The Long and Short
Significant recurring revenues at Autodesk support growth
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Autodesk Inc.’s (ADSK, Baa2/BBB) leading position in design software and significant recurring revenue base helped the company navigate the pandemic well. Even with disruption in its key end markets, the company maintained double digit top line growth in 2020 and year-to-date. The outlook for growth is strong and management has demonstrated a preference to finance acquisitions with cash. Closest peer Adobe Inc. (A2/A+) has 2030 bonds that currently trade 35 bp (g-spread) through ADSK’s. The spread between the two securities this year has been as tight as 10 bp and as wide as 45 bp, with the average just below 30 bp. This presents an attractive entry point to position in ADSK 2.85% 2030 bonds with the spread currently trading closer to the wides.
Exhibit 1. ADSK 2.85% 2030 vs ADBE 2.3% 2030 (2021 Year-to-date – g-spread)
Source: Bloomberg TRACE; APS
Financing Growth
The proposed infrastructure bill bodes well for ADSK although the timeline associated with the bill remains unclear. The company maintains a strong balance sheet and credit metrics for the ratings, while maintaining a track record of reducing leverage post acquisition. ADSK also prefers to build cash on the balance sheet to pursue acquisitions versus returning cash to shareholders. While ADSK does not pay a dividend, it uses share repurchases to offset dilution as it has historically used equity in acquisition financing.
Recurring Revenue at 97%
ADSK’s decision to transition to a subscription-based business model from a license business model is now complete and has resulted in a significant recurring revenue base as well as good earnings visibility. Recurring revenues now stand at 97% of total revenues, which includes both subscription and maintenance revenues. Management noted on its earnings call that product subscription renewal rates reached record highs and that subscription revenue was up 21% in the quarter. Additionally, the net revenue retention rate was at the high end of its 100%-110% target range, which helped to contribute to the company’s billing growth of 16%. Total revenues were up 17% (ex fx) in the quarter. This type of growth rate is expected to through fiscal 4Q and beyond, as customers continue embrace digital transformation to drive both efficiency and sustainability.
Organic revenues are expected to increase as the company’s business model is scalable and extensible into adjacent verticals. ADSK is confident that their business will continue to grow as they help customers navigate their digital transformation. ADSK has witnessed multiple customers who have used more than one software provider, transition away from other competitor’s software and increase their commitment with ADSK, in an effort to integrate all technologies smoothly and with greater functionality. Management expects this trend to continue.
Margin Profile and Free Cash Flow Growing
While ADSK’s gross margin stayed steady at 92%, the company’s adjusted operating margin increased 200bps, to 32%. ADSK highlighted that the operating margin growth reflected both the strong top line growth as well as ongoing cost discipline. While the operating margin is expected to be 31% for the full fiscal year, management sees this growing to the 38%-40% range next year. Even with supply chain disruptions and inflation, ADSK’s margin guidance has been left unchanged. Additionally, free cash flow growth is expected to be in the 6%-9% range this year (in the $1.42 billion-$1.46 billion range), with significant growth expected next year, as free cash flow is forecast to be $2.4 billion. We note that FCF/sales for the year should be approximately 33% and increase to roughly 46% next year.
Leverage Strong for the Ratings
We estimate that ADSK will end this year with gross leverage of roughly 2.0x and net leverage closer to 0.9x. We note that ADSK has historically maintained a strong cash position and spent years in a net cash position. While the company is no longer in a net cash position, it still looks to maintain at least $1.6 billion of cash on the balance sheet. Currently, ADSK has $1.8 billion of cash on hand and could see that increase to over $2.0 billion at year end, as 4Q is their largest cash generating quarter. While ADSK has historically been acquisitive, it has largely used cash on hand and stock to finance the acquisitions. ADSK has some flexibility in its ratings to pursue a debt financed acquisition, but we think the agencies would grow concerned if they were to move closer to their maximum leverage ratio of 3.0x under their credit agreement.
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