Do the French have real software companies?
OK, France is not known for software companies. Food, wine, fashion, perfume, the Cote d'Azure, Provence. A political system that reached dysfunction far earlier than ours. A once glorious history marred since the days of L'Affaire Dreyfus. Glorious palaces, chateaux, and the world's deepest artistic tradition. Verdun and the beaches at Normandy - who would not be moved by those sights. Certainly this writer spent his share of time in contemplation at the Ossuary within the battlefield at Verdun.
Americans of a certain age used to feast their eyes on Brigitte Bardot and listen to the songs of Maurice Chevalier as part of the tradition of the country. And perhaps less pleasantly, there was Devil's Island, and the not so glorious French Empire. La Mission Civilastrice was at best a travesty and at worst a stain on French values.
Many Americans hate the county and its people and the feeling is reciprocated by some French citizens - especially if one is completely ignorant of the language and doesn't value their food and wine culture.
French has some particularly pithy phrases that many find convenient and expressive, and I sometimes use them myself in writing articles
But software? Actually, there are people in France who work and create industrial objects and who do not spend all of their time in cafes or drawing or whatever else urban legend says that French people do. I think I will let that one go for the balance of the article.
Actually, in addition to Dassault Systemes (OTCPK:DASTY), there has recently been one other French software company of note, Business Objects. Business Objects was consolidated by SAP (NYSE:SAP) in the past decade and is till the core of SAP's business intelligence solutions.
Because many readers will be completely ignorant of this name, I will provide a little more background than I usually do. The name of the company is Dassault Systemes. For one thing, the shares are bought and sold on NASDAQ under the symbol DASTY and has traded in the US since 1996. The shares traded in this country are ADRs exactly the same as the ADRs that trade for SAP. The company's headquarters are in a suburb of Paris called Velizy-Villacoublay, although the company has a large US headquarters in Waltham, MA.
The company was founded in 1981 by the Dassault Group which remains the controlling shareholder with a 42% stake. The Chairman of Dassault, Charles Edelstenne, owns about 7% and the rest of the shares are the 'free float." Since 2003, the French government does not own any shares in the company directly. Mr. Edelstenne has been chairman of Dassault Aviation since 2000. At that time, he resigned as CEO of Dassault Systemes but has remained as chairman. He is one of the 60 richest French citizens with a net worth greater than $1 billion.
Dassault founded Dassault Systemes in order to market the CAD/CAM capability that had been built in-house in order to design its complex airframes that it developed. Like all good French companies, the Dassault Group owns a winery. In addition, it is a partner in an electric car venture. I suppose if the contributors who tirelessly write about Tesla (NASDAQ:TSLA) get tired of the subject, they could try writing about the French effort in the space and perhaps justify a tax deductible trip to Paris.
Airbus (OTCPK:EADSY) currently holds about 27% of the shares in Dassault Aviation, but it is selling those shares back to the company in a 3 part transaction.
DASTY is a company of not inconsiderable size. Revenues are expected to be $3.4 billion this year and EPS estimates of 2 analysts are for $2.75, up about 10% from 2015 results. With 254 million shares currently outstanding, the company has a market cap of $19.52 billion and an enterprise value of $18.3 billion. It is just about 3X the size of its closest peer company, PTC Inc. (NASDAQ:PTC). I have written a couple of articles on SA regarding PTC but DASTY has enjoyed both faster growth and greater profitability for about the same valuation. While both PTC and DASTY compete head to head in the CAD/CAM space and the PLM space, this company has apparently created a more extensive and integrated platform and has not gone into some of the other areas that PTC has entered through acquisition.
The special sauces of DASTY
French cuisine is known for its unique and special sauces, and even with the modern emphasis on lightness, a good old liason is a glory to enjoy.
The product development software space has many competitors flogging slightly different things in slightly different ways. DASTY is different enough from both Oracle's (NASDAQ:ORCL) offerings in the space, essentially a heritage of its Agile acquisition. PTC's offerings, a descendant of Windchill and Siemens (OTCPK:SIEGY), the proud owner of what used to be called UGS. There is really no feasible way for me to write about complex and technical subjects of which I have a smattering of expertise in a way that is value add for the readership. One of the more frustrating aspects of writing these articles is my inability to present dispositive evidence regarding which competitor has better technology. It is rarely that simple or straightforward. As I discuss below, it is relatively apparent that the new Dassault solution, 3DEXPERIENCE, is materially more functional than prior Dassault technology. Dassault now has an important poster child for its new solution and that is allowing the company to improve its win rates and possibly to increase its market share and growth rates. But I am not attempting to write a product review here and I simply lack the knowledge to do so properly in any event.
These days the Big 3 in the PLM space are Dassault, PTC (Windchill) and Siemens (TeamCenter). TeamCenter was the last of the Big 3 to offer an integrated PLM solution. The Dassault solution is called 3DEXPERIENCE these days and is considered to be the most extensive of the PLM solutions available. Dassault actually does offer a 3-D printing solution that is used by Airbus amongst others. It offers 14 domains from a Bill of Materials to parts and assembly requirements, verification, styling and electrical design. The reference case for Dassault is Jaguar/Land Rover that now belongs to Tata Motors (NYSE:TTM). JLR, which went into full production with Dassault only a few months ago, is the poster child for 3DEXPERIENCE. (Folks, I do not make up these names - this one is more than a bit hokey). This has been a 7-year undertaking for Dassault and JLR. I do not even want to pretend that I understand all of the nuances of what has been achieved. PLM is, to say the least, a subject that is far easier to discuss in an engineering context. But one of the blogs on the subject called Engineering.com has written a lengthy study of what has been accomplished and what a leap in the dark it was for JLR. The buzzwords are frankly the same amongst all of the competitors. One aspect of the technology that is accessible for the great unwashed masses (that means me) is that Dassault's Enovia, which is part of the overall solution, is able to achieve a "Zero error targeted Bill of Materials." That is a very good thing and is apparently unique to the Dassault product. I do want to make it clear that this is a 3 horse race, at the least, and that while Dassault is in the leadership position these days, it still loses and gets displaced.
In 2010, Dassault was displaced from a 6,000 seat installation at Mercedes Benz by Siemens. The pendulum does swing in this industry and the current momentum has apparently swung to Dassault at this time.
People in the PLM space talk about data driven models all the time. Again, my understanding of the concept is more than a bit hazy. But Dassault is said to have gotten the data driven model right, and it appears to be producing tangible and measurable benefits for JLR.
Because of the advent of smart cars on the not so distant horizon, Gartner's Mark Halpern claims that the major PLM vendors are not ready to support their customers. He opines that there is going to be another scramble on the part of the automakers to develop with their vendor partners new PLM solutions to build autonomous driving platforms.
The transition that JLR has been through with Dassault is supposedly unique. The author of this article says that what has been done is epochal and that he thinks that this experience will equip Dassault to handle the challenges inherent in building a PLM system to handle the requirements of the driverless car.
It would, I feel, be tedious to discuss the other claimed strengths of the Dassault set of PLM solutions. I really would have no objective reference in trying to evaluate the Dassault offerings compared to those of either WindChill or Siemens. If I were trying to encapsulate what I think, the preponderance of the evidence supports is that the JLR experience is unique and showcases what Dassault can do. It is this "beyond PLM" vision that Dassault is beginning to deploy at JLR and other customers that is apparently the company's best secret sauce. Overall, the latest statistics that are available suggest that Dassault has a 22% market share compared to 11% for Siemens and 9% for PTC. Dassault and SAP are collaborators and not competitors which is a considerable benefit for Dassault's sales efforts given SAP's European ERP market share. Dassault recently won perhaps the largest PLM bakeoff of 2016 when it beat out Siemens for a 25,000 seat order at Ericsson (NASDAQ:ERIC). Part of the win is said to be the result of Dassault having more of its solutions on the cloud and having more mobility capabilities than does Siemens or even PTC. This release went into general availability this past February. Both cloud availability and mobility functionality are going to be key competitive elements going forward. Again, it is really impossible for me to objectively evaluate what are, by their nature, extremely qualitative subjects without a whit of quantitative data in support of claims. About all I can say is that DASTY appears to be a bit further along on its transition to cloud than PTC and 74% of its revenues recurring.
There are to be sure, many factors in market share data, most particularly in terms of definitions. To a certain extent, Dassault's market share lead has been the result of its continued focus on PLM technology and on verticals within PLM. As I wrote about PTC recently, it has changed its focus significantly in order to try to achieve some level of consistent revenue growth.
Dassault has approached the PLM space with a variety of different solution areas that include Simulia, which does something called Finite Element Analysis using realistic simulation software. It also offers Geovia, which simulates and models "Our Planet" to determine how new projects would have environmental impact; ExaLead, which is all about data discovery and analytics solutions; 3DVIA, which is aimed at creating complex storyboards for consumers; BIOVIA, which is a tool to provide a scientific collaborative environment for advanced biological, chemical and materials areas; and 3DEXCITE, which is a marketing tool to provide high-end 3-D visualization to provide storytelling for media campaigns. In essence, another secret sauce for Dassault is having a broader, yet still more focused set of PLM tools than its other major competitors.
The other special sauce for Dassault has been its consistent execution. Regardless of what technology is being offered, if it isn't getting sold profitably it really doesn't matter all that much. As we will see, one of the tastiest of special sauces offered by Dassault, at least the equivalent of a bearnaise sauce with a nice filet mignon, has been its ability to execute more consistently than any other vendor in the PLM space.
Does the Dassault strategy have the potential to create significant product revenue growth?
The PLM market is relatively sizable and growing quite rapidly relative to its current revenue base and maturity. According to one research group, the PLM market was $40 billion last year and is supposed to reach $76 billion by 2022 which would be a CAGR of 8%. North America represents 1/3rd of the market, EMEA is essentially the same size and APJ is 30% of the total market size. Not too surprisingly, the cloud is beginning to replace on-prem solutions with the early adopters being SMBs who simply do not have the resources to build their own clouds but need the cost, performance and even the security advantages available from cloud products. That being said, there have certainly been some major cloud based deals announced in the last few months, including the Ericsson deal and Siemens' big win at Bosch.
Dassault has about a 22% market share as some define it. It is probably a share gainer more than a share donor. At the very least, it appears that its revenues recently have been growing faster than the PLM revenues of PTC and the comparable revenues for Siemens. Over the past 5 years, DASTY has achieved top line growth of about 13% and EPS has almost doubled. These results are significantly stronger than the other major companies in this space. While 8% growth estimated by market observers in the PLM space is not all that exciting, market share gains and the potential to use the company's cash balance of €2.5 billion to achieve some non-organic growth should allow the company to continue to achieve mid-teens growth and to sustain 30%+ operating margins. Dassault is very likely to expand its product portfolio into adjacent areas and it has been a market share gainer going back a decade or more at this point. The PLM market size and its growth rate present a broad enough set of opportunities in which Dassault has plenty of growth opportunities.
Some thoughts about cyclicality at both Dassault and in the entire Enterprise space
Over the past few weeks, and particularly today, SA contributors have seemingly been focused on all of the risks in the stock market. Contributors are worried about both valuations overall and the macro outlook. With all that drumbeat of negativity, I think it is only prudent for a contributor to address the cyclical sensitivity of a recommendation.
I would never suggest that either PLM in general or Dassault's shares in particular are going to withstand a significant recession or market pullback. The shares sold off just as did all other tech shares in the correction at the start of this year. If the market cracks, so will the shares of Dassault, and for that matter, the shares of all other IT vendors without exception.
But one of the more surprising things to note about Dassault is just how stable revenue and EPS growth has been for this company over a long period of time, including the Great Recession and the very weak recovery since that time. It is axiomatic and a well-known urban legend that the PLM space is highly cyclical. And so it has been in broad terms. And yet over the last 10 years, Dassault has seen only one revenue decline in the midst of the Great Recession (2009), and it had a sharp bounce back with 26% growth the following year. Perhaps equally surprising, operating margins have been quite stable for all of the past 10 years and only declined from 25.6% to 25% in the one year in which revenues contracted for Dassault. The following year operating margins increased from 35% to 28.5% and EPS set a new record at that point. While new software license sales sagged by 31%, the company that year was able to show revenue growth in the category it labels periodic licenses and maintenance which enabled its overall revenues to decline by just 6% that year. Just for comparison, PTC's total revenues fell by 12% and software license declined 36%.
Another surprising observation is the share price trajectory for Dassault. Overall, DASTY's shares have trebled over the decade. The shares did fall by a bit less than 50% in the Great Recession peak to trough and since that time they have increased by 4.5x.
Other than investing in DASTY, investing in the PLM space has really not been either the easiest or most lucrative of things to do if investments to have made over the past decade. PTC's shares are up 146% over the past decade going from $15 to current quotes of $37/share. The shares actually were as low as $8/share in February 2009. Two other industry participants were consolidated over that time but without much benefit to shareholders. MatrixOne was actually bought by Dassault and Agile was bought by Oracle at valuations that were painful for many long-term shareholders of those companies. One other significant acquisition in the space was that of UGS by Siemens. It is hard to say how shareholders of UGS might have fared. The last shareholders were a group of private equity firms, including Bain, Silver lake and Warburg Pincus. They probably made a nice profit selling UGS to Siemens, although the $3.5 billion purchase price was not considered a bonanza when it was initially announced. The prior owner, EDS, sold it to the PE group at what was reputed to be a bargain basement sale. The basic reasons for the relatively poor returns have been what is considered to be the inherent cyclicality of the PLM business and the difficulty it has been for industry participants to forecast their results consistently.
Overall, there was a growth spurt in the market for PLM solutions in the first years of this decade. Part of that was most likely a reaction to the lack of investment in the space during the recession and part of the growth spurt may have had something to do with the introduction of platform products at that point. In any event, the last couple of years have seen a marked deceleration in PLM growth rates that have been described by industry analysts as a process of digesting the new investments that have been described by market researchers as part of a "digestion" process.
I am not sure as to whether or not there is a digestion process ongoing in the PLM space or if PLM is experiencing what have been negative cyclical trends as the world manufacturing economy struggles to achieve a growth footing. PLM has the reputation of being the most cyclically correlated of all software segments with the macro economy. There is a correlation, but just how strong it is depends on a more careful reading of the relevant data.
The overall secular growth trends can often be masked by severe cyclical perturbations and sometimes results for all PLM vendors are lumpy because of the potential for extremely large deals. For example, by some estimates, the aforementioned Ericsson deal for 25,000 seats is likely to add at least $25 million of annual services revenues. (It is apparently cloud - although I could find no confirmation for that). Dassault has also announced major multi-thousand deals at Caterpillar (NYSE:CAT), Vestas Wind (OTCPK:VWDRY) (the largest wind turbine manufacturer) and DCNS, a French state-controlled shipbuilder that was recently awarded a $43 billion contract to build submarines for Australia. Dassault is known to have the highest list prices in the industry but that has not had a material impact on the company's market share or revenue growth. It has, of course, had a significantly salutary impact on the growth and the absolute level of operating margins and cash flow.
Overall, it seems to me that both industry growth rates and the company's gains in market share, coupled with an expanding foot print, are adequate to support low to mid-teens growth for the next several years.
Is this a decent entry point for Dassault shares?
I do not claim to be a market seer. As I mentioned above, there are no companies in the IT space whose shares would be immune to a significant market correction. In the correction earlier this year, the shares fell from $80 to $70 in a few weeks prior to the announcement of year-end earnings. After the earnings were announced and business turned out to have been decent, the shares shot back up until the nemesis of the tech stock correction drove them down again, after that the shares made a new all-time high. The shares are down 5% in the last few days due to fears of Brexit which would impact European companies significantly it is thought. If readers are concerned that the market or the economy or both might tank, it will be best to avoid the IT sector entirely. I have simply been through too many of these events to think that this time will be different. So, is this a decent entry point into Dassault shares? That very much depends on your market outlook, and I am not the appropriate writer to try to assess market trends. One ought to at least try to stick with what one knows or thinks that he knows.
The company's guidance, as was articulated during the conference call, was considered by management to have been a raise due to FX headwinds that will be overcome by better than anticipated operating performance. As mentioned, although this company doesn't give booking statistics, it is relatively obvious that bookings in Q1 were greater than expectations, and overall, the 2nd half pipeline is looking stronger than had heretofore been anticipated. So, the company's business has shown decent growth, the transition to cloud is not hobbling wither reported revenues or profitability and the pipeline is strong. I will go through valuation below - but really the basic issue in terms of an entry point for Dassault's shares is some expectation of market performance.
Just to provide the conclusion first, given that this company already has achieved recurring revenues of 74%, the shares are reasonably valued. All of my comments about valuation metrics are going to be made using what are called International Financial Reporting Standards. These standards are pretty much the same as GAAP in the US. And just like in the US, this company uses non-IFRS metrics in discussing its performance. That being said, stock-based compensation expense is essentially negligible, although it did grow markedly during the 1st quarter of 2016. Stock-based comp in Q1 this year was about 2% of revenues. Dassault has an enterprise value of $18 billion at this time. Revenue estimates for the year are for about $3.4 billion. So, that is an EV/S of 5.3X. Reasonable for a company that ought to attain long-term low- to mid-teens growth.
Dassault is a reasonably profitable company with operating margins in the 30% range. In Q1, non-IFRS margins grew by 60 bps and the company's effective non-IFRS tax rate declined from 35% to 28% which allowed EPS to rise from €.43 to €.51. Overall, EPS is forecast to be $2.75 for the current year which is a P/E of 27X.
This company has consistently enjoyed strong cash flow and cash flow margins. Last year cash flow margins were 20%. The company increased its Q1 cash flow by 17%, most of the increase coming from the increase in net income and the seasonal decrease in A/R balances. The company has a free cash flow yield of 3.3%.
The company appeared to give very conservative guidance in discussing its projection framework on the conference call. Q1 results were a beat. I suspect that the company will most likely be able to increase full-year guidance if Q2 results work out the way that management's qualitative commentary might suggest.
Dassault is the largest company in the PLM space and has achieved a far more consistent record with higher growth rates than its major competitors. The company has grown revenues at a 13% CAGR over the past decade with only one down year in the Great Recession. EPS has grown by 4.5X over the period.
The company is domiciled in France and is part of the overall Dassault Group, although it trades on Nasdaq and has a reasonably sized float.
The company appears to be enjoying the results of a significant product cycle with its new platform 3DEXPERIENCE. The company's new flagship platform, 3DEXPERIENCE achieved a 33% growth rate last quarter, far greater than any other reporting segment for this company. The company has a hybrid operating model with much of its offering available on the cloud. It still does offer on-premise licenses, at least for the time being.
The company guidance, which appears unchanged, in fact increased somewhat to take account of exchange rate perturbations. Overall, the company booked some major 3DEXPERIENCE orders last quarter, including a 25,000 seat win at Ericsson and comparable wins at a French defense contractor and at Caterpillar.
Based on the best available data, this company has been gradually gaining market share over the past decade and is likely to continue on that track given its product advantages and its ability to execute consistently. It has consistently outperformed PTC over the past decade and it has comparable valuation metrics. PTC is in the midst of a transition to a cloud model that is hobbling reported results and will continue to do so for the next 12 months+.
The French make good food, great wine and paint beautiful pictures. And it appears, that at least in this one software category, they have created a leading PLM vendor with reasonable valuations.
Disclosure: I/we have no positions in any stocks mentioned, but may initiate a long position in DASTY over the next 72 hours.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
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