Chit Chat Stocks - Why We Own Autodesk (Ticker: ADSK)

Episode Date: December 5, 2022

This is our Arch Capital Update episode, a monthly recurring series where we explore holdings and decisions made for our investment partnership. Autodesk provides 3D design, engineering, and entertainment software and services worldwide. The company was founded in 1982 in Mill Valley, California. Brett and Ryan dive through Autodesk and outline the investment thesis for why we own the company in our Arch Capital limited partnership. ********************************************************************** What is Arch Capital? Arch Capital is a concentrated, long-only equity fund aiming to compound capital at an above-market rate. Arch managers are perpetual learners with a long-term focus that strive to build wealth with our partners through intelligent capital allocation. Learn more here: https://www.archcapitalfund.com/ ********************************************************************** Timestamps Why do we own Autodesk? (4:03) What are their products? (15:43) Valuation (47:48) 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 monthly Arch Capital episode on Chitchat Money. We've only done, I believe, three of these beforehand. So it's likely that a lot of you haven't listened to

those episodes. So we're going to do a quick explainer of what those are. But before that, I guess we should say what our names are. My name is Brett Schaefer. The other person here it'll be Ryan Henderson, who you'll hear speaking shortly. And these Arch Capital episodes, first off, they are not stock pitches. They are more stock discussions. We're going to be covering say once a month for the investment fund that we do, any stock that we own, any stock that maybe we're considering, any stock that we passed on, any stock that we sold, or maybe not even just a specific company. We're going to be doing a variety of different things. But once a month, we'll cover that. We're doing this mainly selfishly to help promote how we think about

investing, but also to share it with other people so they can give us feedback and maybe learn from us as well. Ryan, anything to add before we start? Yeah. A lot of our listeners, basically, the feedback we got from our listeners is that with the not-so-deep dives, we'll look at a company and then we'll basically have no takeaway. We'll say, eh, we liked it. We're kind of interested, but not at this price, something like that. They wanted something that we're actually optimistic about. And so we thought it would be a good idea to explain our rationale for why we own things in our actual fund, which if you want to check it out, it's the archcapitalfund.com. We'll link to it in the bio or in the description if you want to see

all our holdings. But we're going to talk about Autodesk today. And I believe as of this recording, Autodesk is greater than an 8% position in the fund. So one of our larger holdings. That is correct. Yes. And we're going to go through why we're optimistic about the company today. But first, let's talk about our sponsor, 7investing. Ryan, we just got word of a new deal they are doing. So for anyone that's heard about 7investing, do you want me or you to discuss the promotion? Yeah, I'll do it. Don't skip through this because I know some people maybe skip through the sponsor, but if you've ever considered getting 7investing, this is the best time to do it. They are doing a $1 free trial offer for a week. So you pay a dollar and then

you get access to all of their recommendations, the entire service. And if you use our code money, it's literally free. So this is the best value you're going to get. It's free. You get access to the entire service on December 19th. They're doing a year in review where they're going to look at all the recommendations and determine, basically give an update on them, what they think about them today. So all their active recommendations dating back to when they first started. And if you sign up, let's say December 14th, you've got that within the week. And if you use the code money, it's completely free. And then if you use the code money again, you're getting $100 off your annual. So you still get the subscription, the original rate that we had,

the original discount, but you can try it out and see whether or not you actually like it and whether you want it to be a part of your process for free. I can't recommend it enough. 7investing, use the code money, check out the free trial. That is right. And if you use the code, you will get access to the $100 off regardless of whether you use the free trial or not. All right, let's hit Autodesk. First off, we're going to be doing some stuff over video today. So it's possible when we reference stuff, we might do some share screens. We're kind of going to explore some really big technological innovations by sharing the screen. So if you want to access the video, watch us either on Spotify

or YouTube where the video will be uploaded. And we might reference stuff that is in the newsletter, which is free that goes along with a lot of our stock analysis shows. So sign up for that. Links will be in the show notes if you want to access all those numbers. But let me pull up the document here. Who asked the first question? Because the way these go is we do a cross interview with each other. So I think Ryan, you're supposed to ask me the first question here. Yeah. And these might sound a little inorganic or like brute forced because we're, we know what the questions are and we're interviewing each other, but let's just lead with the basics. What is Autodesk? It's obviously a large company. They have a lot going on. So give us, give us an explainer on the

company. Okay. Autodesk is a software provider for multiple industries that include architecture, construction, engineering, manufacturing, and media. So they sell these software products through subscription packages and enterprise agreements to large companies. And these are typically to other businesses. Although for most of the products, you can buy them as an individual, they're just quite expensive. So usually it's for a professional. Here's the full definition from their website. Autodesk is changing how the world is designed and made. Our technology spans architecture, engineering, construction, product design, manufacturing, media, and entertainment, empowering innovators everywhere to solve challenges big and small from greener buildings

to smarter products to more mesmerizing blockbusters autodesk software helps our customers to design and make a better world for all pretty great overview a lot of buzzwords but i think that can help everyone understand how this works uh so any more details that are relevant for investors or that the software is either sold on a monthly annual or multi-year contract directly by Autodesk or a third party distributor. So sometimes they go through, say, a reseller of software that'll distribute it around the world. Now with minimal variable costs that mainly just include, say, your cloud computing stuff, your setup costs, and your maintenance costs that include in the variable costs there, Autodesk has extremely high gross margins that are greater than

90%. And if we look at its operating expenses, just to go down the income statement, the majority of its operating costs or operating expenses are going into two different buckets. First, its sales staff, and second, its research and development staff. So last fiscal year, they spent $1.1 billion on R&D, or 25% of revenue, and then $1.6 billion on sales and marketing or 37% of revenue. But despite these large costs, Autodesk produced a strong free cashflow margin of approximately 33.6%. This year, if they hit the full or top end of their revenue and free cashflow guidance range, they will achieve free cashflow margins of just under 40%. Over the long term, they believe they can support a free cashflow margin at 40% or higher.

So that's the overview of what they think they can do financially. Lastly, and this is important if we talk any nuances on foreign exchange, Autodesk is very diversified geographically. If we look at their revenue allocation by global region, the Americas is 40%, Europe, Middle East, and Africa are 39%. And Europe, Middle East, and Africa is mainly Europe because they do have a very large presence in Europe. And then Asia Pacific is 21% spread pretty evenly across those areas. They do have some exposure to China, but it's not a huge part of their business. Something to watch. And they were in Russia, which was a low single-digit percentage of their business that hurt growth a bit this year. But again, for Forex, since they

are a US company and they have the Asia-Pacific and European exposure, the rising value of the US dollar definitely hurt them this year for revenue growth. And that's why if you look at their revenue, or excuse me, free cash flow guidance for fiscal year 2023, which is calendar year 2022, it continued to decline this year. And a lot of that was due to foreign exchange. Ryan, anything to add before we move on to the next topic? No, that might have sounded vague in that we described generally what they do and not the actual products, but we'll touch on the products in a little bit here, or at least some of their big products. It's kind of hard to touch on everything because they have so much and some

of it's not really that relevant to the top line, but we'll hit on the big ones like Revit, AutoCAD, Fusion 360, and some others. But why don't I talk about the history of the business and how it is quite relevant today because it's helped form the company that exists now. This business was actually started, I guess you could say early 80s and And every engineering software company we've talked about during this month seems to have started right around then. That seems to have been sort of the proliferation of computer-aided design and the early onset of it. But the original software that Autodesk was built on, which is now known as AutoCAD, but it was called Interact at the time, was developed by a gentleman named Michael Riddle. He was a really bright programmer.

He started developing CAD programs throughout the 70s. So that was like at the beginning of personal computing. But he wasn't much of a businessman. So he, and initially when you developed the software, you had to have, you had to sell a computer with it in conjunction. So you had your own specific hardware for that software. Ultimately, after trying to go at this himself, he ended up selling 30 computers in total. So it wasn't enough to support being a business, but he was introduced to a gentleman named

John Walker by the person who was making his computers. And he said, and John Walker had expressed interest in buying the company. Riddle had sold software in the past for, I think it was $8,000 and that software went on, I can't remember what it did, but it went on to sell millions of dollars worth and generate plenty of profits for the buyer, but he didn't want a situation like that. So they haggled over price for a long time. And finally, Riddle said, I'll sell you the business for a dollar, but I get 10% of all sales of Interact or what eventually became AutoCAD. And Walker accepted the deal. And he started forming, he got a bunch of developers together and he formed the company known as Autodesk. And eventually, that royalty agreement was eliminated after a pretty long legal dispute. And Riddle ended up making, I believe it was $11.8 million.

So more than that, they were haggling between $8,000 and $16,000, somewhere in there. So he ended up getting paid out a little more than he would have initially. But by 1989, Autodesk possessed 60% market share within the CAD market. So they were one of the early pioneers. And being early was a big benefit for them. They actually went public in 1985, so right after forming the company. And because they were able to raise that money early, they quickly started their acquisition spree. And that cash from the public equity markets allowed them to buy a bunch of other smaller CAD-based companies. And they've been doing that ever since. That's basically been the story of the business is today you look at all their products and you see a lot of them have been acquired or they've been developed by a team that was acquired or some of the acquisitions have been integrated into their existing solutions. But it's just been decades worth of acquisitions, too much to really count. Other things that are important, they started their evolution to a cloud-based SaaS offering, I believe, in the 2010-2011 timeframe. They were one of the, I think, the early software companies to switch and switch successfully.

um this among other things has really improved the business and it it allows them to increase prices allows the sales process to be much simpler because people just simply subscribe and re-up and buy the next software as opposed to having to go out and sell them the next on-premise license still sticky software just like it was before but um just gives them a lot more control and a lot more flexibility and ultimately more profitability as well. They're a more profitable business. And if you look, maybe, maybe we can try the share screen here. Do you want to share or do you want me to do it?

Let me, let me share. I can't do it. Share the Autodesk free cashflow per share chart so they can see kind of the cycle they went through as the company went through the cloud transition. I will do just that. All right. Well, anyone listening here, you'll be able to see the chart uh here is here it is so if you look at this or ryan you can go ahead and explain it yeah i'll just explain it for anyone that's not watching the video but they're they were a very profitable company uh pretty profitable prior to the cloud transition coming out of it they've been on it's they've been growing the entire time their customer base but

now they they are are seeing the inflection of profitability as well it just basically looks like your typical valley, your, your valley and profitability, and they've come out the other side improved. And those, those X there's expectations on the end there. So those are the estimates, but the companies come out for the better. And hopefully that was our first good experiment sharing the screen. So if you're watching on YouTube, I hope that helps. Yeah. We'll see how it turns out when like how the recording goes into the actual, you know, how it turns out on the video that people see, but I think it's good. And yeah, we have the expectations here of, and we'll get into why we expect this, the shares outstanding to decrease

by a slight amount and free cash flow on an overall basis to increase by around 15% a year from 2025 to 2027. That's fiscal year 2025 to 2027. So that's really move it backwards because they're one of those weird software reporters that has the strange fiscal year. Ryan, something to add before the next section. Yeah. One last thing on historical context. A lot of the businesses we've looked at, I mentioned this earlier, started in the early eighties. Their core software is still around. They've obviously expanded, become a bigger business, but it's a testament to how sticky and how embedded a lot of these software systems are in their end markets and how much of a pain or difficulty it is to switch. And especially when you have the enterprise customers

and you have a lot of engineers or coworkers on the same system, it can be a real pain to retrain that entire staff. And then obviously, there's nuances in how you communicate those files as well. So it can be very difficult to switch. And I think if you look at the returns of almost all the engineering stocks over the last decade, and probably since inception or IPO, they're impressive because they are good business models. And I would argue Autodesk is probably one of the best of them. That's right. And we think it's one of the best run and the cheapest, but that is teasing the next section. I guess we'll move on to products. We don't have to ask each other the question, but I'm going to hit what are the most important products within another

overview. Because again, if it's your first time hearing about Autodesk, it's really hard to understand. So we're going to hit product a lot on this episode. And they actually just went through another change in the definition and their overall strategy for the next decade as they try to move everything to the cloud. So as of today, Autodesk has three main software clouds, which they describe as clouds, but it's really product portfolios. They are three Fs and they're called Forma, Fusion, and Flow. Forma is the software products that cover architecture, engineering, and construction. The engineers in this case, if you're thinking about it, means civil engineers, construction engineers, stuff like that. So these software products

include stuff like AutoCAD, Revit, the Autodesk Construction Cloud, which we'll abbreviate as the ACC, and other things like Navisworks, a lot of civil engineering stuff. So over time, management says the goal for the software cloud is to connect building and infrastructure construction from land purchase down to operating a completed project. So they want everything connected through however they're going to do it, through the cloud, through all these software tools through the internet they want these various software products within the suite to help people you know they one of them might help design one of them might help manage one of them might help for communication but they're all under forma and they're all going to be hopefully intertwined so

say the architect working on revit can seamlessly go down to the engineers and construction workers down at the site and everything connects seamlessly. So with Informa, the most important single product is Revit, which will hit specifically and why we're very confident in that company or that segment to grow over the next decade. And second is the ACC, the construction cloud stuff, which we'll cover in another section as well. The second cloud is Fusion, which are software products covering manufacturing, mechanical engineering, and industrial systems. So the most important products here are Inventor, Fusion 360, and UpChain. Over the long term, management wants to connect, quote, the top floor to the shop floor.

All the strategies here are similar, where in the manufacturing process, you might have design over somewhere else with people just working on computers, some engineers just in the design realm. And they want everything to move down to manufacturing through the same software system, which they'll be calling Fusion. And that is design, simulation, testing, and building and products all connected to the Fusion Cloud. The most single important product here is Fusion 360, and we'll cover why we're very bullish on that in another section. Lastly, we have Flow, which are the software products for the media and entertainment space. Like with engineering and construction, they want to connect workers from, say, the inception of a project down to the final product. And the most important single software product here is Maya. we're not going to focus much more on media and entertainment during this podcast because it's

small part of the business today however they are very optimistic about this long term and think they can really do a lot of value add for visual effects and the complicated nature for all these new shows that are very um just they get more difficult and more difficult to make every year for example at autodesk university their recent product uh conference they brought in uh i think the head of Amazon Studios or the head of whatever division is using Autodesk products at Amazon Studios and talked about how they used Maya and what will eventually be called the Flow Cloud for the really complicated Rings of Power series, which is that big Lord of the Rings thing that Amazon spent millions and millions of dollars on.

So again, they're very bullish on that, but we're not going to hit much on that there. So I just kind of wanted to use that anecdote. It's only a small part of the business, but it's starting to pick up some growth. And no matter how fast it grows, it's not going to contribute much over the next few years. But management says, watch out for it this decade. So I guess just keep track of it. Now, to maybe even make things more confusing, on top of Forma, Fusion, and Flow sit Autodesk Platform Services, which, if you followed the stock, was formerly known as Forge. I think they just didn't want to make something the fourth F.

this is a set of apis and programming tools that allow autodesk customers who want to customize software to connect software products within the three clouds and across them so for example this could mean a specific customer who wants to use revit but also fusion 360 on a project but to do so in a seamless manner say connect a data point connect something within them and autodesk platform services allows you to customize all this stuff and for a fee where they're paying Autodesk for this. This is a harder thing to

underwrite as an investment, but I think it's really good to allow the more complex users, the bigger users, the enterprises to connect all the products together because that can increase the moat. And we'll talk about the bundling and all that stuff and how it'll, we believe,

gives Autodesk a competitive advantage and will widen it over the long term. And that's sideways into the next topic here. So, Ryan, your question assignment was why does Autodesk have an advantage over its competitors and where do we believe

that advantage comes from? Yeah, ultimately all these, I've labeled three, but, or I've segmented it into three, but ultimately each one contributes to high switching costs. It's difficult to switch. And the three factors,

well, the first one I'll talk about is bundling or pairing, as you mentioned, because Autodesk portfolio extends beyond just product design software, the company is able to cross-sell a lot of its solutions as a part of a bundle. So this allows Autodesk, in a lot of cases,

to be the low-cost provider. It might not be the low-cost provider of a single software, but when you bundle the two together, it's at a relative discount to buying the point solutions independently. Simultaneously, it allows them to sell more licenses. Selling more licenses means your customers are more dependent on multiple products from you.

It kind of increases the switching costs and it makes it more difficult for a customer to go to a competitor or something like that. So the bundling aspect, I guess you could call it the scaled economy shared where they are able to offer paired discounts relative to others because they have such a diverse product portfolio compared to a lot of their competitors. The second one I want to talk about is the resume moat. This is a term that I wouldn't say we've coined, but let's say we've coined it. We stole it. I mean, I guess the resume mode is our term, but other people have had this idea before. Right. And basically within many of the end markets Autodesk serves, its products are considered

the industry standard. And so that means, and this isn't some new concept. I'm sure a lot of people have thought about this before, but this means that the workforce now expects their potential hires or the graduates that are coming out of school to be equipped with an understanding of Autodesk's various products before they even join the team. And that is in all cases. I'm sure you can train your employees on a different software if you use it. But in most cases, it helps kickstart them or get them rolling right from day one if they already know the software going in. Autodesk leans into this by giving students free limited term access to a lot

of its product suite. A lot of colleges subscribe to it. And I know specifically for Autodesk, whether it's Revit or AutoCAD, there are classes, semester-long classes dedicated to teaching their students these software systems so that they enter the workforce already knowing it. And so on top of it, it raises the switching costs for the actual customer bases as well, because Then you've got students coming out of college equipped with their understanding of Autodesk software that it's a lot easier to just stick with the software that the graduate students are understanding instead of making them retrain or learn a new system. So it's kind of a great sort of two-sided, I guess you want to call it a network effect, but it's a great moat in that the potential employees are listing this on their resume. Is that a good way to explain it? I would. Yeah, I agree with that. And I would almost describe it as a self-fulfilling process where if you're trying to compete with this, it's a sort of a chicken and an egg problem.

How do you start? Do you give a bunch of stuff to students that no one's using in the real world? Well, OK, then the architectural firms are going to get mad and they're going to get mad at the colleges and they're not going to hire as many people from the colleges and the colleges will get mad because then, you know, their students are graduating into jobs that they can brag about on their two other colleges. So it's all locked in and it's all very, very difficult to displace. Think of it very similarly, say, for the finance world. Think about it as Excel, Microsoft Excel, Bloomberg Terminals, CapIQ, stuff like that, where it's a product that you're in all day, which also goes on a resume. although I wouldn't put maybe CapIQ on a resume. Bloomberg might go on a resume. I'm not so sure. But Excel, as we all know, even a lot of people joke about it nowadays, you put that on a resume

and Revit is one of those tools. And not just Revit, but other Autodesk products. Yeah, there's a couple. I mean, Autodesk is not the only software company that has that advantage. I'd say Adobe has that advantage as well for a lot of their products.

But it also kind of leads into my third competitive advantage. And I'm a little reluctant to say this one, but it's the brand. Typically, I don't talk about brand as a competitive advantage just because brand can change. But this goes hand in hand with the resume mode if you think about it from a competitive standpoint. So if I'm a competitor, not only do I have to assemble vastly superior software in order to get their customers to switch over to your solution, but you also have to win the reputational battle. And when Autodesk products already have such a strong reputation within their ed markets, especially let's think architecture design or architecture with Revit, even if you come out with a best-in-class product, you're going to have to get colleges to switch. You're going to have to get the workforce to switch, the employees that are coming out of it to switch. It's just very difficult to do, and people know Revit really well. I think you described it. It's kind of like the Kleenex for architecture. It's a perceived product that everyone has to use.

No one even thinks if they're making a super professional thing. There are obviously other products out there. But if you're making something that is a high-rise, like you're at a big architectural firm, no one thinks of using anything but Revit. And that makes you rely on Autodesk. Yeah. And so I guess ultimately, as I mentioned earlier, all these factors contribute to high switching costs for Autodesk, which high switching costs typically begets good pricing power. It also begets lower likelihood of churn and low churn. A higher pricing power is sort of the two inputs to lifetime value.

So you're extracting really high lifetime value out of your users. And on top of all this, it's just the software itself, it takes a while to learn. And it's critical software. So it's software that their end markets are using all day. They live on this software and it's just an absolute... When's the last time you took a software you use on a daily basis and you switched it and tried to retrain a whole system? It sounds like it might not be that hard, but I haven't done it in a really long time.

And these people are using Autodesk products a lot more than I'm using any one specific software. So the point is really difficult to switch. Yep. And the cloud stuff even plays into that more, which we'll probably hit on later. Let's go to the next section. And that is why we expect Autodesk Building Information Modeling or BIM. We might say BIM as an abbreviation there. Their products within the BIM market to see consistent growth this decade. First off, let me share the screen here and share it.

And we'll check out one of their recent. Let me get to the title here. All right, here it is. So if we look at the recent Q3 results, all right, here it is. AEC revenue, I'll describe it here for anyone. So from 2017 to 2023, which is really fiscal year 2017, which is 2016, and that's right at the end, or sorry, the beginning of the software as a subscription transition. their AEC revenue, which is majority the BIM revenue and their Revit revenue has really soared and it's compounded at 18% rate. So if we look at it, it's gone from $212 million in

revenue to $575 million in revenue. And if you look at here, you'll see this in the newsletter as well. There's a nice pretty chart that just goes up and to the right, really, really steady. Wouldn't you say, Ryan? Just beautiful, consistent growth. Now, why is this happening? Why is it growing so quickly? We'll get to that. But first, I guess people might want to know what BIM is. And the definition is loose, but it essentially means creating and managing realistic 3D assets across the construction and infrastructure industries. So Revit, with its 3D modeling platform, is the most popular software for architects to create and manage new projects nowadays. And if you combine AutoCAD, which is a smaller portion of the business today,

but the original Autodesk product, Autodesk has more than 50% market share worldwide for the BIM market. Governments are starting to mandate BIM software be used on construction projects, along with general industry trends. This has increased the usage of BIM over the last few decades. But as you can see from the chart below, which again, I'll share the screen after we get done with this section. And again, I'll describe what it is. The vast majorities of countries are still under 50% BIM penetration. So this should easily, or excuse me, steadily converge to close to 100% as government mandates flow through to the architecture industry. And as the leader in the space, Revit should benefit greatly for this. Let me share the screen again and we can check

that out. All right. So if you see this picture here, again, I'll just describe it. They have this from their investor day presentation. Almost every country, is it full? You want me to show it bigger? All right. Well, there it is. I'll zoom in. If we look at this chart here, you have the only country that's at 50% BIM penetration is Finland, which is a very small market. And the majority of countries, they kind of had a blurry image on their investor day. But if you look at the US, it's only at about 36%. If you look at a lot of other countries, it's even lower. Only Western Europe and US are really in that 30% to 40% range of BIM penetration. That should give them steady, steady revenue growth as that continues over the next decade.

All right. Now, let's go out to even other stuff that we think can help Autodesk grow within the BIM market. On top of the government mandates, Autodesk has been able to tighten down on the pirated software with its transition to cloud-based subscriptions. So with the ability to monitor and shut off accounts if customers misbehave, they've been able to, and they describe it as convince pirating customers to start paying for what value Autodesk provides. So last quarter, for example, they won a $5 million contract through these compliance methods.

And before, they really couldn't because they'd sell the license, wasn't connected to the internet, and people can kind of share it across. It was much, much harder to track. Now they only share stuff that they can monitor because a lot of the times people will pirate it because it's very expensive. And now they can get people to not do that. They've been very lenient on this, though, over the years because they don't want to lose customers. So it's just going to be a steady trickle. They're not going to say, all right, by this year, you have to do it or we're shutting you off.

They usually negotiate and try to be nice with customers. Now, lastly, or not lastly, but next on, I guess, reasons why the BIM market will grow and why REVIT will grow are the government incentives for infrastructure projects this decade. So many governments have announced and are allocating hundreds of billions of dollars in incentives to improve and modernize their physical infrastructure. We saw that in the US, but there's been stuff all around the world as well. One of the main ways to quote unquote modernize is to increase digitization, which means increasing the use of Autodesk products in most cases. And I wouldn't forget price increases. So Revit has really consistently been able to raise prices by about 5% a year. And right now, the cost is, as of what I just checked, is still at only $2,675 a year, which if you compare to a six figures plus salary per architect employee, plus travel, plus whatever, plus computer costs, you could argue that Revit is providing much, much more value versus all the other expenses. at a company, especially with all the automation stuff in there nowadays and how they improve it every year and how they're going to connect it down with the form of stuff. There is plenty

of room to increase prices in the future. The way I thought about it one time is if we woke up in 2032, whatever, 10 years in the future and Revit cost... The price of Revit was $5,000 a year, I wouldn't be surprised. I don't think that many architects would churn off. Now, if they raised it $5,000 next year, I think a lot of people would churn off because that's a huge price escalation within one year. But I think that steady 5% increase or $100 a year increase or however much it is, is really, really easy for them to do. So on top of that, you have one of the general trends within BIM that will get more users on the platform. And once you have more users, you're going to have the pricing power as well. So if you add all that up, we think there's

a really clear path to growing revenue at 10% to 15% a year through 2030. Now, 2030 is just an arbitrary number because that's kind of a number a lot of people like to throw out for when they think things will grow. But really through 2025, through 2028, and really beyond, we think that it'll grow at 10% to 15% a year. And that is their most important segment. So that's why it's really important for us to hone in on that. All right. Next category, unless I forgot anything, is we're going to talk Fusion 360. It's growing like a weed. Ryan, I'll let you talk about why we think it has so much potential. And then maybe at the end, I can show any charts. So we don't, I think it's better to not interrupt. We'll do the charts at the end. Yeah, sounds good. So Fusion 360,

It sounds, the product in a way is similar to the name. It's a fusion of a number of different functions. And so the way I understand it is it's kind of Autodesk's all-in-one integrated solution. Users get design, manufacturing, engineering, and printed circuit board functionality. I had to look up what that was, but it's basically for your semiconductors, all within a single unified system. So in other words, Fusion 360 simplifies the process of design to fabrication by combining what would have previously been multiple disparate solutions. And it's really kind of, it's very seamless.

I watched and I've linked to, if you're reading through our newsletter, which is free, feel free to go sign up. I've linked to a video that kind of shows a tutorial of Fusion 360. I really recommend looking at that because you can see how valuable it would be from a customer's point of view because it's displacing so many other independent point solutions. And then on top of it, it's also cloud-based. So that means that a user's product progress can automatically be saved and uploaded to the cloud so that let's say you are a Volkswagen or you're an employee at Volkswagen, you're designing a part and you have to get it checked by a quality team in another part of the world. you can easily just your progress is saved

that other team member signs in checks the product does his checks, moves it forward to the next part of the team and it's all cloud based and makes it very easy and it's basically saving costs for a lot of its customers

obviously it's going to be cheaper than buying every individual solution independently but it's also a fraction of the cost of its next closest competitor which is Onshape on shape. And we talked about that with its PTC software.

We talked about PTC last week. Costs about $1,500 a year per user, whereas Fusion 360 costs just $495 a year and offers free trials. Yeah, Brett, you have something? And I would add to that when we talk about how

Fusion 360 is only approximately $500 a year right now. They purposely underpriced versus the value they wanted. And they actually got people... concerned that they were selling it for too little. They had people asking, are you really selling the same amount of capabilities at only $500 a year? So typically, these type of software products will be in the thousands of dollars a year. Like we mentioned before, Revit is a little

over $2,500 a year. So they're really trying to undercut. And that is because, well, the legacy players, which one of them is themselves with Inventor, but the other ones with PTC, and especially just so systems with solid works and uh what's the other one katia right have uh they're the market leaders and they're trying to displace them and the switching costs are high but so they they really want to undercut on price um and as you're going to talk about in the next section the growth has been phenomenal so far yeah i mean they since over the last 10 quarters subscriber count has increased from 85,000 seats to 211,000. So that's 10% growth each quarter. And the opportunity here is really huge. I mean, you think about all the different software

solutions that they're replacing. Management estimates the market at 38 billion. That's probably a little high, but you can see why this would be so valuable to customers and why this would be so valuable to a lot of different customers. We talked about this before, but do you want to give the example? You worked in a lab for a while, so you kind of have a better understanding of how this software works in the workplace. Do you want to give the example? Yeah. So they talk about the connection from the top floor to the shop floor. An example here would be, and this is very simplified in a place that didn't have many workers. So think about how much more complex it would be in a workplace with thousands of people. Let's say in the lab I was

working on, we needed to design a part and bring it down to the lab, excuse me, the manufacturing floor to get it processed for this custom thing you would design the part in solidworks you would make a drawing within solidworks you'd have to print out the drawing or email the drawing and then bring it over to the manufacturing place the shop right where they can build parts for you with the people that are experts in that then they would get the drawing they have to check to make sure that it fits all their qualifications they would have to upload it to their own software which is typically called Mastercam or something else. And within that, there could be bugs, there could be things that are off. Then they have to make the part within your specifications.

They got to hope everything isn't wrong. So if you connect everything to the same software platform and have it cloud-based, you could build something in Fusion 360, make the drawings, and they can immediately be available within a cloud file system for the manufacturing person who is signed up for the manufacturing extension on Fusion 360. So they can use that and immediately take it out. So it just saves so much time, so many headaches. And I was thinking, since we were at SolidWorks, I was at a college, so we were at a SolidWorks university.

So everything was SolidWorks and Mastercam, I believe, was the manufacturing one. if we had fusion 360 people would be upset for a little while because you gotta learn it's different you're at it all day but once you switched I think it would save so much time and everyone would enjoy it because you just

have way way less busy work alright I think that encompasses fusion 360 pretty well well given the numbers on do you want me to share to give the numbers yeah

share the screen if you want And then I'll talk through it to the people that are listening on the podcast, since that's the way most of our audience still consumes our content. So this is a little old. I believe it's a year old now. But their three-year CAGR or compounded annual growth rate in billings was 107% within Fusion 360. And their three-year growth rate within subscriptions was 53%. So both really solid, but it also indicates that they're getting more, they're essentially raising prices and getting more value out of their, or more billions out of each user. So it's a category that we, it's probably the, would you say it's the fastest growing?

Well, I guess we're about to talk about, it's one of the fastest growing products within Autodesk portfolio. And it's definitely one, it's one we track every quarter and it's one I think investors should keep an eye on. So the other one, though, is the Autodesk Construction Cloud. Do you want to talk about that? It's very similar to Procore. We just had our show on Procore. Hopefully, you can talk about, I guess, the competitive dynamics there as well. Yep.

And then lastly, in Fusion 360, I'm showing a chart of updated for Q3 2023, which, again, is basically Q3 2022. They just passed 211,000 subscribers on Fusion 360. And growth has slowed a little bit coming out of the pandemic because they got a boost. people wanted cloud-based stuff but the progress has still been very steady and remember that billings which is revenue essentially revenue uh is growing much faster than that but yes i will hit the acc uh which is not uh the atlantic coast conference uh but yeah let me load up my notes there so we looked at procore uh and i would definitely listen to that show to get a more

comprehensive overview of the construction management software market but But I think a plausible scenario is that Autodesk saw the rapid growth of Procore, which is the leader in the construction management software space, and they decided it was a market they wanted to attack because it was adjacent to their core design products. So after multiple acquisitions, it now offers software products for construction contractors and on-site workers through the ACC. So general contractors, subcontractors, owners will buy ACC products and say painters, construction workers, whoever is at electricians, all the people can get access and use the ACC to communicate, send documents, all that good stuff. So there are a variety of products, but the most important is Autodesk Build. The software program allows construction workers across a project to connect, communicate, send documents digitally. It is virtually a copy of the core Procore product. And again, I would recommend listening to our Procore episode for more product details.

Some numbers on Autodesk Build. It's very early and they don't give out any consistent numbers. But the last two quarters, they gave us some things that are very promising. So if you look at MAUs, which are monthly active users, last quarter, they grew 60% quarter over quarter. And then that is on top of 40% quarter over quarter growth in Q2. So clearly, customers are liking what Autodesk Build has to offer. And we think the ACC has so much potential for Autodesk for two reasons. One, for how early digitization is within the construction market, is one of the lowest, I think, only agriculture and hunting are behind it for all industries worldwide. So Procore and the ACC have a clear path to building a duopoly in this space. And with how large the market opportunity is, both companies could, and I want to say easily, because Procore is closer and Autodesk is very, very far away within the ACC.

But I think it's very plausible they both can be doing north of $1 billion annual sales within a few years just because of how large this market is. There's trillions of dollars spent on construction annually. And if 1% of project dollars-ish, maybe even 2% are going to the software tools that they're using, that's a huge addressable market that a lot of the companies estimate to be in the tens of billions of dollars. And even if it's a lot less, both Autodesk and Procore can do quite well. Plus, we also think Autodesk has a competitive advantage because it can bundle the ACC with its other products like Revit, AutoCAD, Navisworks, et cetera, that other people within the construction supply chain are already using. So they can say you have your model in Revit, you can connect it down to the construction site and have documents, data, and other important things that need to happen when passing out projects from the architects down to the actual construction. And this is what management says

they're doing. So again, I think it was very nice to see at Autodesk University, then talk about FORMA and the long-term plan, because that's kind of what we were hoping management was going to do as well. Now, right now, ACC is a small part of Autodesk revenue. So before say 2025 or two to three years from now, it's not going to be meaningful to top line growth. But we think from then onward, given the huge opportunity within the space, it can drive meaningful top-line growth for the company. Ryan, anything to add on this before we hit valuation? No, it's small now, but I think if you think about Procore's size today, I think it's very possible for Autodesk to achieve that within the next couple few years. And Procore's growing too,

I think it's not going to be a winner-take-all scenario, but I think they can achieve that. And I think Procore's got north of $500 million in ARR, so that would contribute to the top line for Autodesk, which as of the last 12 months generated just under $5 billion. So it's still small, but it could certainly be meaningful in the long run for them. I'll talk the valuation though, because that's a big part of our investing process. And so it's not just looking at business, but obviously you want to be right about your qualitative assumptions on the business first, and then look at the valuation. So at today's current price of, well, I did type this out yesterday, but $208. And Brett, you can maybe look up the current price.

But at $208, Autodesk has a market cap of just under $45 billion. It has $2.6 billion in total debt and $1.8 billion in cash and marketable security. So it puts their enterprise value at $45.6. Yeah, Brett. Confirm it is slightly lower today because I think the software stocks were down. We're at about $200 a share. So whatever Ryan is saying here, just slightly lower, 2% to 3%. It's cheaper as of this recording.

So anyway, let's just then let's go $45 billion enterprise value. Over the last 12 months, Autodesk has generated $1.84 billion in free cash flow. And management expects to finish the current fiscal year, which as Brett mentioned, I believe we just passed Q3. So it's almost there. They expect to generate $1.94 billion in free cash flow. So a little under $2 billion. If they get to the high end of their range, it's basically $2 billion in free cash flow for the

year. That would mean Autodesk trades at an EV to free cash flow of basically 23 times, or that would be current year free cash flow. Trailing 12 months is about 24 and a half times. While that might not seem like the cheapest business we've ever discussed on the show, I think the last time we talked about our large capital holding was Consorcio Ara, and that is a Mexican home builder that I believe trades at like three times cashflow. So obviously cheaper optically. Autodesk, we have a much higher degree of confidence can compound its earnings per share

or its free cashflow per share at a double digit rate. And mostly because of what we discussed above. It's competitively advantaged. It's going to grow its customer bases across a number of its products because of a number of tailwinds. And then it can also raise prices because of the massively high switching costs.

So, those factors, we believe it can generate double-digit free cash flow per share growth over the next five to 10 years. For reference, over the last eight years, and I chose two years that are not just optimal for this comparison, but I chose the peak of free cash flow earnings before the cloud transition to the current fiscal year. If you compare those, Autodesk free cash flow per share has still compounded at 16% annually. So the business has demonstrated a remarkable ability to just continue growing. And I already kind of showed that chart for anyone that's watching, but basically it shows free cash flow per share going from $2 to just under $10, and we believe that's going to continue to grow as well. While I don't typically use relative valuation in my own analysis, I don't think Brett does

either. Because we just finished up a month of engineering software stocks, and the businesses are frankly very similar in how they run. I have compiled all the different valuations of the businesses that we talked about this month. And Autodesk is the cheapest on a free cash flow basis. Brett's sharing his screen here. It's the cheapest on a free cash flow basis. Dassault Systems is probably the second closest. And it's growing other than Procore, which isn't profitable, but it's growing quicker. Autodesk is growing the fastest of Bentley Systems, PTC, ANSYS, just so had the benefit of foreign exchange. So they're actually growing slightly faster. But it's the cheapest business. And of this list, I would call it the highest quality

and the most likely to compound at a double-digit rate, earnings at a double-digit rate for the Ultimately, I don't think – it trades at roughly 24 times free cash flow today. I don't think the multiple will compress too much over the next five years. And so under that assumption, shareholders would basically get the returns on – the shareholder returns would mimic the free cash flow per share growth over that timeframe. But if the multiple does compress significantly, Autodesk has a buyback, and they've shown that they will buy back their stock opportunistically when they see it's right, and they will increase how much they're buying back as well. So if the multiple does compress,

you basically have to assume that the share count will go down quicker, which would increase the free cashflow per share assumption. So multiple comes down, free cashflow per share assumptions probably goes up because we trust this management team to allocate capital in a wise manner. So one way or another, we think that double-digit rate of growth is going to show up. Yep. And the last thing I would add there is they are facing foreign exchange headwinds right now. So the growth could even get better. But again, that stuff's a little bit unpredictable and not something we focus on too much. So we kind of assume it's going to stay neutral, although this year has been really tough on that.

All right. Next up is management allocation. this one will be short. But from our vantage point, we give Autodesk management a fantastic grade for product execution, and then maybe a passing grade for capital allocation. I'll go through each and why. So right now, the company is led by Andrew Anagnost, who has excelled at really every position at the company, and he has been the CEO since 2017. So before that, he was still at Autodesk, and he was in charge of Inventor, and took it to a $500 million revenue business and then manage the business model transition to cloud-based subscriptions. So great track record at the company, and it's now doing another business model transition

into the different clouds. He has been instrumental really in Autodesk growth and tightening its competitive advantage and has also been focused really strongly on improving the company's product offering for customers. The main thing that gives us confidence with management besides others, or excuse me, compared to other software companies. And I think one that everyone knows or a lot of people cover

that would be a great example here is Adobe. Is we think Autodesk is on the top tier of companies willing to disrupt themselves. They did this with their old software products, which are, I guess, not old. It's their mainline one. But Revit was the disruption to AutoCAD. They're doing a Fusion 360 to disrupt Inventor

and they plan to do it for all their products over the long term with these three cloud platforms. So we think that compared to, say, maybe an Adobe or some other companies out there that are maybe more legacy, older within the software realm, Autodesk is preparing itself to not weather any sort of competitive advantage attack. And what's interesting is when they disrupt themselves,

some of the older products still continue to grow at a really consistent rate. So AutoCAD, which again, they have been trying to disrupt themselves for years within this product is still growing revenue at a double-digit rate. I find that highly impressive and is why I think it's an example of the competitive advantages being so strong. Now, one low light, again, we've been very bullish on today. One low light, and I think probably our biggest low light is capital allocation.

It's a bit of a mixed bag. They use heavy stock-based compensation and have repurchased stock in the past to, quote, offset dilution, which is not really something we like. And they spend money on acquisitions without valuation or price in mind. So for us, those are both big concerns that we're going to be watching and hopefully doesn't continue. We don't want any large acquisitions as a percentage of their market cap or buybacks at absurd prices. Now, to maybe help with this, they got a new CFO, Debbie Clifford, and she has shown a strong capability to repurchase more shares if the stock gets depressed as they have been in 2022. So So shares outstanding are really only down 4% in the last 10 years, but a lot of that

was in 2022. However, they went through the business model transition where cash flow wasn't really, there wasn't much in say a few years back. And over the next five, that's not going to happen. So the company is set to generate a lot more cash over the next five years compared to what they did in the previous five. And we think shares outstanding could decline at an accelerated rate if the stock doesn't go up too high. And if the stock goes up a little bit higher than maybe is warranted,

we're not going to... That's a good problem to have as shareholders. All right, last question. Board just approved a $5 billion authorization as well. That is true. All right. To close things out, let's hit the premortem. What are the risks we are watching? How could this go wrong? How will we know if the competitive advantages are deteriorating? Yeah, this is a question we always ask our interviewees. So it's kind of fun to ask ourselves, there are a couple of ways that we'll be able, I think we'd be able to tell if Autodesk business quality is deteriorating. So the first one would be diminished pricing power. Sometimes this requires, it's not always easy to tell, but they report a 100 to 110%

dollar-based net revenue retention figure. Obviously that's a pretty wide range, But if they stopped reporting that, then it could potentially be cause for concern. The other one would be bookings over time. If customers are growing and bookings aren't growing in tandem or billings, then you know that the pricing power is over a sustained period. It's potentially losing some of its pricing power. The other one would be market share losses. also not easy to track in real time. But basically, if there's a competitor that's public that has a competing product, we can track the seed additions relative to one another. So

I think Fusion 360 with Onshape, it'd be pretty easy to track which one's growing more seed additions. Obviously, they're at different starting points, but that's one way to see who's growing fastest in the market. And then the last one, and you mentioned this briefly, is increasing acquisitions as a percentage of their enterprise value. Autodesk has always been a serial acquirer. They're going to continue to be a serial acquirer, but they've been able to limit how much they spend

as a percentage of their enterprise value on these acquisitions. So it's typically been smaller acquisitions that they then iterate on and grow themselves. What we don't want to see is a Figma-like situation with what Adobe had, where they're paying a big chunk of their own value to go out and acquire a competitor. That, to us, is kind of admitting that we were wrong about the competitive advantages that their products have. On top of that, Autodesk has typically been – they typically acquire differentiated solutions. It's additive to the ecosystem as opposed to replicating something they already have, which to us, we see more as a bit of a defensive acquisition instead of buying a replicated product is more defensive. Autodesk has typically been, at least optically for us, looks like more offensive with their acquisitions.

Yep, for sure. All right. I think that's going to cover it. Anyone has any questions, email us. There's the email in the show notes. And if it's not in the show notes, they're in all the show notes. You want to contact us on Twitter, you should be able to do that in the show notes as well. Subscribe to the newsletter, contact us there.

And check out the fund for any more information. We do write-ups on that website. We publish our holdings monthly. And yeah, it's archcapitalfund.com. Let's get to the disclosure. As we do know, as of this recording, Autodesk is a holding in our fund. So yes, full disclosure, but let's get to it. Remember, we are not financial advisors.

Anything we say on the show is not formal advice or recommendation. We are general partners at Arch Capital and clients may hold securities discussed in this podcast. Thank you all for listening. We'll be back next month covering Wix for our website and e-commerce software month. And besides that, through 2023, we're going to be covering other topics that are relevant uh, for our themes. All right. Thank you all for listening. We'll see you next time.