Software as a service can be a lucrative business model, but it only works if customers stick around for the long term. Autodesk (NASDAQ:ADSK) believes that its software products are so good that its customers will stick around for years on end, but do the numbers back that up?
In this week's episode of Industry Focus: Tech, host Dylan Lewis and Fool.com contributor Brian Feroldi talk about the risks facing Autodesk, its management team, its corporate culture, and whether they will be buyers of the stock today.
To catch full episodes of all The Motley Fool's free podcasts, check out our podcast center. A full transcript follows the video.
This video was recorded on July 2, 2019.
Dylan Lewis: All right, Brian, you have a wringer that you like to throw stocks through. We have talked about some of the things that I think a lot of people would tend to hit on when they are looking at a business. Look at the books, look at some of the opportunity out there. We're going to dig into some of the things that you always make sure to check the boxes on. One of the first things, particularly in the software-as-a-services space, is customers -- specifically, do we have customer concentration?
Brian Feroldi: Yep. You have to think about customers from a number of angles. The entire SaaS model falls apart if you have trouble attracting, and importantly, retaining, customers. That's why we like to put any business through a checklist. On the customer side, is acquiring them expensive? Well, in Autodesk's case, I do think the answer is yes. There are significant barriers to entry to learning how to use the software, and the company spends heavily on sales and marketing to get the word out. Those investments, I think, are worthwhile because as we saw from the net dollar expansion rate, once they do become customers, they do become very sticky. So that expense is OK in my books.
Are they dependent on the software? Well, I think the answer there is yes. Once you take the time to go through and learn it, you continue to use it. Is Autodesk's revenue recurring? In this case, yes. Now that they've made the transition to a SaaS model, their revenue is almost all recurring in nature. Does this company have pricing power? Well, we've seen the gross margin rising in recent years, so I think the answer is yes.
Overall, I think that these are typical things that you see of any successful software-as-a-service business.
Lewis: Yeah, I think you're absolutely right there. One of the things, it's not a very measurable thing -- I mean, I guess you could look at market share, but the thing that I love to see with the software-as-a-service segment is, is whatever this company offering industry standard? If so, even if the acquisition costs are a little high for customers, it's going to be really hard for someone else to come in there and disrupt the model. Not only do you have all of the regular stickiness that comes with a software product, but you have a market-leading position, which is huge, and you have customers that truly need the product, in the case of these designers, these architects, these engineers. That makes me willing to give the benefit of the doubt to a company that may have some higher acquisition costs than the average business.
Feroldi: Yeah, and these are products that take months or even years to master and learn how to use. Once you've spent the time to do that, the switching costs become enormous. That's something that's very attractive for investors.
Lewis: All right, next on the checklist, we have management and company culture. What do you see there?
Feroldi: Well, let's start at the top. The CEO is Andrew Anagnost. He has only been on the job for a few years. One thing that we like to see, as Foolish investors, is huge inside ownership. Unfortunately, that's not the case here. He owns about 31,000 shares of stock, which is worth about $5 million at current prices. That's not nothing, but this is a $30 billion business, so that is not even close to a rounding error. But the good thing for investors is that the CEO is required to own six times his base salary in stock. That way, his incentives are sort of aligned with investors. But the business is almost 40 years old. This has been publicly traded for a long time, it's been a very successful company. It would be wrong of us to assume that the insider ownership rates would be very high here. But that is something that we always like to see.
Let's look at the culture. We always check out companies on glassdoor.com. This company gets four stars out of five on Glassdoor. The CEO rating is 84%. Employees seem to like working here, and they seem to give it good reviews.
So, not the best management and company culture that we've ever seen, but I think it's perfectly acceptable.
Lewis: When you look out big picture at the business, any big red flags for you?
Feroldi: No. You mentioned one before about customer concentration. The company does have more than 4 million paying customers at this point, which, as we talked about, is a small number compared to what we think it could be in the long term. The industry itself does not face any long-term headwinds. In fact, there are significant tailwinds behind this business.
The one thing I will point out is, this business does rely on an outside force for its success, more so than we've talked about with other SaaS businesses. These guys sell their software to architects, construction managers, so there is a need for worldwide spending on infrastructure and building projects to be strong. You could see, if that industry did take a cyclical downturn, that it would be very hard for Autodesk to grow. Now, offsetting that is their amazing opportunity to convert current customers. They may be able to at least tread water, if not post modest growth even during an industry downturn. But that is something for investors to keep in mind.
And then finally, we always look at stock-based compensation, which was not insignificant. This company spent $250 million last year in stock-based compensation. That's a pretty high number for a company that's doing just over $3 billion in revenue. But offsetting that is, this company has been a buyer of its own stock pretty heavily, so that its share count has actually declined over the last couple of years, even with a pretty hefty stock-based compensation.
So, nothing that would be a red flag for me, but maybe a slight yellow coloration flag on some of these.
Lewis: What gets me excited looking at a business like this and looking at the growth rates that management is throwing out there is, you think about the growth that a company might be putting out there, the subscription rates, the renewal rates, all these types of stuff. They're saying like 22% growth, that's what they're eyeing. 26% growth compounded for three years puts the company at a double, just about. So, if you're in a business where most of your revenue's recurring, you have customers spending more money, and you're growing in the low 20% [range], even though they're already a fairly large business for a niche SaaS company, I still think there's a lot of room for this company to grow, especially if they can maintain growth rates in the high teens or low 20s.
Feroldi: Yeah, I completely agree. $30 billion, which we've talked about a couple of times as their market cap, sounds huge. But Adobe cracks $100 billion, and Microsoft is a trillion. When you think about those numbers for comparison, even though Autodesk does provide a more niche product than, say, Microsoft would produce, I believe that there is still substantial upside, even though this company is very sizable already.
You mentioned the growth rates, which are very strong. Wall Street is pricing this business for growth. Its stock has been a terrific performer over the last couple of years. The valuation here is stretched. We see about 13.5 times sales right now, and about 36 times next year's non-GAAP earnings. Those are high numbers. But I believe that the business has so much going for it, and there's so much visibility into this company's growth, that those numbers are not crazy. I think this stock is actually a buy today.
Lewis: Are you putting this one on your watch list right now, Brian?
Feroldi: Oh, yes, this one is actually at the top of my watch list right now.
Lewis: Anyone who listened to the July 4th week episodes that we did with all the hosts from Industry Focus might remember that Jason Moser and I were both very excited to talk about Autodesk as a stock on our watch list, so much so that we ran into each other during the taping and didn't realize that we both independently had that as our One to Watch. So I, too, have it on my watch list. Once I have the gap in not having talked about the company and having solid internet access so I can access my brokerage account, I will be probably initiating a small position in Autodesk.
Feroldi: That would make two of us, Dylan.