Altium (ALU) is a global printed circuit board (PCB) design software provider serving customers across a diverse array of industries. The company has grown significantly from $49.5m (all figures in $USD unless stated otherwise) in revenue in FY12 to $220.8m in FY22, a CAGR of >16% and grown underlying EBITDA from $1.4m to $81.1m at a CAGR of >50%, demonstrating significant economies of scale and operational efficiencies.
Large addressable opportunity. The PCB software design market is forecast to reach $8.13b in 2030, growing at 11.3%pa. Growth is driven by the booming consumer electronics industry, both in emerging and developed economies. The growth in the number of new appliances and consumer electronics has in turn boosted the adoption of advanced PCB design software worldwide. Other growth factors are increased use in manufacturing and construction, healthcare, communication devices, automotive and emerging Internet of Things.
Geopolitical risk impacting growth potential. China now represents 10% of group revenue and is a key source of growth for the business. The decoupling of China and the US economies is slowly giving rise to the formation of two independent and competing ecosystems for electronics, resulting in on-going supply chain challenges and disruption that may potentially deepen. We remain cautious on the outlook for growth in China, albeit the opportunity is significant.
FY26 targets may be too ambitious. ALU has stated its intention of achieving $500m in revenue, with a 38-40% EBITDA margin by FY26. To achieve the target, ALU would need to grow revenue by c.23%pa, which is well above its historical average. The law of large numbers implies that achieving the same growth rate also becomes increasingly difficult as the revenue grows. The target EBITDA margin however seems more achievable, with the FY22 margin of 36.7% being within reaching distance. For context, consensus revenue for FY26 is only $398m, nearly 20% below the target.
Investment View
We rate ALU a Sell. Whilst the company is high quality, with a solid opportunity and runway for growth, we believe at current levels, the stock is too expensive. At 45x fwd PE, we would expect higher EPS growth than the consensus CAGR of c.17% over the next 3 years and believe there are better opportunities for capital within the market.
However, if the company does look on track to achieve its stated targets for FY26, there would be significant earnings upgrades and an accompanying rally in share price, although with industry growth of <12%, the >22% required growth seems implausible at present.
Business and Industry Overview
Altium is a developer of electronic design software focused on the PCB design market. Altium’s flagship product, Altium Designer represents ~60% of group revenue. Founded in Australia in 1985, Altium is headquartered in San Diego, California and has more than 800 employees. Altium operates worldwide with Americas and EMEA representing ~85% of group revenue. ALU also owns and operates Octopart, a search engine for electronic components and industrial products, which represents ~20% of group revenue. Revenue for Octopart is predominantly generated through advertising and is driven by volumes of searches. The remaining revenue is split between other PCB design-based software brands serving specialised purposes, services-based revenue and selling actual manufactured hardware.
The chairman Sam Weiss has been in place since 2007 and owns 1.2% of the company. The current CEO Aram Mirkazemi has been with the company since 1990 and made CEO in 2012. He currently holds 7.2% of the company which is quite significant. We note that there have been no sell downs in holdings since 2018, indicating solid alignment of management with the company.
Figure 1: FY22 Revenue by type
Figure 2: FY22 Revenue by geography
The company has grown revenue significantly over the last 10 years at a rate of c.16%pa. ALU has been able to achieve significant scale and margin benefits as it has grown, compounding EBITDA at a rate of c.50%pa. Whilst we expect the growth rates to moderate as the company reaches a more mature stage, EBITDA growth over the last 5 years has been c.19%pa, including the impact of Covid-19 on the business, which is still impressive.
Figure 3: Historical Revenue and EBITDA
What is a Printed Circuit Board?
Printed Circuit Boards (PCBs) are central to the design and production of electronics and smart connected products, with virtually every electronic product constructed having one or more PCBs. PCBs support and electrically-connect components using conductive tracks, pads and other features. PCBs are formed by laminating together layers of copper sheets, with each layer having thousands of intricate copper traces, and serve as the carrier of all electronic components, microchips, electromechanical parts and embedded software. For an investment in ALU, it is less relevant to understand the intricacies of the engineering behind a PCB, but rather the important software market dynamics which we explain in more detail later in the report.
Figure 4: PCB stack up drawing example
Figure 5: Physical PCB example
Recurring subscription-based revenue.
As ALU’s main product is software, it can be sold on subscription-based licenses, generating recurring revenue throughout the cycle. c.75% of group revenue was recurring in FY22, with the company increasing its focus on subscription-based licenses rather than one-off perpetual licenses. The focus has seen annualised recurring revenue (ARR) rise significantly from c.56% of revenue in FY18, providing a much more predictable and higher quality revenue stream. The rate of change from perpetual licenses to term-based has continued to increase, and now comprises a third of all new licenses sold. ALU has targeted 95% recurring revenue ex-China and developing countries by 2026.
Figure 6: Recurring revenue growing as a proportion of total revenue
Figure 7: Higher average subscription price driving higher ARR
Key Earnings Considerations
Pricing. ALU has traditionally needed to discount its products to maintain its customer growth. However in FY22, discounts were less than 10%. The realised price for Altium Designer seats sold was 22% higher, far outpacing inflation. We would expect the market to remain competitive, with pricing outcomes expected to pace closer to inflation levels moving forward. Whilst ALU can upsell its customers onto higher value licenses, we would expect new customers to be priced more competitively. There is considerable upside risk however if ALU can reduce its need for discounting and demonstrate continued pricing power.
Seat license growth. With the PCB market continuing to grow and new devices being created at a rapid pace, we would expect seat growth for licenses to continue. License seats were at 56,912, as at 30 June 2022, which has grown solidly from 38,826 in 2018 (a CAGR of c.10%). Seat growth however slowed over FY22 to just 4.6%, impacted by Covid lockdowns in China. We remain cautious on the China opportunity, with increasing geopolitical risks potentially impacting growth in the region.
Can Octopart repeat its growth? Octopart grew revenue 85.3% to $50m in FY22, underpinned by increased search activity for integrated circuits caused by the ongoing shortage in the semiconductor industry. It is unlikely the business will be able to retain the growth rate and may even see negative returns in FY23 as the supply chain disruption to semiconductors normalises. Guidance is for modest growth to $60-$65m for FY23, which we believe is at risk of downgrade.
Pull forward demand? It is difficult to accurately quantify if there was a pull forward of demand for ALU during the Covid-19 lockdowns, given that ALU is more leveraged to enterprise software contracts, rather than a general increase in PCB manufacturing. We expect there was some level of increased adoption, given ALU’s cloud integration and global reach, with remote working driving seat license growth. There is a risk some of the previous growth seen during the lockdowns unwinds.
FY26 aspirational targets. It’s always important to have aspirations, however it is equally important to ensure they are achievable. ALU is targeting $500m in revenue and an underlying EBITDA margin of 38%-40% and 100,000 software seats on subscription (noting that a higher-value subscription seat number of 75,000-90,000 could be enough to achieve the $500m target).
To reach the $500m target, ALU would need to grow revenue above 22%pa, which is well above historic growth rates. The EBITDA margin of 38%-40% however is more reasonable, with the company not too far behind this figure, although there are risks that it underinvests in its products and does not remain competitive by focussing too much on margin. For context, consensus is forecasting $387m revenue for FY26, and EBITDA of $163.5m, a c.42% margin.
We would posit that ALU would need to seek inorganic growth to achieve the stated targets, which may not necessarily be accretive to earnings. If ALU can demonstrate it is on track to meet its targets, there would be meaningful earnings uplifts. We would posit that the FY24 result would likely see ALU revise its aspirational targets if it looks like it is unachievable.
Core PCB Software Business and Industry Outlook
PCB software market outlook.
The PCB design software market is competitive and fragmented given several international and domestic players. Winning market share has been difficult and innovative product strategies have been needed to accommodate clients across geographies, which has been ALU’s competitive edge. The below factors contribute to the forecast growth of the industry from c.3$b in 2022 to $8.13b in 2030.
Driving market growth has been the increasing need to minimise the product development time and potential errors. Engineers are required to consider numerous aspects, where utilising advanced software can assist and ensure a more efficient process. The availability of flexible designs should also assist the market growth. It is easy to misplace a component, where any minor errors would usually result in additional cost, labour and time. Using software, engineers can modify designs and make necessary changes easier, which saves on potential additional costs. The need for visualisation is also increasing demand for software.
The advancement of technology can provide lucrative growth opportunities for the industry. The growth in portable devices with additional features such as enhanced performance, increased storage capacity and better processing speeds represent major opportunities. As innovation in the space continues, the size of PCB boards is decreasing, with enterprise customers seeking to take advantage of innovation. Improving software capabilities to cater to the demands of these enterprise customers could present large market share opportunities in turn as demand for smaller and more powerful devices continues to rise.
Whilst there are several factors contributing to the increased adoption of PCB software, the availability of open-source PCB design software may act as a market restraint over the forecast period. Pirated software has been a threat to the growth of the market and may continue to be for the foreseeable future. This has seen the rise in ‘free’ base level software being available, impacting revenue generation and increasing competition for small and infrequent uses. Further, the shortage in skilled users may also impede market growth. The software is complex and challenging and may fail to meet the needs of certain users, potentially seeing growth rates slow.
PCB manufacturing market outlook.
Forecasts for the PCB market estimate it reaching $128b by 2030, up from $78b in 2021 a CAGR of c.5.7%. Similar to the themes above, the growing demand for additional and more powerful products is expected to drive PCB market growth. In addition, the increasing prevalence and capabilities of 3D printers is anticipated to further drive growth.
PCBs are becoming more widespread, with increased usage in electronics, aerospace, IT & telecom, industrial, medical devices, and automotive sectors, contributing to overall growth in value of sales. With growing demand for technology, increased investments by organisations on R&D as well as government support should also support growth of the market.
Figure 8: Forecast PCB Market Size ($USb)
Market share opportunity.
ALU has continued to grow its market share in a growing market. The opportunity in the design software remains large and is forecast to grow above the actual PCB manufacturing growth, given the increasingly complex needs of designers. Competition remains intense, with competitors offering similar products which is becoming increasingly difficult to differentiate. ALU has been innovative launching cloud solutions and API integrations, which has seen it win market share recently, and should continue to drive growth above market. Some competitors however have significant balance sheet firepower to invest in product and marketing, which may erode ALU’s advantages over time.
Over FY22, ALU was able to put through 10-15% price rises across its products. Its competitive advantage with global reach and cloud offering has seen strong adoption and customer retention. We would expect ALU to continue to retain customers, however, note that similar price rises are much more likely to revert to inflationary levels. If competitors continue to reinvest and improve product offerings, we view ALU’s pricing premium at risk and the company may need to look at discounting to retain and attract new customers.
Figure 9: Altium market share continues to grow
Valuation Considerations
ALU has traditionally traded on lofty multiples compared to the market, given its higher earnings growth rate. When compared to peers, the FY24 PE multiple of c.43x based on consensus earnings is more reasonable considering its earnings growth rate is above the peer group. We however believe that consensus earnings are at risk, given the likely softness in seat growth driven by a global economic slowdown.
Figure 10: Peer Comparison – ALU has the highest earnings growth rate forecast
Figure 11: ALU trading in the middle of the peer group for forward PER
On an index relative basis, ALU has historically traded at a PER just over 3.1x the ASX200 PER. ALU is currently at in line with its historical multiple. Compared to its own 5-year history, ALU is trading -1SD below its average PER. We believe that both earnings are at risk and that the multiple should contract in a higher interest rate environment, and a lower earnings growth rate moving forward. We therefore would caution on the current low PER.
Figure 12: PER Relative to the ASX200 is in line with the 5-year average
Figure 13: ALU trading at lower end of its 5-year PE range
Previous takeover offer. In June 2021, Autodesk, a key US competitor proposed a takeover offer at $38.50/share, which was rejected, before verbally discussing a $40.00/share bid, valuing the company at c.A$5.25b. ALU also rejected the higher offer, claiming it ‘significantly undervalues’ its prospects. Autodesk pulled the offer, and the share price has only recently returned to similar levels. We note that the industry is ripe for consolidation with multiple competing software providing a similar service, and ALU remains a potential target from some of the larger companies. We do not however factor in any M&A premium into our investment thesis and valuation, although remain wary of the upside risk.
ATO dispute. ALU is currently in discussions with the ATO regarding a potential tax liability of between A$21.1m to A$80m related to transfer pricing and anti-avoidances provisions. A larger than expected tax liability or any penalties could impact earnings and the share price.
Investment Thesis
We rate ALU a Sell. Whilst we acknowledge the company has a strong pipeline for growth and a high-quality income stream, we believe that lower forward growth rates would see the company trade at a lower multiple. Further, we believe that short-term earnings are at risk given softer macroeconomic conditions impacting seat license growth, and an unwind of Octopart’s FY22 benefit from semiconductor supply chain disruption. With the increase in ‘free’ software offerings, we believe the industry will remain competitive. ALU should be able to continue to take market share, albeit not at the same historical growth rates.
License seat growth returning to historical levels is dependent on growth in China and other developing markets, which invites geopolitical risk into the business model. The main driver of growth therefore is likely to largely be from pricing outcomes and upselling current customers onto more advanced or global licenses. We believe that ALU will be able to deliver some level of pricing upgrades given that customers are becoming more globally connected, although not to the extent seen in FY22, and more likely to track slightly above inflation. We like the company and the opportunity, however, would like to see evidence that the company is tracking towards its FY26 targets before adopting a more positive stance.
