Autodesk (ADSK 2.53%) offers high-margin software that designers and architects depend on. The market recognizes Autodesk's long history of stellar performance: It trades at 42 times trailing-12-month operating cash flow and 17 times trailing-12-month sales, roughly triple its multiples from five years ago. While this valuation seems alarming at first glance, it's rarely the wrong time to buy the right business -- and Autodesk is just that.
Customers need it
Though Autodesk doesn't look cheap, it offers a service that is core to its customers' day-to-day operations. Architects, engineers, construction workers, interior designers, and many more rely on Autodesk's systems to get their daily work done. Autodesk provides the industry standard for computer-aided design (CAD) programs, essential for AEC businesses to virtually design and test the real-world applications of their own projects. It offers a comprehensive yet easy-to-use suite of software programs to enable these industries to function efficiently.
Management doesn't offer specific renewal rates for its entire customer base. But on the second-quarter conference call, CFO Scott Herren mentioned that renewal rates among enterprise accounts are close to 100% .
To supplement that strength, Autodesk is already growing its revenue within its existing customer base, as highlighted by Autodesk's consistent net revenue retention rate above 100%. Customers are either subscribing to additional Autodesk services, or accepting incremental price increases for the services they already use. Either way, with more than 18 million active users and consistently strong renewal rates, Autodesk requires very little additional investment in order to sustain its organic growth. At this point, re-subscribing to Autodesk's software is habitual for most customers. This allows Autodesk to spend less money trying to retain customers or sell additional products, and instead spend money on constantly improving its existing products. This should enable Autodesk's profits to rise as a percentage of revenue over the coming years.
The university system
At the university level, institutions want to constantly develop and churn out best-in-class workers for various fields. If the university wants to provide the best potential employees for the workforce, they have to teach and train their students the systems that they'll need to know when they get job opportunities. In most cases, since Autodesk products are the industry standards, that means universities require their students to learn various Autodesk systems . For Autodesk, this builds a funnel of potentially lifelong users, and they get to pay very little to acquire these customers.
On the flip side, if an architecture or construction firm is looking for new employees, the majority of candidates will probably come from universities. So the incoming employees are now acclimated to Autodesk's systems, which makes switching away from Autodesk very costly for most firms. Whether it's the costliness of downtime, expenses required to train and teach employees a new system, or potential delays on output due to the firm's new software, it's simply too much of a burden for most firms to bear. Thus, most firms just choose to resubscribe.
A more profitable model
In 2016, Autodesk announced that it would be switching from a license revenue model to a subscription revenue model . Building this strategy and getting customers to switch increased expenses for Autodesk in the short term, but it's a much more profitable strategy in the long run. This model makes software updates easier on Autodesk's side and makes onboarding customers less expensive.
As we look at Autodesk's current valuation, it's important to note the shift from license to subscription. A more profitable strategy means higher reinvestment potential. Since this software-as-a-service model requires fewer ongoing expenses, each dollar of revenue is more likely to flow down to the bottom line, ultimately increasing Autodesk's profitability.
As investors, we should expect higher valuation multiples across the board compared to the Autodesk of the past. As long as Autodesk's renewal rate stays strong and customers continue to pay more, it should be in good shape for a long time.