A growth story
Russell Muldoon November 13, 2015
Altium Limited (ASX: ALU) is a business we own in our domestic portfolios at Montgomery. It’s highly likely that the business is unfamiliar to most investors given it’s by no means a big business and nor would it be considered by many to be a ‘blue-chip’, but that’s probably why we like it.
In our opinion, Altium is a business that has excellent prospects for the future. The reason for this is pretty straight forward. It has exposure to a high growth market that will last decades, the machine-to-machine revolution. Also widely known as the internet of things (IOT), it’s a multi-year structural growth story which appears to be gathering pace.
Everything from elevator lifts, to your smart phone and even the family car is now filled with electronic processing power. You’d have to be living under a rock to have not seen the almost daily improvements in driverless or electric cars. It’s such growth markets as these technology advancements, that sees Altium well-placed.
And ‘why?’ do you ask, because Altium owns and builds the software that is used by some of the largest businesses in the world to design circuit boards in a virtual environment. Think BMW, Audi, BAE Systems and Bang & Olfusen to name just a few.
Importantly, in the current economic environment where organic growth is scarce, this is not a headwind for this business. Altium is an impressive growth story and we think it could continue for some time yet. This growth is obviously coming from being exposed to a fast growing market, but also because they have been reinvesting and improving their software capabilities to further meet their customer’s needs.
According to our research, these improvements / upgrades have been well received and have resulted in
Altium Designer being successful in taking market share from the dominant players in the space such as Mentor Graphics. This and the fact that their software is at a significantly lower price point for the products features than their competitors.
Importantly, once a customer has made the decision to integrate Altium’s software into their design process, it’s tough for them to just up and leave. Think about the logistics required if they did – staff would need to be retrained on new software, processes would need to be redesigned and the library of existing product designs and components would need to be transferred and changed.
As you can get a feel for, it’s not a simple task, and it’s this point which appears to provide them with some pricing power. Also known in the industry as ‘switching costs’, the barriers make portability a complicated task and make for a customer base with very high attachment rates and thus sticky revenues.
This is a powerful combination. Altium not only operates in a fast growing market, resulting in higher sales volumes, but they are taking market share given a quality product and an attractive price point. To this we can also add sticky clients which means that overtime, Altium appears to have the ability to raise their product prices and given it’s a business with a relatively stable level of fixed costs, the operational leverage is often missed by analysts given revenue largely is able to flow straight to the bottom line. All this makes for a highly attractive investment, but we are not done yet.
In terms of an upcoming catalyst, we noted that Altium had a balance sheet flush with $62 million cash in US dollars at their full year result. A combination of a $45 million capital raised last year and internally generated cash flows (this business throws off cash). And it’s with these funds that we fully expect to see a material acquisition to be made and hopefully within the next 12 months.
The benefit of such a move would be threefold. First, cash on the balance sheet is earning nothing so an acquisition of circa $100 million USD would see another profitable business being brought into the fold, lifting the business’ earnings with no further dilution. Second, we know that management are only interested in acquiring a software business that further lifts their existing product capabilities. This results in the third impact of increasing their market reach. And third, a product with more features will potentially attract a newer audience, extending their growth outlook for longer.
All of the above leads to one simple conclusion for us and that is that the business is in a strong position with a long runway ahead of them. And if you needed one more positive, the business reports in US dollars and a lower Aussie dollar sees these cash flows worth more when converted.
