ADBE, MSFT - what beautiful stories of transitioning to a SaaS-based model and "pulling the string" - showing what it means to truly deliver an operating model that scales in the brave new cloud-based world.
Here's how the story is supposed to go -
Step 1) Move your revenue stream away from expensive, perpetual licenses towards less expensive short-term (e.g. monthly) access to the software
Step 2) Revenue and earnings crater in the short-term
Step 3) Execute on COGS/SG&A changes to reflect the new (lower) cost structure of delivering software-as-a-service
Step 4) Rain an ungodly amount of earnings and cash flow on your wise, patient investors.
It's an execution story. There's nothing magical about it. Yes you have to have a product that works on a SaaS basis and a customer base willing to adopt the change (Step 2 can be pretty significant if pricing discounts are required to enable the transition). But there are no "unknown unknowns" here. It's all right in front of you. Management shouldn't have to sell you on the transition as it happens; the results should speak for themselves.
So where's PTC?
"...it’s clear we are in the final stretch of our business model transition." (Source: CEO James Heppelmann, Q3 2017 Earnings Call)
Presumably, then, the company should be on its way toward high leverage and ready to rain earnings and cash flows on its patient investors...so let's have a look.
(Source: Q3 2017 PTC Earnings Press Release)
Do revenues seem to have stabilized? Sure, in fact year-over-year they're actually up just a smidge. So far so good.
Are we executing on COGS/SG&A changes to reflect the new business model? WHOOPS!
We've actually slipped from a GAAP profit to a GAAP loss. Hmmmm, that's interesting. I wonder what the CEO had to say about that when talking about the transition -
"Subscription adoption continues to gain traction and based on our forecast, we expect the subscription mix to rebound in Q4 to 68%. With our plans to move to a subscription only model in the Americas and Western Europe beginning in Q2 of 2018 and with additional subscription programs coming on line each quarter, we remain confident in our long-term subscription mix and recurring software revenue targets."
(Source: Q3 2017 PTC Earnings Conference Call).
Gee, that's funny. No talk about costs. Well maybe he discusses it elsewhere? Searching the entire conference call for the words "costs"... NO RESULTS.
Hmmm, ok I'm getting a little worried these guys don't actually care about execution. If I see a lot of references to revenue but not costs, that would be a really bad sign. Let's search for the word "revenue". Well what do you know...26 REFERENCES TO REVENUE PRIOR TO Q&A!
Ladies and gentlemen, we have a problem. I'm afraid we're dealing with a "sales" management team, not an "execution" management team. They're already onto "The Next Big Thing." In this case, that's IoT, and that's ThingWorx. So while they're off playing with their shiny new toy, what are the investors left with?
- A $6.2 Billion Market Cap company (based on market prices as of today - 8/22/2017) that
- thinks it has completed its transition to a leveraged business model
- has not reduce costs in any meaningful way
- is only expecting to throw off a midpoint of $165 million in Adjusted Free Cash Flow for the year (Source: Company guidance on Q3 2017 Earnings Call) and
- did not turn a profit on a GAAP basis in the most recent quarter
If you're looking for excuses, you'll get plenty. Oh it was just a bad quarter. Don't worry we're going to kill it in the $4.0 billion IoT area. And on and on and on.
We're supposed to believe that there's some magic wand out there that will make them suddenly be able to throw off $525 million in free cash flow?? (Source: August 2017 Investor Presentation)
Even if we take the Adjusted Free Cash Flow of $77m from Q3 and consider that the going run-rate, we're still talking about paying $6.2 billion for $308 million in cash flows. A 5% free cash flow yield for a company in a competitive industry and a management that lacks the discipline to execute? I mean, that's even ignoring the "Adjusted" part of that equation where they ignore $40 million in restructuring costs, which if that were a one-time thing maybe we could ignore it, but based on company data they've had restructuring charges every year for the last 5 years! (Source: E*Trade fundamentals data).
Thanks but no thanks. To current investors I'll say this - enjoy the perpetual presentations that have vague "CAGR" growth arrows going up and to the right in investor presentations, the dream-selling of management, and the fairy tale of being a dominant player in the IoT movement.
Disclosure: I am/we are short PTC.