Not So Deep Dive: PTC (Ticker: PTC)
A software company that is actually up over the past year
Reminder: these are show notes and charts that should be used in conjunction with the podcast. Do not expect these notes to be a polished research report.
Next week, we kick off our e-commerce/website software month where we plan to cover Mercadolibre, GoDaddy, Squarespace, Adobe, and Wix.com.
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Charts
Show Notes
(Ryan) What they do: PTC (short for Power-To-Create) owns a large portfolio of software that’s used in engineering and manufacturing processes. Between its 10+ products, PTC groups each one into one of two categories: Product lifecycle management (PLM) and computer-aided design (CAD).
Product Lifecycle Management: They have 7 different products in this category and each one meets a bit of a different need, however, from what I can tell, Windchill is their biggest product. Within Windchill and PLM generally, the platforms have a number of functions such as CAD Data Management (access control, version history, product structure), Document and Release management, Bill of Materials Management, Manufacturing Process Planning, Supplier/Vendor management, and more. This segment accounts for 55% of overall revenue.
Computer-Aided Design: CAD software is used for “product data authoring”. This is where PTC is most similar to Solidworks and other CAD software providers like Autodesk. They have 4 different products under their CAD category (Creo, Vuforia, Arbortext, and Onshape) with Creo and Onshape being the largest. Creo is quite similar to Dassault’s Solidworks product and it’s used to build really complex parts.
PTC’s customers include some of the largest manufacturing companies in the world such as the major automotive makers (Volvo, GM, Mercedes), oil and gas producers, and just general retail and consumer products companies. Like the other engineering software companies we’ve studied in the last month, PTC has gradually been shifting to a cloud-based recurring revenue model. This has been easy for its PLM solutions but much slower for their CAD customers. In total, today more than 90% of their revenue is recurring, meaning PTC recognizes revenue ratably over the life of a contract but often accepts the cash upfront.
(Ryan) History: Seems as though most engineering software companies started in a similar way. In 1985, a Russian immigrant named Samuel Geisberg left his work at Computervision, which was another CAD company at the time to begin developing his own CAD product. He started by forming a company called Parametric Technology Corporation and they launched their first ever software (Pro/ENGINEER – would eventually become Creo) in 1988, quickly landing John Deere as its first customer.
At the time this was apparently the first ever parametric feature-based modeling software. Things got off to a hot start. In 1989, the company went public under the ticker PMTC and by 1991, PTC already had $45 million in revenue and its software was receiving tons of accolades. Throughout the 90’s they began making acquisitions, and really haven’t stopped since. Their first Windchill PLM solution was developed in 1998. Since then it’s been more of the same.
The only other thing worth noting, in 2018 Creo and Ansys signed a big partnership. With Creo Simulation Live, Ansys’ simulation technology is integrated into Creo’s solution for native testing.
(Brett) Industry/Landscape/Competition:
PTC competes within product lifecycle management (PLM), computer-aided design (CAD), industrial augmented reality (AR), and industrial internet of things (IIOT)
The global PLM industry is valued at around $25 billion and is expected to grow at mid-single digits this decade. Competitors: Autodesk, Dassault Systemes, Siemens
The CAD industry is valued at just under $10 billion a year and is expected to grow at mid-single digits this decade. Competitors: Autodesk, Dassault Systemes
Analysts are extremely bullish on the growth of the industrial AR market. If the hardware makers like Microsoft and Meta can improve the technology significantly, it wouldn’t be surprising to see the market grow by solid double digits this decade. Competitors: Microsoft, TeamViewer, ScopeAR. This is a more immature market compared to CAD or PLM.
The IIOT market is estimated to be in the hundreds of billions of dollars and growing at 10%+ a year. However, PTC is only attacking a small part of that with the software overlay/connectivity for users. Competitors: Amazon, Oracle, Siemens, SAP.
(Brett) Management, Ownership, Compensation:
The CEO is James Hepplemann. He has been the CEO since 2010 and was the inventor of Windchill, which PTC acquired in 1998.
Heppelmann owns 0.76% of the company’s stock, and no other executives/directors own more than 0.1% of the shares.
Rockwell Automation has a 9% stake in PTC and the companies have a “strategic alliance” to cross-sell products to industrial customers, specifically with a focus on PLM, AR, and IoT. Here is more from a very buzzwordy press release: https://www.ptc.com/en/news/2020/ptc-rockwell-automation-extend-strategic-alliance
Total director compensation of $3.3 million last fiscal year (FY 2022 Proxy not out) or 0.2% of gross profit
Total executive compensation of $34.8 million last fiscal year or 2.25% of gross profit. However, the year before Heppelmann got over $40 million in stock awards himself.
A small amount of executive compensation is an annual base salary and annual incentive bonuses (based on ARR and non-GAAP operating expenses). The majority comes from long-term equity awards
Half of the equity awards are standard RSUs, and half are performance stock units based on hitting adjusted free cash flow targets and a relative total shareholder return hurdle
(As of 2022 Proxy)
(Ryan) Earnings: Just wrapped up its 2022 FY
Total revenue was $1.9 billion, up 7% YoY (11% in constant currency)
53% of revenue comes from Europe and Asia Pacific
~$1.6 billion in annual recurring revenue, up 7% (16% in constant currency)
80% gross margins
They offer professional services (customer support/integration help) which are extremely low margins.
$416 million in free cash flow (22% free cash flow margins)
$175 million in stock-based compensation this year and repurchased $125 million worth of shares.
The long-term goal is to return 50% of free cash flow to shareholders in the form of repurchases.
$1.5 billion was spent on acquisitions in the last 3 years.
(Ryan) Balance sheet and liquidity:
Liabilities:
$1.35 billion in total long-term debt with an average interest rate of 3.9%.
$500 million in 2028, 4% senior notes.
$500 million in 2025, 3.625% senior notes.
$359 million in a variable rate, revolving credit facility. Over the last year, the rate on this debt has jumped from 4.1% to 5.7%.
Assets/Cash Flow:
$272 million in cash and cash equivalents
~$561 million in 2022 EBITDA
Net Debt to EBITDA of 1.9x
(Brett) Valuation:
Market cap of $14.4 billion
Enterprise value of $15.5 billion
EV/s of 8.7
EV/OI of 34.6
EV/OCF of 35.6
Anecdotal Evidence:
(Ryan) Product tutorials of their PLM products. Lots of native Creo integrations on Windchill, so looks like it really helps to use a PTC lifecycle management product if you’re also using their CAD solution.
(Brett) I have no personal experience with these products. However, my feeling is that a PLM product will have high switching costs but not as high as a CAD/design/simulation software product.
Future growth opportunities:
(Ryan) Kind of difficult to pin down any sort of unique opportunity here since PTC’s growth looks pretty straightforward. Continued cloud transition, new customers, price increases, and acquisitions. I’ll highlight two, Thingworx and Vuforia. These comprise the Digital Thread – Growth category. Thingworx is supposed to be IoT software for industrial companies (workforce efficiency, asset optimization) and Vuforia is their enterprise AR platform. Together these are generating $230 million in ARR, up 19% YoY. They said they’re focusing a lot on cross-selling these.
(Brett) Transitioning its product portfolio to cloud/SaaS. Management says the transition will take through the end of this decade due to the more complex nature of engineering and industrial software vs. others in the B2B market. It recently accelerated this with its acquisition of ServiceMax (projected to close in early 2023) which offers a SaaS PLM platform. The benefits for shareholders? According to management, customers generally pay 2x or more when they transition to SaaS, which they believe can help drive revenue growth this decade.
Highlights and lowlights:
Ryan’s Highlights:
The one shared characteristic about all these software engineering businesses that I really like is that it’s a pain to switch. PTC is no different. In fact, if you’re using both their CAD and PLM products, it’s even tougher to switch.
Clear track record of growth. See the charts Brett laid out.
Durable and growing end markets.
Ryan’s Lowlights:
They still hold an equity stake in Matterport. I’m generally not a fan of executive teams making equity investments unless I have a way to vet their capital allocation skills.
A lot of capital likely being destroyed in acquisitions, but it’s hard to really tell how much.
Brett’s Highlights:
I believe the switching costs for these products are high and it is a positive sign that PTC is the leader in the PLM space and has been for many years. These switching costs should only increase if they get customers onto SaaS products, IIOT, AR, and other products.
Management has a generally long tenure and seems to want to be around for many years.
There is a consistent track record of revenue growth to go along with margin expansion (check out the revenue per employee chart) that should continue this decade.
Brett’s Lowlights:
I believe the accelerant of acquisitions over the past few years adds some risk of value destruction for shareholders if PTC Is unable to hit its FCF targets. Compared to its market cap, the executive team has spent a lot of money at high sales multiples for these software businesses.
With the way management has set up the capital structure over the last few years, it will be very difficult for PTC to return cash to shareholders through buybacks, which means shares outstanding will start growing at a steady clip over the next three to five years. Over the past five years, shares outstanding are virtually flat while PTC spent $1.4 billion repurchasing its own stock.
Management compensation is based on “adjusted” free cash flow and not on a per-share basis. With that in mind, I think management may be too incentivized to pursue acquisitions without thinking about increasing shareholder value over the long term.
Bull Case:
(Ryan) Plainly, at a $15 billion enterprise value, I think they have to get to $1 billion in free cash flow within 5 years for this to be a good investment. That’s more than a double from here, doable but tough.
(Brett) At the latest investor day, management laid out a goal to hit $850 million in free cash flow generation (adjusted, most likely) by fiscal year 2025. If they hit this and get to $1 billion+ a few years later, I think it would be difficult to lose money in the stock at this price. However, to be comfortable penciling in 5% - 10% annual returns, I believe investors need to expect PTC to beat this target given where the stock trades.
Bear Case:
(Ryan) I think anything less than 20% FCF per share growth over the next 5 years and you’ve got an underperformer. I also think capital allocation is a big risk here. This is a management team that for whatever reason really wants to make acquisitions. I don’t like when that’s a part of the strategy.
(Brett) As with most of the engineering software businesses we’ve covered, I don’t think there is much risk of business quality degradation with PTC. However, at the current stock price and with shares outstanding set to rise over the next three to five years, the stock looks richly valued. At a market cap of $15 billion they are trading at 17.5x FY 2025 projected free cash flow, and that is before considering share dilution. PTC could hit its target and you might see negative returns over that timespan.
More or less interested?
(Ryan) More interested, just not at this price. It’s certainly a high-quality business but I think investors have to make some rosy assumptions for this to be a market outperformer.
(Brett) More interested, but the price is much too expensive to consider buying today.
Sources and Further Reading
Creo vs. Solidworks: https://all3dp.com/2/solidworks-vs-creo-cad-software-compared/
Onshape vs. Fusion 360: https://www.buildercentral.com/onshape-vs-fusion360/
FY 2022 Annual Report (ending in September 2022): https://d18rn0p25nwr6d.cloudfront.net/CIK-0000857005/1ffdcd16-f2a8-486e-b025-818a757c8c70.pdf
2022 Investor Day Presentation: https://s27.q4cdn.com/610238322/files/doc_presentations/2022/11/FY'23-Investor_Day_Posting.pdf
Windchill Product Tutorial: