- Shares of Altair rallied ~7% after reporting fourth quarter results.
- Despite beating Wall Street's expectations, Altair's growth prospects and execution hardly justify the ~2x rally the stock has seen over the past year.
- Altair's outlook for 2021 calls for just 8% y/y growth. Against this revenue view, Altair's current valuation multiple sits at nearly 9x forward revenue.
- For a legacy technology company with few notable growth drivers on the horizon, it's difficult to see the Altair rally continuing.
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With the rout in tech stocks over the past week, investors have gotten an opportunity to examine their portfolios and hopefully weed out low-quality names that are at risk of a correction. During the years-long bull market for technology stocks, stocks have rallied almost indiscriminately, where basically any software company that wasn't facing any immediate or major problems has seen a major rally.
But some of these stocks truly have very little to show against the massive valuations they have amassed. Altair Engineering (NASDAQ:ALTR) is a prime example of one of these companies. Founded in 1985, Altair enjoyed its heyday as one of the premier provider of CAD (computer-aided design) software. But after years atop its saturated market, it's unclear whether Altair has much room for growth left in front of it.
It's worth noting that not all legacy software companies have met a similar fate. Adobe (ADBE) is also a four-decade-old company, and yet the company has managed to maintain ~20% y/y growth and continually justify its premium valuation multiple by expanding its product portfolio, converting its user base to cloud applications, and continually staying on top of its market. Microsoft (MSFT) is yet another example of a "legacy" technology company that has rebuilt its brand around the cloud and rolled out a host of new business lines that kept the company relevant in 2021.
We can hardly say the same for Altair, however - and the company's story each and every quarter seems to be that the business is just plodding along.
Take a look at Altair's guidance for next year:
Figure 1. Altair FY21 outlookSource: Altair Q4 earnings release
Altair is calling for between $502-$510 million in total revenue for next year, which would represent just meager 8% y/y growth at the midpoint.
Meanwhile, its stock is trading at a very rich multiple against that revenue, which is very atypical for a company that is seeing only poor mid single-digit growth rates. At current share prices near $61, after a post-earnings rally that took Altair shares up ~7%, the stock is trading at a $4.54 billion market cap. After we net off the $241.2 million of cash and $219.0 million of debt on Altair's most recent balance sheet, the company's enterprise value is $4.52 billion.
Against the midpoint of the company's $502-$510 million forward revenue range, Altair trades at a rich 8.9x EV/FY21 revenue. That's hands down an uncompetitive multiple for a stock with Altair's growth profile. Comps that are growing in a similar ~10% neighborhood to Altair include Box (BOX), Talend (TLND), Zuora (ZUO), and New Relic (NEWR) - the "penalty box" stocks of the software sector, all of which are trading around or below ~4.5x forward revenue.
To me, this indicates that Altair is at least ~2x overvalued. That might be okay if the stock had any meaningful growth drivers to push it forward (rising margins, a cloud conversion, an exciting new product rollout or vertical market push, etc.) - but these are far and few between for Altair. In my mind, this stock is very vulnerable to a correction given its current valuation seems to be based on thin air.
If you're holding this stock, I would advise locking in gains before the air gets knocked out of Altair's balloon. If not, staying on the sidelines is your best move.
Let's now cover Altair's most recent, and rather lackluster, fourth-quarter results in more detail. The Q4 earnings summary is shown below:
Figure 2. Altair Q4 resultsSource: Altair Q4 earnings release
Altair's revenue grew at 8% y/y to $133.4 million, beating Wall Street's expectations of $116.7 million (-6% y/y) by a fairly substantial margin. Altair operates on a usage-based business model wherein clients purchase blocks of computing units, which then get used up over time. The pervading consensus was that the pandemic would slow down a lot of the engineering-related use cases that are performed on Altair, thus making it difficult for Altair to sell more credits. But while growth was slow, Altair at least maintained positive year over year revenue.
92% of the company's business now comes in the form of recurring licenses, up from 87% in the year-ago quarter. The company has also noted that renewals have tracked closely in line with expectations. Sales of actual software products actually grew at a faster 12% y/y pace, but services-related revenue - where Altair takes on more of a consulting role in either implementing tools or executing certain projects on behalf of its clients - fell in the quarter, impacted by COVID-19.
This mix shift toward higher-margin software has been happening all year, and is a net positive for gross margins even though it does create a revenue headwind. For the full year 2020, Altair's gross margin jumped 300bps to 74.2%.
This, in turn, helped Altair push its adjusted EBITDA for the full year up to $57.3 million, representing 45% y/y growth and a 12.2% adjusted EBITDA margin, up from 8.6% in 2019.
Figure 3. Altair EBITDASource: Altair Q4 earnings release
Altair's incoming CFO, Matthew Brown, however, warned that some of the company's cost cuts from reduced sales and marketing/T&E spend in 2020 will be reverted in 2021. Per Brown's prepared remarks on the Q4 earnings call:
In particular, during 2020, we reduced marketing and tradeshow costs by almost 40%, relative to the prior year and reduced travel and entertainment costs by 68%. In 2021, we expect some of this activity to return to normal, resulting in an increase in costs year-over-year, particularly in Q2 through Q4 2021.
As we anniversary some of those cost cuts, and as travel resumes. However, we will continue to be disciplined in our expenditures. We are currently looking at targeted reductions in employee costs, contractor costs, and professional services spend as we reorganize within the business."
As such, the pace that Altair is currently growing adjusted EBITDA is expected to moderate in FY21, with the company's $58-$66 million EBITDA guidance representing only 8% y/y growth at the midpoint. We note that Altair also looks expensive against its EBITDA guidance: its $4.52 billion enterprise value is at a 72.9x EV/FY21 adjusted EBITDA multiple.
From all angles, despite all the "small wins" that Altair has been able to achieve in beating rather muted Wall Street expectations quarter after quarter, I see few reasons to be bullish on this stock.
Most software companies growing below 10% y/y fail to earn a valuation multiple greater than 5x forward revenue, but for some reason Altair has been an exception. Having seen its stock rise ~2x over the past year without any notable catalysts to continue taking it higher, I view Altair as a propped-up stock with nowhere to go but down.
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