Ansys: 14% Growth In Annualized Contract Value In Q2; Reiterate Buy

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About: ANSYS, Inc. (ANSS)
by: Blue Sky Capital
Summary

Ansys shares have returned 14.2% in the 6 months since our Buy recommendation in February.

Q2 results released on Monday (Aug 5) showed another strong quarter, with 14% year-on-year growth in Annualized Contract Value (ACV).

Management raised FY19 outlook and now expects 10-13% ACV growth (ex. FX), despite a weaker China; long-term outlook was unchanged.

At$201.80, Ansys is on track to deliver a sustainable 10% p.a. earnings growth and deserves its premium valuation. We reiterate Buy.

We also take the opportunity to look at Ansys' historic ACV and share buybacks in more detail to address some investor concerns.

Introduction

Ansys (ANSS) shares have returned 14.2% in the 6 months since our Buy recommendation ("Ansys: Unique Software Asset With 10-20% Upside") in February, outperforming the S&P 500 index by 1,100 bps, as shown below:

Ansys Share Price Performance (Last 12 Months)

Source: Seeking Alpha website (07-Aug-19).

Shares have been more volatile lately, falling 12% from their late July peak but rebounding 4.3% on the day after Q2 results this week (Aug 5).

Our investment case is based on Ansys being a high-quality asset with long-term revenue growth rate of near 10% p.a. The 10% annual revenue growth is part of a structural trend in the “democratisation” of simulation software, and also helped by Ansys' expansion of its sales channels. While EBIT growth has lagged revenue growth in the last few years due to investments, we believe operational leverage will eventually materialize, and allow earnings to grow sustainably at approx. 10% p.a.

We believe Ansys' 19Q2 results are in line with our investment case, as we will explain below. We also take this opportunity to look at Ansys's historic Annualized Contract Value ("ACV") and share buybacks in more detail.

19Q2 Results Highlights

The key figures for Ansys' Q2 results are as follows:

Ansys 19Q2 Results – Key Items

NB. Al figures are non-GAAP unless otherwise stated; non-GAAP adjustments include amortization of acquired intangibles, stock-based compensation, restructuring and other costs.

Source: Ansys 10-Q filing (19Q2).

As a reminder, we believe ACV to be the most important metric for Ansys, basically reflecting the annualized value of its bookings. ACV grew +14% year-on-year (in constant currency) in Q2, taking the growth rate for H1 to +10%.

Contract wins were the most notable in the high-tech, automotive and aerospace & defence sectors. They included a $49m multi-year deal with a “South Korea high tech leader”, which was the largest single-physics deal in Ansys' history and its third largest deal overall. Partnerships with SAP (SAP) and PTC (PTC) are progressing well.

Ansys' P&L figures were more volatile, because the ASC 606 accounting standard means that lease revenues of large contracts are now recognised upfront, rather than spread over time. Ansys' revenues and EBIT showed double-digit growth rates, in both Q1 and H1, due to large contract wins.

EBIT margin contracted as expected, due to ongoing investments, including new hires in R&D and sales.

Outlook

As part of the Q2 results announcement, management revised its full-year 2019 outlook slightly upwards, increasing its guidance for revenue, EBIT and EPS (but not cashflows), with the new outlook as shown below:

Ansys Updated 2019 Outlook

Source: Ansys results press release & transcript (19Q2).

ACV growth for FY19 is now expected to be 10-13% year-on-year (in constant currency), including a 3% contribution from acquisitions, while revenue growth to expected to be 14-17%.

EBIT margin for FY19 is to expected to be 43.5-44.5%, compared to 47.4% in 2018, and in the middle of the FY20 target range of 43-45%.

The revised outlook includes lower expectations for China, which was less than 5% of Ansys' revenues in 2018 (i.e. less than c. $65m). Management had factored in a $5-10m reduction in their expectations for China in 19H2, but this is offset by greater momentum elsewhere.

Management also reiterated their 2020 financial outlook, which includes explicitly targeting revenue growth of at least 10% p.a.:

Ansys Mid-Term Financial Targets (2020)

NB1. Margin target is based on ASC 605, comparable to figures for 2017 & before.

NB2. Mgmt. non-GAAP op. margin has share-based comp. added back.

Source: Ansys investor presentation (19Q2).

Annualized Contract Value

We take the opportunity to look at historic ACV performance, and shows how volatility in quarterly figures are structural and should not worry investors.

As mentioned above, ACV is the most important metric for Ansys' growth , reflecting the annualized value of bookings that start in each time period:

Ansys Annualized Contract Value ("ACV") Definition

Source: Ansys results presentation (19Q2).

Management has stated the company looks at ACV targets on a full-year basis, as quarterly figures will be volatile, with Q4 being seasonally the heaviest:

“As we head into 2019, I would like to again remind everyone that our focus will be on progress against annual targets as opposed to quarterly results simply due to the volatility in quarterly revenue operating margin and EPS that result from the timing of large lease transactions under ASC 606. As we saw in our 2018 results, our Q4 business volume with 28% constant currency ACV growth continues to grow seasonally stronger. It is by far our largest quarter for new business particularly for large multi-year deals. As we look ahead to 2019 we see a very similar seasonal pattern with a disproportionately large Q4 dynamic.”

Maria Shields, Ansys CFO (18Q4 earnings call)

The actual ACV figures since 2017 (below) shows that quarter-on-quarter volatility in their dollar value is frequent and not meaningful, especially with Q4 being heavy for seasonality reasons:

Ansys ACV by Quarter (2017-19Q2)

Source: Ansys company filings.

Similarly, year-on-year growth rates in ACV are also inherently volatile - as shown below, 18Q2 and 19Q1 each supposedly showed a “slowdown” in the year-on-year growth in ACV, only for it to accelerate again later in the year:

Ansys ACV Y/Y Growth Rates (ex-FX) (2017-19Q2)

Source: Ansys company filings.

Share Repurchases

We take the opportunity to look at historic share buybacks, given some investors are concerned that they have become smaller in size.

Ansys has been spending much less in share buyback this year, with only $59m repurchased in 19H1, compared to $117.8m for 18H1. However, as shown below, this appears to be due to a desire to maintain a prudent cash balance of at least $600m, after $285m of cash has been spent on acquisitions year-to-date. A similar pause in buybacks was seen in 18Q2 last year:

Ansys Share Buybacks vs. Quarter-End Cash (18Q1-19Q2A)

Source: Ansys company filings.

While Ansys' share buybacks this year have so far been done at an average price of just below $180, this does not seem to reflect any management view on the shares' fair value; instead it may be due to coincidental timing as cash became available at the company. Our evidence for this (as shown below) is that the average price of $179.42 for 19Q1 buybacks implies that most of them were done towards the end of the quarter, despite the share price being much lower at the earlier part of the quarter:

Ansys Average Buyback Price Each Quarter vs. Share Price (18Q1-19Q2A)

Source: Ansys company filings, Yahoo Finance.

Ansys' share buyback authorisation is based on a number shares, not a dollar amount; and 3.5m shares (4% of outstanding shares) remains in the program.

Valuation

Our definition of Free Cash Flow ("FCF") removes the benefit of working capital inflows and also subtracts share-based compensation as a cost. We only subtract working capital inflows, but do not add back the outflows in 2018, as these are likely lease revenues that are booked early base on ASC 606.

Under our definition, Ansys had LTM FCF of $358.0m, implying a FCF yield of 2.1%; P/E is 31.2x (on non-GAAP EPS, which excludes share-based compensation). Details are shown below:

Ansys Cashflows & Valuation (2014-19H1A)

Source: Ansys company filings.

We believe Ansys' current valuation multiples are fair, given the company's resilient earnings and structural growth potential.

Conclusion

Ansys continues to deliver strong ACV growth, in line with our assumption of a long-term sustainable revenue growth of 10% p.a. EBIT margin has been shrinking due to investments as expected, but it will have reached its target level in 2019 and likely to stabilise thereafter. We believe Ansys is on track to deliver a sustainable earnings growth of 10% p.a.

At $201.89, Ansys' shares are on 31.2x P/E and 2.1% FCF Yield, reflective of the company's resilient earnings and structural growth potential.

Ansys likely to deliver long-term investor return of 10% p.a., based on earnings growing 10% p.a. and valuation multiples remaining stable. As an unique asset in enterprise software, it may have further upside from strategic or private equity interest. We reiterate our Buy recommendation.

Disclosure: I am/we are long ANSS. 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.