pretty favorable. Okay, that makes sense. You got anything else, Brian? No, no. We're going to hit a quick break here, and then afterward, we're going to try to poke some holes in Brian's thesis. Cox Panoramic Wi-Fi includes advanced security to help protect all your connected devices. You'll get real-time alerts. oh like this one so you don't have to worry about malware or when your kid downloads a song from a shady link and now all your computer can play is red color red color where are you all blocked thanks to advanced security included with cox panoramic wi-fi advanced security must be enabled in the panoramic wi-fi app restrictions apply

All right, welcome back. Next, we have Devil's Advocate. This is our segment where we try to provide some counterpoints for Brian to refute. So the first one for me is many of Autodesk's larger customers are probably going to see a decline in volume because they, whether that's designing commercial buildings or commercial real estate, that kind of thing, there's less people working in the office. So that naturally means lower volume for the customers. That could potentially lead to lower spend on Autodesk products. Do you see that as a concern? As a macro concern, that could be one area that the growth slows for them if there is indeed less spending on, say, office buildings. But if there's less spending on office buildings, won't that probably mean there's more spending on warehouses to facilitate more e-commerce? Or how about just gaming? These guys do a lot

of stuff with gaming and entertainment and 3D. So I do think that some of the growth drivers that are behind this company could slow because of COVID. I mean, there's no doubt about it. But you could also make the argument that others are going to offset that and at least make it revenue neutral however if that does prove to be a significant hindrance to this company and it really slows their growth rate i would certainly consider changing my bullishness okay that does that make sense yeah i'd follow up and they have a i forgot about the gaming part but don't they have a partnership with uh unity as well uh if i'm not mistaken yeah i think i think they do okay i'm not i'm not aware of that off the top of my head but they do have a big growth segment with

within just broadly the gaming and media and entertainment industry i mean their their products are in very very real ways the industry standard for creating special effects uh in fact i read something like uh every single every single movie that has won an academy award for special effects in the last 20 years was using autodesk's products wow i did not know that at all you kind of like instinctively think the physical world but it sounds like they're doing a lot of uh stuff in the virtual world as well. Correct. Yeah. And the other thing I'll throw out there too, is these guys have been investing heavily in machine learning capabilities, as well as augmented reality. And I think that the augmented reality angle here is especially interesting

because I think there's a lot of potential use cases for augmented reality, but the one that is just like a slam dunk in my mind is the construction industry. If you were about to build a home wouldn't it be awesome to put on goggles and walk through that home as it was being constructed or if you're going to build a factory wouldn't it be great to actually walk through the factory so you can make design changes to it while it's still in the r&d phase not only that but if you are an engineer designer isn't it faster to get a client to sign on the dotted line on the design after they by putting a virtual reality goggles on them so that is a kind of feature that is going to be, that they're investing aggressively into now. And I think that

kind of thing will convince a huge number of their legacy, non-compliant, non-paying users to upgrade. Okay. And then I guess my counterpoint was going to be that retention rate. So I'll just hit on another topic. This isn't really a counterpoint, but just something that Autodesk is investing a lot of dollars into, and that is the construction industry. What are they, I know they have a few products about, you know, collaborative software and, you know, people use AutoCAD as well. Do you think that's worthwhile for them to continue investing into construction and construction management? I definitely think so. I mean, they believe that there's trillions of dollars in infrastructure spending that's going to happen worldwide over the next, geez, decade plus. We're

talking about roads and bridges. I mean, most people are pretty familiar with US, United States roads, not exactly sparklingly perfect. If there's going to be huge investments in infrastructure, as well as other types of collaboration softwares related to construction, I think there's tremendous opportunity for there. One of the things that they call out is their software has become so advanced that it can minimize the amount of materials that are used to design any given product. That goes to energy savings, as well as sustainability trends as well. When it comes to management's decisions on things like this, I don't pretend that I know more than they do. Like the CEO here has been in this industry for almost 25 years, and he's produced stellar returns for shareholders. So

whatever he says is the place to invest, I kind of say, okay, I believe you. So then on the flip side, what would have to happen for you to say, okay, maybe I was wrong in my thesis and I think I should sell this. Yeah. So there's no doubt that Autodesk right now is priced for high growth. I mean, the thesis moving forward is non-compliant users will be eventually monetized. When adding in new products, new services, new features, revenue will grow at a low double digit rate and profits will grow even faster than that. If there is some kind of software that's out there that I'm not aware of that comes in and eats their lunch and really dramatically slows their growth rate, I would say, okay, I was wrong here. And the stock price

would probably get smashed pretty darn hard. The nice thing about investing in a big company like Autodesk is if they did see an existential threat like that, they could go out and buy it, or they have the resources to kind of invest in their own to counteract that. So the biggest threat that I see as an investor is just that you're paying too high of a price today for not enough growth. Okay. And then is another thing to look at for, because I know you mentioned the network effect. And I think a part of that is that they're in a lot of universities. Is there any way to track how many universities they're in or if there's any other software programs getting traction within the undergrad programs? Is that something to look at as well?

I'm sure there is. I never get into that level of detail with my investments. My investment thesis is always much more simplistic than that. And again, it's this awesome company is going to stay awesome. And I can tell if it's not just by looking at revenue. That's been a timeless strategy. So it's definitely a good way to go. If you were management, so if you had the power to make any big change for Autodesk, what's one change you would make? Again, I would just say, keep doing what you're doing, fellas. You're doing a great job with all my, with all my investments. If I see, if I see a management team that is in charge and has made a business change to the business that I approve of, and I definitely approve of

the transition to a SAS, the market has appreciated that the management team is excellent at communicating to shareholders. And this is a company that is superbly excellent at communicating with shareholders. They produce, they do regular analyst days, as well as produce beautiful presentations that make it easy to understand the thesis and their employees provide them with love. I just give them free reign to do whatever they want. And I don't think that I'm smart enough to second guess what they've done. So I don't have a good answer to that question. No, that's good. I think when we do this, everyone tries to come up with an answer, but that is a good, that non-answer might be the best way because if you're an investor,

you can't doing, trying to think of what management should change is not something you can control. So it may not be actually worth it to spend time on. And it's a testament to the fact that maybe management is doing everything right. If you can't think of a clear change to the business. Yeah. Again, my, my, a big part of my thesis is this awesome company is going to remain awesome. Is it been awesome up until this point? I mean, there's no doubt about it. Pick a, pick a metric. It looks really good with this company. So the thesis is it's going to stay awesome for a long time. And I think based on the information we have today, the CEO that's in charge here is going to keep the company awesome for a long time. Okay. Well, I think

that's it. Is that all your questions? I got nothing left. Okay. That was Autodesk with Brian Feroldi. Brian, for anyone listening that wants to find some of your work or find, maybe connect with you, what's a good place to do that? Follow me on Twitter. I'm at Brian Feroldi. Perfect. Awesome. All right. Thank you guys for listening. We want to remind you that we are not financial advisors. Anything we say or discuss here on Chit Chat Money is not formal advice or recommendation. Thank you for listening. We'll see you tomorrow.