This sleeping software giant has a lot of room for growth

What does Autodesk do? What were the significant events in the past 5 years?

Founded in 1982 and headquartered in California, Autodesk creates software for professionals in engineering, architecture, construction, manufacturing, media and entertainment industries. Some of you may know Autodesk by its notable product AutoCAD. Basically, what Autodesk is to architects, engineers, manufacturing professionals is what Adobe is to creative folks. See below for a few examples of what Autodesk software can do.

Figure 1 – Some of what you can do with Autodesk software. Photo source: Autodesk

The company’s main business segments include AEC (Architecture, Engineering & Construction), AutoCAD & AutoCAD LT, Manufacturing (MFG) and Media & Entertainment (M&E). Below is a summary of some of the main products offered in each business segment:

Figure 2 – Autodesk Products. Information source: Annual Report FY 2020

In FY 2020, revenue share of these segments was 42% for AEC, 29% for AutoCAD, 22% for MFG and 6% for M&E. Compared to FY2019, share of AEC and AutoCAD increased by 200 and 100 basis points respectively, while that of MFG and M&E decreased.

Regarding distribution, Autodesk employs three different distribution options. Firstly, the company sells products through its online store to end users and through dedicated internal salesforce. Secondly, Autodesk sells directly to resellers who, in turn, sells to end users. The last option is a two-tiered distribution in which Autodesk sells to tier-1 distributors who sells to resellers before products get to end users. Combined, the two largest distributors (Tech Data and Ingram Micro) were responsible for 45% of the company’s revenue in FY2020. Given that indirect sale was 70% of total revenue, those two distributors occupied 64% of the indirect sale.

Geographically, EMEA and the US were Autodesk’s two biggest markets with 40% and 34% share of revenue in fY 2020 respectively, followed by APAC (19%) and other Americas (7%). Emerging economies such as Brazil, China, Russia and India made up 12% of the total revenue. These figures have stayed largely consistent in the last 3 years for the most part.

Just like most software companies, Autodesk traditionally sold their products through perpetual licenses and earned additional revenue through maintenance plans which allowed customers to receive future upgrades. Perpetually-licensed users could use the software forever, but without new features. Companies could buy a multi-user license or a network license.

The transition was first signaled by the current CEO Andrew Anagnost, who was then the Senior VP of Strategy & Marketing. Later, in February 2016, Autodesk announced that it would stop selling standalone licenses. The only way that customers could use its software individually is through a subscription. The announcement was made in advance to smooth out the transitions in the near future. But why did Autodesk move to subscriptions? There are several reasons:

  • Subscriptions allow management to make reliable forecast on the business in terms of revenue and cash flow; which is important to any executives.
  • By continuously delivering new updates and features frequently, Autodesk can increase customer satisfaction. Additionally, Autodesk can also receive customer feedback through data analytics and incorporate such feedback into product development faster.
  • Frequent updates also bring more security .
  • Instead of a hefty sum upfront, a smaller subscription fee makes it easier to convince potential customers to buy in.
  • Plus, customers can easily scale up and down investments on a monthly/yearly basis, if necessary.
  • The longer a customer stays subscribed, the more profitable he or she is. Hence, Autodesk is incentivized to deliver on products and services to keep customers happy & locked in.
  • The company probably took notice of the success of the trailblazer Adobe, which also switched to subscriptions in 2012.

In June 2017, Autodesk revealed a Maintenance-to-Subscription (M2S) which enabled customers on maintenance plans to trade in their seats and credit for subscriptions. At the same time, Autodesk increased the price of maintenance plans to make them financially unattractive to nudge customers towards subscriptions. The company later said that it would retire maintenance plans by 7th August 2021. On the 2020 Analyst Day, Autodesk declared that their transition to subscriptions was complete and the company is now onto the next targets.

Financials and fruits of the switch to subscriptions

In FY 2020, Autodesk recorded its highest revenue ever at almost $3.3 billion, up 27% from FY 2019 which in turn was up 24% from FY 2018. Recurring revenue rose from 46% in 2015 to an astonishing 96% in 2020. Remaining Performance Obligation (RPO), which refers to revenue that is contractually stated, yet realized, in FY 2020 was more than $3.5 billion. Subscription Annual Run Rate, a key performance metric in subscription model, went up to $3.1 billion in FY 2020 from $1.2 billion in FY 2018. Subscription revenue in 2020 stood at $2.7 billion, up 53% YoY, offsetting the decrease in maintenance revenue.

This is the power of subscriptions. The management team can forecast future revenue very reliably. As a result, they can plan ahead for strategic moves and allocate resources accordingly.

In FY 2020, Autodesk delivered $1.36 billion in Free Cash Flow (FCF), meaning that their Fresh Cash Flow Margin (over revenue) was 41%. To put the figures in perspective, in fiscal 2019, Autodesk’s FCF was $310 million. The outstanding growth in FCF showed that the company became much more efficient in generating cash from its operations.

For the first time since 2016, Autodesk was profitable operationally with $343 million in operating income (a tad over 10% operating margin). It was due to the economies of scale when revenue grew substantially and marginal cost was minimal. Furthermore, Autodesk’s operational leverage was higher in 2020.

Expenses as % of revenue rose from 2016 to 2018 and gradually declined in 2019 and 2020. Marketing expense as % of revenue in 2020 was actually a bit lower than that in 2016, and so were other expenses. This proves that even though expenses in absolute dollars increased, the company became more efficient and grew the top line as a faster pace than expenses’ growth.

What is next for Autodesk?

Guidelines till FY2023

On 2020 Analyst Day, Autodesk announced targets for FY2023 that include 16% – 18% Revenue CAGR, $2.4 billion in FCF and 55% – 65% of FCF Margin + Revenue Growth. In the SaaS world, there is a rule of 40 which states that if your FCF and revenue margin combined is 40%, your company’s efficiency is pretty awesome. Hence, Autodesk’s target of 55-65% is pretty incredible.

Noncompliant and legacy users

One of the main initiatives is to convert legacy users who are on perpetual plans and noncompliant users that refer to those who are using Autodesk’s software illegally. According to Autodesk, in addition to the existing 5 million paying subscriptions, there are 12 million noncompliant users and 2 million legacy users. Out of the 12 million noncompliant users, they estimate to have 7 million users that opened their software at least 11 times in the last 90 days and are using a version released in the last 5 years, a population considered to be highly convertible.

There are several initiatives aimed at converting these noncompliant and legacy users, including:

  • Stop offering maintenance plans in 2021
  • Harden student verification process
  • Ban offline activation
  • Switch from serial numbers to named users, a change that can allow corporate IT teams to avoid leaks and control usage
  • Apply concurrent user limits
  • Message target users with in-app messages and emails

Untapped market

Autodesk has a lot of tailwind behind them. Lisa Campbell, Chief Marketing Officer, estimated that in FY2025, the total addressable market (TAM) for Autodesk would be $69 billion. Given that the company’s FY2020 revenue was around $3.3 billion, the estimate implies a lot of room for growth for Autodesk. The confidence stems from favorable trends such as 1) collaboration between professionals from different backgrounds on increasingly complex projects in architecture, manufacturing and construction; 2) digitization in industries that use Autodesk’s products; 3) suburbanization; 4) Building Information Model (BIM) mandates in countries.

Source: Autodesk

In addition, Autodesk can also grow horizontally by expanding its footprint in overseas markets. In some areas, its penetration is still low, signaling that there is a lot of opportunity at play. Take BIM penetration as an example. Building Information Modeling (BIM) is a process that essentially enables Architecture, Engineering and Construction professionals to collaborate effectively and efficiently during the entire construction project. In some countries, there are BIM mandates in construction projects while a growing number of other countries are planning to introduce their own mandates. Below is Autodesk’s map of BIM footprint. Almost all countries where Autodesk’s presence is low are developing countries whose need for building new infrastructure will undoubtedly grow in the future.

Source: Autodesk

Summary

The decision to switch to subscriptions is massive for Autodesk. It enables the company to be more agile and unlock more value for both customers and shareholders. From what I have seen, the future is bright for the company. There are a lot of tailwinds behind Autodesk and the fact that its revenue has grown since the switch to subscriptions signals a positive acceptance from customers. One look at Adobe can offer a bit more perspective. Adobe started its journey to subscription-based model in 2012. Below is how much the company has grown since then

The trend looks familiar. If Adobe’s 2012 is Autodesk’s 2016, the former’s 2016, when its growth really kicked into high gear, can really be Autodesk’s 2020. Hence, Autodesk can likely follow the trajectory of Adobe and grow its top & bottom line further in the years to come.

Disclaimer: This post took me a few days to write. When I first started, I was looking into it as a potential investment. By now, I own the stock in my personal portfolio

Leave a Reply

Fill in your details below or click an icon to log in:

WordPress.com Logo

You are commenting using your WordPress.com account. Log Out /  Change )

Google photo

You are commenting using your Google account. Log Out /  Change )

Twitter picture

You are commenting using your Twitter account. Log Out /  Change )

Facebook photo

You are commenting using your Facebook account. Log Out /  Change )

Connecting to %s

This site uses Akismet to reduce spam. Learn how your comment data is processed.