DASTY & PTC-Who can win this race?
It is the morning before the eagerly awaited Apple (OTC:APPL) earnings report and I am diligently beavering away at an article comparing two of the major PLM vendors. But I promise not to muddy the waters of that pristine debate-just joking what could I possibly say that hasn't been said many times and in many ways. Trying to compete with the drumbeats from many who are waiting for the denouement of another quarterly drama for Apple shares is a bit of a daunting exercise. And doing so by discussing the PLM sector is even more so
One of the quieter backwaters of the IT world has been the broad space known as product lifecycle management. At some point in the distant past some bright and eager marketing person had the idea to call the space by its current name which sounds as exciting as a fraternal kiss. Overall, PLM and its adjuncts of which there are many is all about designing new products in a fashion that minimizes costs and pushes the design envelops. Regardless of the definitions used, it is a huge space including areas like CAD/CAM which are almost antique and which have little if any growth available to very high-tech solutions including simulations and analytics.
Are current product designs better than those they have replaced? That is an impossible question to answer across the board. Are new designs better in terms of being more efficient to build and more profitable to make-little question they are and that is really the impetus for the growth of the PLM space. Many times the investment discussion regarding PLM degenerates into terms that are impossible for a layperson to understand and drive investors who are trying to maximize their alpha simply nuts…and not the kind of nut used in product design.
My poor tongue is not going to make any discussion of PLM exciting. But I think that investors will find interesting investments to consider. At one time a few years ago it was thought that the PLM category could sustain long-term double digit growth. Then came the "Great Recession" and the not so great recovery. Without belaboring the point, the lack of productivity growth has more than a little something to do with the lack of product innovation and that is in some way correlated to the modest growth in the overall PLM space. There has been a significant amount of new technology made available and it has seen some uptake, the cloud revolution has come, muddying up real comparisons but in the long run accelerating user engagement and revenue growth.
Lately the shares of none of the major industry participants have done much, certainly not by way of producing positive alpha. So far this year, shares of Dassault, (OTCPK:DASTY) the largest of the companies in the space have depreciated by a bit more than 1%. Competitor, PTC Corp, (NASDAQ:PTC) has seen much better share price performance and positive alpha with a return of just below 18% YTD. And the third major competitor publicly held competitor in the space, Autodesk, (NASDAQ:ADSK) has also lost a bit of ground seeing a bit more than 3% depreciation in its shares. (The other major industry participant is Siemens PLM which is built on the foundation of a company called UGS which Siemens acquired in 2007. Siemens PLM is a very small part of Siemens overall although it is most likely the second largest company in the space.)
Last week, two of the market leaders, DASTY and PTC reported their numbers. The other major competitor in the space, Autodesk has a quarter ending in July and so will not report until the end of August.
Both companies had decent quarters although in neither case was there some heroic break-out. PTC enjoyed a significant beat on bookings and Dassault achieved double digit constant currency growth and reaffirmed its guidance for the balance of the calendar year.
I would have liked to include ADSK in this analysis but because of their transition it is not feasible. Autodesk is going through a very comprehensive transition and is dropping the availability of its on-premise products. That is leading to the publication of financials that are in no way reflective of its 'economic" performance. I believe ADSK is doing well with its transformation but many investors are simply looking for simpler stories that have much more pellucid headline numbers-because of that I just decided not to include an analysis of ADSK in this comparison.
The fact is that none of ADSK's numbers published numbers are apples to apples with its own past let alone the numbers that are being reported by PTC and by DASTY. The current valuation metrics simply cannot be contrasted with those of its competitors and that will certainly remain the case for the next 12 months.
I think it is interesting to do a dive into what was reported and the outlook for these two companies. There is no doubt that DASTY shares look a bit more expensive than the valuation of PTC shares based on some valuation metrics, DASTY is gaining market share and it appears it will continue to do so. Because of the number of moving parts at PTC it is hard to make a market share call one way or the other although the bookings metric for its most recent quarter might suggest some signs of optimism-or then again, maybe not. Should investors participate in the space and if so which is the recommended investment choice? I think at this moment that the percentage upside potential is a bit greater for DASTY than for PTC but there is no huge gap. Both companies are enjoying a certain level of success greater than the overall software space. DASTY should be enjoying benefits from its current platform offering that just now seem to be flowing into top line growth and it certainly has the wherewithal and management capability to achieve a significant level of inorganic growth. Just how much better that might be than the outlook for PTC is not easy to handicap. At the moment, I think that DASTY has some advantages both in Analytics/Simulations and the IoT that are of significance. And I think it is continuing to reap some benefits from its 3dExperience platform that has allowed it to win a few more competitive engagements when compared to its largest competitors.
There is to be sure one giant sized difference. DASTY is a company located in the EU and reports in euros and uses the IFRS rules as its basic accounting methodology. It has ADR's and its shares trade readily on NASDAQ but it has an average daily volume of 35k in the US. I shall make the necessary adjustments so that the comparisons between Dassault and PTC make reasonable sense. As might be known by many readers, both Dassault and PTC are in the midst of transitions to the cloud and that makes for additional complexities for which I shall attempt to adjust.
I wrote about DASTY a few weeks ago and in that article presented a view of some of the company's numerous product offerings. It would be tiresome in the extreme and unnecessary to reprise most of that kind of analysis.
The company has simplified the ownership structure of what had been SolidWorks which is the company's primary 3D cloud based design platform. The SolidWorks offering was a solid upside performer in the June ending quarter.
Like many other vendors in similar circumstances, Dassault's future growth rate is to a lesser or greater extent likely to be a factor of the success of the company's "newish" platform called 3DEXPERIENCE. (3DX grew by no less than 68% in 1H and is now 33% of new license revenues. The current release of 3DX has about 85% of the design and engineering solutions available in the cloud and it also offers increased mobility tools coupled with more simulation offerings and much more in the way of analytics. I do not expect that any of the new capabilities have led to the strong growth; 3DX is a platform that encompasses much of what DASTY sells and the "horizontal" components such as ENOVA.)
Overall, 72% of DASTY's license revenue is recurring. Some of recurring revenues are software maintenance and some are cloud. PTC uses a similar presentation. Cloud means cloud and not maintenance and cloud can and is growing faster than maintenance. The company has made no comments that might foreshadow any move to end the sale of on-premise solutions. Professional services revenues are 15% of the total and showed little growth and have relatively low gross margins.
I simply lack the technical expertise to attempt to describe the functionality of 3DX T in any level of detail. 3DX is a platform and is used in a variety of verticals including "Smart Nation", life science and others. I must confess that the translation of the most recent earnings press release from French to English leaves one wondering about how we communicate on a level much more sophisticated than food, wine, cosmetics and fashion-and for me Maurice Chevalier and Edith Piaf. I have never before-and I sincerely hope never in the future- to see the word "ideation" which is apparently a real word that came into use before 1900. 3DX is said to be a leader, in, amongst other things, ideation.
I think it is sufficient to comment that 3DX is the company's technology flagship and that Q2 results appeared to validate its market position. (I am sure ADSK would have contrary thoughts on the subject-you can, if you search find ads deprecating what you get with 3DX or ads that say it cost too much but I really am not in a position to gainsay a solution offering that has increased from 20% to 33% of revenues and has seen a 68% increase in revenues in the past 6 months). I am far more interested in the triple digit growth that Dassault has been able to achieve for 3DX last quarter and consider the results to be part of the argument for owning Dassault shares.
Dassault released its earnings on July 21 st. The company reported 4% top line growth, 6% in constant currency and EPS of E.57 up 8% from the prior year results. The company has been and continues to show modest but visible gains in operating margins which are far greater than those of rival PTC (As discussed below PTC cannot report representative margins in the midst of its transition.). These results were consistent with prior expectations and showed moderate growth acceleration in the quarter. By this point, most of the company's software revenues are recurring in nature at 72% of the reported total although how much of that is cloud/subscription and how much is support is not reported. The growth of deferred revenues by 12% year over year suggests that bookings are rising more rapidly than reported revenues and it is likely that this trend will continue for the foreseeable future.
I think that it might be surprising to many readers that DASTY saw its greatest percentage growth in Europe where new license growth exceeded 10% and that growth accelerated in Q2 in Europe with France and Northern and Southern Europe showing the strongest results. The weakest growth areas were in APJ countries particularly Korea and Japan.
Company guidance remained consistent with prior expectations. Overall, the company is expecting revenue growth of about 7% in constant currency with stable operating margins. Total license revenue growth is expected to accelerate to double digits ex currency impact during the 2H. Revenues for the year are estimated to be about $3.4 billion using the company's estimated exchange rate. Stable margins coupled with accelerating revenue growth works out to EPS of E2.40 or about $2.70 in EPS. That is equivalent to a P/E of 29X. That isn't particularly cheap, but given the growth rate acceleration it is probably "cheap enough" particularly in comparison with many other software names.
The shares showed but a minor reaction to the results, and are down 3% YTD compared to a 7% gain for the IGV over that time span.
Obviously there is a significant level of concern amongst investors and analysts regarding Brexit and its impact on a company that historically is super-sensitive to macro-economic conditions. In the last quarter, the company cited 2 million dollar deals that has been postponed. If Brexit leads to a broad recession, particularly in Europe, this company's business is going to be impacted and impacted significantly. If that isn't the case or if the acceleration of QE both in the UK and in Europe are the results, then both the exact impact of Brexit and of share price valuation as are likely to be favorably impacted. PLM is a global software sale and it is correlated with the economy!
Dassault is significantly involved in the development of software solutions for the facilitation of intelligent cities, i.e. the Internet of Things. IoT software is going to be a significant component of the development of cities that are equipped for the use of autonomous vehicles. The company has won a significant initial contract for 3DX to power and manage the "intelligent city" functions in Singapore and Dassault, on its call, sees other opportunities in China to replicate that success. Smart Cities are seen as a crucial component of the current Chinese stimulus package. I would like to drill down further with regards to quantification of some of these specific opportunities-but that simply isn't an option at this time as the numbers are not reported
Dassault is about 3X the size of one of its chief rival PTC with about double the level of non-GAAP margins (that was before the start of the transition which has eviscerated reported PTC margins). PTC has an enterprise value of about $5.1 billion and DASTY has an enterprise value of $17.9 billion. Overall, DASTY has an EV/S of 5.3X based on current forecasts and an EV/S of about 4.5X based on projections for 2017 compared to an EV/S for PTC of 4.4X for both years. While it ought to be simple to compare top line growth rates for PTC and DASTY, that is not really the case as PTC has seen a significantly greater impact on its reported numbers in its cloud transition which has gone far more rapidly than planned.
There were some analysts who questioned Dassault management with a degree of what I might best describe as accelerated concern relative to the company's expectations to see double digit license growth, particularly against a strong Q4 2015 comparison in the last half of 2016. Management, and in particular, CFO Thibaul de Tersant was equally emphatic in its assertion that its forecast was based on the most granular and rigorous pipeline analysis. I have no way of discounting management's forecast-they said the right things and did so without the presence of the company's usual cheerleader, i.e. its long-time CEO, Bernard Charles who was on travel.
Dassault held its analyst briefing in Paris last month. Sometimes those events provide quantitative frameworks for future expectations. This one, sadly did not. That being said, it appears that the company is attempting to achieve low double digit growth with some modest margin enhancement. Overall, that kind of performance would produce EPS for FY '17 of about $3.10-$3.15. At that level, the company's P/E would be about 25X. The company has been growing cash flow more or less consistently with non-IFRS income. The company's deferred revenue balance grew by 12% year over year through 6/30. Presumably, with the growth of the company's cloud revenues, deferred revenue growth ought to accelerate. Based on the company's cash flow through the first 6 months of this year coupled with its forecast and its projections, the company should generate a free cash flow yield over the next 12 months of 4%.
There has been little change in market share trends in the last several months with regards to PLM. Dassault remains the leader and continues to achieve organic growth a bit faster than the market as a whole and is also growing by consolidating smaller companies in the space. It isn't remarkably cheap although with the lack of share price appreciation coupled with continued top-line and EPS growth the shares have become cheaper.
Overall, depending on what the definition is of the market, PLM is an enormous space (one estimate is that it will see revenues of $75 billion by 2022 which equates to a CAGR of in excess of 8%+). Dassault, based on the growth trajectory of its core products and particularly including 3DX as well as its growth in ancillary spaces such as 3D printing, IoT and particularly analytics solutions ought to both gain in market share and in profitability modestly over the coming years. So, the question is how does it stack up against PTC.
PTC reported what for it was fiscal Q3 on July 21 st. Just for the record, the company reported revenues of $290 million and non-GAAP EPS of $.26. Neither of those numbers is really particularly significant given the company's transition. The company's subscription revenue grew by almost 90% overall or just shy of $17 million, to just short of $32 million while its license revenues declined by $22 million to about $47 million. Total revenues shrank by $15 million as given the drop in perpetual license revenues, professional services declined along with support. Non-GAAP earnings fell by more than half to $.26. Last year had several items including the legal settlement accrual, the cost of terminating the company's pension plan. Stock based comp made up around half of the total non-GAAP, but was more or less unchanged over the course of the year. I really do not think that those metrics matter all that much. At least so far, the most recent earnings event has been close to a non-event so far as investors are concerned with the shares rising a bit more than 2% in the past week.
So what should investors look at in terms of operating metrics that accurately reflect the company's growth. Management says, that the switch from license to subscription impacted product revenues by $38 million. In Q3. reported software revenues declined by $11 million. So, that would be the equivalent of a net growth of $27 million which implies "apples to apples" growth of about 11-12%. That is more or less the same level of DASTY's current growth rate. PTC reports more than a few other metrics including ACVG and ARR to define what is going on its business but I think for investors focusing on apples to apples growth is simplest and presents the most accurate picture of what is happening at the company.
I do not think it is really a practical exercise for a company like this to attempt to forecast the percentage of bookings coming from subscription vs. perpetual sources. The company is providing significant incentives to its customers to buy products on a subscription basis as well as providing its salespeople with quite large spiffs to sell subscription deals but it has no historical experience in forecasting the success of these incentives. As can be readily seen in the presentation called "prepared call remarks," bookings exceeded the top end of the company's prior guidance range but the difference was more than consumed by the level of excess commissions that were paid.
Overall bookings growth for the quarter was 30% but a substantial component of the growth was a function of non-organic sources such as the recent acquisition of Kepware which added 600 bps to overall bookings. PTC has a rather complex formula in trying equate license and subscription bookings-I will just accept that bookings were stronger than forecast and were consistent with high single digit "real" growth in terms of product revenues.
It is important for readers and potential investors to note that some of what this company calls bookings really do not reflect new business. The company has a support conversion program that it launched at the start of this fiscal year. The CFO, Andrew Miller may not throw fast balls at 100 mph as does his namesake does for the Yankees, said that, "Q3 subscription performance benefited from the conversion program that drove a portion of the over-performance." As the company doesn't report the metric, I have no idea of what it might be. Mr. Miller said that "19 customers including some very large customers converted their support contracts to subscription with an ACV uplift that continues to range from 25%-to more than 50% above prior annual support amounts, although this (past) quarter it averaged near the higher end of the range."
Mr. Miller reported a vignette that might not resonate positively with some observers and readers. He said that, 'we had 4 customers defer converting yet, because they had below-market support rates we renewed their support for the coming year at market rates, which were about 25% higher than they had been paying." Is there anyone amongst the readership of this article that imagines that those 4 customers are currently a target to buy more PTC software solutions? Talking very personally about my past experience on just that topic, that kind of strategy is a really inappropriate strategy to follow. Punishing customers for not buying what a vendor sells in the way the vendor wants to sell it really is not a strategy that can long stand the stress of time within a competitive market.
Fork lift replacement of application software is difficult, no doubt and very rare to see in the real world, but if there is anything that might dispose a user to embark on the work entailed in replacing a current installation, uplifting a maintenance charge by a material amount as a punishment would be one of the rare drivers. A really bad idea!
The existence of this program and the impact it has on sub-headline numbers and even possibly reported subscription revenues is one of the factors that leads me to conclude that on some kind of "apples to apples' basis, Dassault Systemes is likely achieving and will continue to achieve more rapid "real" growth.
I do not think that it is worth the time to analyze the impact of the mix swing on reported non-GAAP EPS. A company of this size that loses almost 10% of its reported revenue due to a mix switch is going to be very challenged in terms of reported profits. And with lower reported revenues, PTC undertook to provide both user and sales force incentives to promote subscription revenues. The results were probably ones that might have been anticipated; overall sales expenses increased in the face of falling revenues. So, trying to use traditional valuation metrics in looking at PTC in the middle of 2016 really makes little sense.
Mr. Miller, throwing his version of fastballs with quite the same amount of spin that is offered by the Yankee pitcher, is expecting to see bookings growth of 7%-17% in Q4 including whatever the impact might be of the support conversion bookings program and also including 500 bps of bookings contributed by Kepware. It would seem that bookings growth on an organic basis and excluding the support conversions will likely be flat against a strong year earlier quarter. Looked at another way, averaging the two quarters in the last half of this fiscal year, adjusting for the Kepware acquisition and the support conversion program, it seems that bookings are rising a bit below 10% and that is marginally below a comparable number for Dassault.
The CFO is projecting free cash flow for the fiscal year of between $236 million-$239 million. That is equivalent to a free cash flow yield of 4.7%. The magnitude of the conversion is such that free cash flow is not likely to rise in the coming fiscal year as the consensus earnings estimate of 9 analysts who publish on this name is for a further EPS decline of 14% with more or less flat revenues.
Again, partially as a result of its transition program that has artificially depressed total reported revenues, current EV/S is based on guidance and on the consensus revenue forecast is at 4.4X for both fiscal '16 and next year and is thus comparable to the same metric for Dassault.
- Both Dassault and PTC reported decent if not spectacular numbers when they reported their quarterly operating performance last week.
- Dassault most likely did a bit better than the results posted by PTC.
- DASTY is benefiting significantly from its 3DEXPERIENCE platform which is showing dramatic growth that appears to be accelerating and is obviously a significant competitive factor.
- DASTY is forecasting a continuation of a trend toward greater percentage growth in its 2H despite very difficult compares, particularly in Q4.
- The company saw some significant wins, particularly in its major success selling the city of Singapore an IoT application and in seeing a significant success in its "diversification" program which aims to broaden the company's sales into different verticals.
- PTC is in the midst of a significant transition that makes using published headline numbers impossible to use as a point of comparison with a company like Dassault.
- PTC enjoyed strong bookings in the quarter and when adjusting for the transition, its revenue growth was in the range of 11%-12%.
- The company's bookings numbers are benefiting from a tactic called a support conversion program which books revenues for customers who switch their traditional maintenance agreements for what is the equivalent of a maintenance subscription at a material upcharge.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within 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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