The Capital Cycle Podcast - Dassault Systèmes

Episode Date: February 28, 2025

A French technology champion which has undergone a valuation de-rating and merits investor attention. Presented by Edward Chancellor with Jordane Guillot, an investment analyst.For more information, or to access select articles from Marathon’s Global Investment Review publications which accompany this podcast series, please visit www.thecapitalcycle.co.uk Hosted on Acast. See acast.com/privacy for more information.

Hello, this is Edward Chancellor with another episode of the Capital Cycle podcast. I have with me today, Jordan Guillaume, who's a research analyst at Marathon. The capital cycle approach employed by Marathon isn't directed either at value or growth parts of the stock market. Rather, the aim is to select stocks that the market appears to have an excessively pessimistic view. Thus, an out-of-favor growth stock is just as attractive. as a neglected value stock. I think it's fair to say that since the turn of the century, Marathon's portfolio has gradually shifted away from traditional value

to buying great businesses at a reasonable value. And today I'm going to talk with Jordin about one of France's global technology leaders that he believes isn't getting either the attention or even the valuation that it quite deserves. Yes. generally speaking, when investors think about technology leaders, they think about the US. Europe has largely missed on the digital revolution of the past several decades,

though there are some exception to the rule, and one of them is Dassault System. This is a world-leading software engineering firm, French-listed, who is essential to global innovation of industries such as the aerospace, automotive, and life sciences. So I think it is very much deserve a bit more attention than the market's been given to. And you tell us a bit about Dasso system's history. Yes, the Dassault system was born out of Dassault Aviation,

the French defense company behind the fighter jets, the Rafal, the Mirage. And it trace its origin back to the 1960s. And I think it's quite important to place the context of France in that era. It's roughly in the middle of the Trent Glorios, the 30-year period of economic growth following the Second World War and General de Gaul is back in power. And under his leadership, the country is very much focused on innovation to retain its independence, notably from the growing influence of the US. And the two priorities are energy and defense. And this is very much how France became a leader in nuclear power and fighter jets, for example.

And back in 1967, a group of engineers in the research department of Dassault Aviation simply bought the first ever computers designed for scientific applications, IBM System 360. They learned how to write codes and develop mathematical formulas that led to a revolutionary digital design tool. So that was very much serving the engineers to visualize planes on the computer screen for the first time in 3D. That was the first step, and then they could start designing every single pieces individually,

putting them together, so the assembly line started working on the software. That was initially developed as an internal tool, and that saw Aviation very much scratch the head between keeping it internally as an advantage to the competition or to spin it off as an individual product. And I obviously went for the latter, using IBM as a partner to distribute the product because French engineers were not very good

salesmen back then. So they simply needed partnering and IBM was a great distribution force. And that's how Boeing became actually the first customer, external customer of Daso System. And then he rapidly got integrated into the engineering workflows of Airbus and the automakers. And it became an extremely profitable business. Yeah, so it's very much a business selling unique intellectual properties. So it delivers top-class software margin of above 80% gross margin, north of 30% operating margin. So it's no surprise to see that Dasso system today is more than three times as valuable as it's more cyclical, capital-intensive, parent company, Dassault Aviation. And can you tell me a bit about how the capital

cycle works for engineering software companies such as DASO? Sure. So if you look at the past five decades, the evolution of software has been driven by waves of capital deployment. So the 1970s and 80s were very much focused on personal computer and the operating systems, fueling the rise of Microsoft and Apple. And since the 2000, the arrival of the internet, we have seen an explosion of consumer-facing technology. leading to boom and burst. But throughout those decades, very focused engineering software faced very little competitive intensity. It follows a very different economic cycle. It is not driven by viral adoption and somewhat it became less attractive to venture

capitalists seeing lower chances of fast return. And these engineering software businesses are able to gain a competitive advantage by locking in their customers, is that correct? Exactly. So the engineering software industry is very much shaped by deep technical expertise. So there are high switching costs and very long-term customer relationships. So one key advantages of those software is that they are basically being deployed in universities. So engineers can train on them from their early years and they are very, very reluctant to change. So the user inertia serves very much industry and raise the barring.

to entry. And with decades of accumulated intellectual property and highly specialized R&D force, DASO has built an extremely competitive position in its core aerospace and automotive markets. So firms in the sector don't exactly compete with each other. There are other businesses in engineering software, but there's relatively little overlap between servicing different industries? That is correct. And that is mostly driven by barriers to entry in the engineering parts as well as consolidation. So the market is to them mostly represented by only a handful of global scale players. To name a few other than Dasso system, we would have the likes of Simmons, Autodesk, PTC and Ansys. These companies compete on certain overlapping

industrial areas, but they all have kind of carved out their own niches or sometimes giant niches. So Autodesk dominates the architecture, engineering and construction industry, whilst ANSI is a leader in electronic simulation where Dassault system isn't even present. There are ANSI is also a leader in niches such as electromagnetism and fleet dynamics where they share the leadership with Simmons. So Dasso system has remained at the forefront of product design, testing and lifecycle management of certain industries that have very little competition. And can you describe DASO Systems products in slightly more detail? Yes, so the first few decades of DASO System were very much a single product company called Katia

for computer-aided three-dimensional interactive application. And that was very, very focused on the aerospace and automotive end markets. Recall that these were the largest industrial cap expenders at the end of the last century and the beginning of this century. So they remained very focused on those and markets for decades. And adding to their R&D leadership, they have been also excellent capital allocators. The company IPO did in 1996 and used the proceeds to acquire a company called Solid Works. That was a software used for mainstream 3D design. So think of household appliances such as dishwasher of coffee machine, personal care equipment like an electronic razor.

This transaction proved transformational as it was able to target much wider in markets. Katia is today still 30% of revenue of the company and solid work more than 20% and they are still two of the best selling product of Dasso to this day. So they have remained the technological backbone of many mainstream industrial companies. And they've got into other sectors through more recent acquisitions. Yeah, so building on this foundation, strong foundation of their core business, they have looked at adjacent opportunities along the way. And some of the key acquisition they've made

in the past two decades have been simulation software, supply chain management software, as well as product lifecycle management called PLM, which has now become a very large part of this industry. More recently, they've expanded into life sciences via two acquisitions of which the latest called MediData in 2019, which is actually the leader in clinical trial software and the company's largest acquisition today. How does clinical trial software actually work? That is very much from the research part where a biotech or pharmaceutical companies would be laying out the prospect of a new drug from the design of the actual science all the way to the first clinical trial. So that would involve many steps internal and external.

So you'd have like a software backbone that would register all those steps to lead to, to much more efficient first clinical trial, then leading into Vib if Barr being successful or not at the first round, you then go into the second, and all of this involves a lot of administrative tasks that the software will help you simplify and centralise. And is that also a case where it's used in academia by research scientists and also by biotech and pharma research?

That would be more of the first part of their life science business, which was an acquisition called Acceleris, and they turned this into a software called Biovia, which is very much into here the design of the molecule, so how the drugs would be created, and those were being, as opposed to being testing physically in chemical labs, they would have been tested on software first prior to doing physical testing. So this is very much the combination of the design and simulation of new drugs,

now adding the part of clinical trials. So it's the full suite of drug development. Dasso is now covering. So Marathon likes to look at management's incentives, because after all, management is responsible for capital allocation within a business. So can you tell us a bit about Dassault ownership and the alignment or otherwise of management with shareholders? Yeah, so the shareholder structure of Dasso has been extremely stable

with the Dasso family still retaining a 40% stake in the company to this day. In addition to this, we've had since the company has been public, only two CEOs, of which the current one has been named only in 2023. And he was actually in the company since 2001. We've had only three CFOs, of which the previous one is the current CEO. This has very much ensured continuity and consistent execution of the strategy. towards a wider platform of suite of product. And I think this is very unique in publicly listed companies today.

So Dasso Systems have traditionally traded at a premium, but recently ran into some headwinds. And as far as I understand, it was during this period when the stock was relatively depressed that Marathon made its purchase. Let's talk a bit about the valuation and the inception of Marathon's ownership. As we discussed, this is a very high margin business, very high recurrence, very steady cash flows through economic cycles. And historically, the market has very much rewarded this profile for DASO system. So it has been trading at a premium to the wider European equity market, more aligned to its U.S. listed peers. However, DASO has been facing some headwinds recently. So that acquisition we discussed earlier, MediData, in the last.

life science space, which was done in 2019, has looked extremely smart in 2020 and 2021 when the world got into a frenzy of drug development and clinical trials applications. So that part of the business had a boom, which is now followed by several years of under exciting growth. So there was a lot of funding stopped in the life science place area. All across these portfolios, are businesses suffering from COVID hangover. Hangover, completely. So the life science industry has faced, you know, lower funding since COVID. So 2002, 22, 23 have been relatively low gross years for the life science industry.

So MediData suffered from that, which was priced at the time for high gross portion of the business. And subsequently, we've also found. faced now the difficulties of European auto manufacturers, which are facing the rapid growth of Chinese electric vehicles. They are rethinking now how to adapt. Dasso system only recently signed a new 3D experience contract with Volkswagen for their full suite of EV transition. So this is taking several years to adjust. Ultimately, it has driven Dasso into a lower, slower growth than its history. And you're reckoning that that can rebrand. There's only a temporary reversal of growth. Exactly. So we've seen that in the past with Dasso. And this is also a phenomenon that

started in the past kind of decade where the software industry has been shifting away from a license model to a subscription model. Yeah, because there's a huge boom in valuations of companies that were so-called software as a service, S-A-A-A-S. And I think that Autodes was, one of those businesses that expanded its profits and margins by migrating customers to a subscription model. Yes, so the Autodesse typically took the view of switching off licenses with no servicing and no maintenance. So they kind of forced customers into a SaaS model. When Dasso took a much more customer-friendly approach by letting the customer decide when and how they would need to transition if ever they needed to. So one of the option they've used,

has been to upgrade the Katya version for their customers. So the version 5 was a mechanical driven software. So you could not design and produce an electric vehicle on the version 5 of Katia. So any new project on electric vehicle would have had to subscribe to the version 6, which is a cloud-based product. So you could not get away with it on that case. But Dasso has taken a very, very customer-friendly approach. are taking a lot longer to transition completely to a fully subscription-based model.

And let's finally talk a bit about valuation. Stock is still trading at a premium to the broad market, but you think it's a relatively cheap, if not, you know, a complete bargain. Yeah, I wouldn't say that Dasso's ever been a bargain stock, but we saw an opportunity last year to acquire the shares when almost simultaneously the market was derating the shares, as Synopsis, a US-based semiconductor design firm, was bidding for ANSIs, one of the leading competitors of Dassault System.

The offer from Synopsis was on very high multiples of 13 times EV2 sales and 25 times EV2 ABDIE, which compares to the time of our purchase for Dassau at around 6 times EV sales and 18 times EVABDA, which by contrast to this offer was substantial. and also at a much lower discount to its historical average. Good. Well, thank you very much. That's interesting conversation. Thank you, Edward. Thank you for your time today.

I hope you will listen to the next edition of the capital cycle. This communication is provided for information purposes only. Please refer to Marathon's website and the Global Investment Reviews for further information, including important disclosures.