One of the most underappreciated software companies on the market today may be Autodesk, Inc. (NASDAQ:ADSK), the company synonymous with computer-aided design (CAD). It doesn't make many products that would ever make their way into consumers' hands, but it does make indispensable tools for dozens of industries, from architecture to injection molding.
The standard in CAD
When I first started drawing CAD designs two decades ago, AutoCAD was the standard for the industry. Nothing has changed in the years since, and Autodesk has expanded its market very successfully. It's clearly a standard in architecture and related construction businesses, but it's also serving designers building plastic and metal parts.
The fact that Autodesk products are standard in industries that use CAD is incredibly powerful. From the time students start engineering or architecture school they're learning on Autodesk products. When they get into the professional world, knowing AutoCAD, or another Autodesk product, is often required.
Autodesk's standardization makes the switching costs to competitors very high for companies. Training staff on a new product would incur costs and difficulties, and the result may not communicate well with other vendors.
The feedback loop
When the most valuable part of the value chain uses a standard product, as is the case with CAD, it becomes standard up and down the value chain. Take construction as a great example. Architects normally use AutoCAD, which means equipment vendors that want their products included in a design will end up using AutoCAD. Partners like mechanical, plumbing, and electrical contractors downstream from the architect will also end up using AutoCAD so they can seamlessly cooperate with the head designer.
The mechanical design of goods is moving in the same direction, although consolidation has taken longer because there were dozens of disparate software programs for different functions. That's changing as Autodesk consolidates capabilities like injection molding modeling (Moldflow), machining (Powermill), and stress simulations (Nastran).
The result of all this consolidation and standardization is that an entire industry will end up using a single software platform. Now if one company switches to new software it will leave them as an outlier, rather than give them a competitive advantage. Standardization is a good thing for industries that communicate in CAD, and that works to Autodesk's advantage.
By most traditional metrics Autodesk is very expensive. Shares trade at a whopping 14 times sales and 149 times fiscal 2019 earnings expectations.
But the company's transition to a subscription model will ensure continual revenue and cash flow, rather than allowing companies to skip a software update to save money. Management expects to generate $1.4 billion in free cash flow in 2020, which puts the company's $29.3 billion market cap at 21 times expected 2020 free cash flow. I don't think that's a bad valuation considering the company's lock-in in key markets and potential upside.
Management estimates Autodesk's design and manufacturing addressable market will grow to $27 billion total by 2020, so there's a lot of room for growth. The stock may be up a lot in the last year, but I think Autodesk still has a lot of runway left for investors long-term.