Beneath the numbers, the Altium story just keeps getting better

Being one of Livewire readers’ 10 most tipped big caps, technology company Altium (ASX:ALU) has high hopes among our audience. The company rounded off FY 2020 with over 50,000 subscribers and the successful launch of its highly anticipated Altium 365 product.

While earnings met guidance and the share price reaction was erratic, Ben Clark of TMS Capital - who has held ALU for 5 years - says the market is missing the big story beneath the headline numbers.

Read my quickfire Q&A with Ben to understand the groundwork Altium CEO Aram Mirkazem and his team are laying to drive this growth company’s profitability into new horizons, and the three big things not being reflected in its valuation today.

How long have you held the stock and what attracted you to the company?

We’ve held ALU for five years within the TMS High Conviction strategy. What drew us to the company was:

• The fundamental role their Altium software plays within the ‘Internet of Things’ thematic, which is all about connecting devices to the internet and each other
• Their willingness to provide long-term guidance to the market
• The success that the CEO had achieved in transforming the business, the size of the market they were moving into and the gains they’ve made in that market

When we first bought it in 2015, they already had their targets for 2020; we thought if they came anywhere close to that number the business would be worth well more than it was at the time.

What were the key points of the recent result?

They actually came slightly short of their own target. Their main goal was for revenue of US$200 million by 2020 and they would have hit that had it not been for what’s happened over the last few months.

It’s still one of my favoured holdings because they’ve set themselves a new target of 2025:

• They’re guiding to achieve 100,000 subscribers (up from 51,006 in FY 20)
• They announced they have pushed their new 2025 revenue target back by 6-12 months, so they’re guiding for US$500 million in revenue probably by 2025-2026
• The other thing he spoke about was the ‘Rule of 50’. Basically, what this is is revenue growth plus EBITDA as a percentage of revenue. If that combined number is greater than 50% then Altium will be significantly more profitable than it is today and meet a metric that very few companies globally attain.

How did the results compare with your expectations? And those of the broader market?

They largely met market expectations – maybe a touch under. There were a couple of accounting items in there which meant their EBITDA number was a bit ahead of consensus but their NPAT was below. Altium is a company that you normally don’t hear a lot from in between results and AGMs. But since COVID they have been regularly updating the market on their business, so there’s not a lot of real surprises there as far as the numbers go for the final six months of FY 20.

What else popped out regarding their outlook?

I would say the new information we saw in this result was that in May, Altium launched their new software package called Altium 365. That’s game-changing in that it will move their software platform into the cloud and it will mean that someone working in a factory in China can collaborate with, say, a parts manufacturer elsewhere in real-time.

That’s Aram's goal of how it’s all going to fit together, and we’ve had some early numbers on the adoption of 365. It’s only been live for 2 months in FY20 and they already have 2,600 users, and Aram’s comments were that the customer reaction is very strong and well ahead of internal forecasts. That’s a good indicator of take-up.

The other interesting part is that they are going to change their pricing approach – they are hoping over time to move 365 subscribers from a perpetual license fee to a SaaS-based model. That’s going to increase Altium’s quality of earnings and so their earnings base, which is 60% recurring, should increase. In turn, that should also make the software more attainable for smaller businesses.

What are the other things the market is missing about Altium?

There are three things I think the market is overlooking.

• Firstly, they have a China strategy. They’re building an Altium 365 platform from the ground up purely for that market. It’s going to sync in with Alipay and WeChat, so they’re aiming for market dominance there.
• Secondly, the overall Altium strategy is shifting from building/scaling to market dominance. Aram used a cricket test match analogy where he explained that from 2015-2020, Altium was chasing as many runs as possible to build a dominant position. The next five years will be about taking all 20 wickets – so it’s now about winning and complete domination.
• Thirdly, there's the tax side of things. People talk a lot about the high P/Es of these tech stocks, but what they don’t take factor in is the accounting policy companies like Altium and CSL use. Altium expensed all their R&D costs in year one – they have the option to amortise that over a 20-year period, which would make the profit number look a lot better. This is a very conservative accounting approach that assumes their R&D won’t earn any return – I can guarantee you it will. If they employed the same accounting treatment that most other companies do, their P/E would look more attractive than it currently does.

What weighting is the company in your portfolio now and are you buying, selling or holding?

We’re holding at a weight of 4.7%. The share price has range traded for about 18 months now. I think that in the low $30s we will potentially add more money into ALU as we’ve become more confident about the new 365 platform.

We’re confident backing this company for another five years. You maybe won’t get as good a share price return as the last five years, but hopefully a good outcome still.

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Throughout August, my colleagues Patrick Poke, Bella Kidman and James Marlay will also publish similar Q&As on Livewire readers' most-tipped big caps and small caps. Hit FOLLOW on our profiles to be notified when these wires are published.