Altair Engineering Stock is a Play on Simulated Design
Investing in disruptive technologies appeals to investors because it promises high growth over short periods of time when compared to a slow-moving technology benchmark like Nasdaq. In many cases, it’s a get rich scheme in disguise. In other words, if that “next Microsoft” you think you’re holding can’t manage to beat a bog-standard market benchmark, you’ve taken on a tremendous amount of company-specific risk and actually lost money by missing out on the broader market’s returns.
For your average Joe investor – what we call “retail investors” – investing in disruptive tech is largely confined to stock picking or ETFs. In the case of stocks, you may find limited options that provide high levels of exposure to a particular technology theme, and making meaningful money requires putting all your eggs in one basket. As for ETFs, they’re usually put together by some index provider who needs constituents, and consequently throws in everything but the kitchen sink.
In the case of 3D printing, we’ve been working our way through the Solactive Total 3D-Printing Index and finding some interesting stocks that offer exposure to a variety of disruptive technology themes – ironically, none of which seem to be meaningfully focused on 3D printing itself. For example, our recent piece on Investing in IoT and Augmented Reality with PTC Inc. looked at how IoT and AR might provide some synergy for investors. Today, we’re going to talk about a software stock we found that’s dabbling in everything from digital twins to predictive analytics.
Motown’s Still Got It
While the name Michigan might conjure up images of derelict buildings, poisonous drinking water, and drive-by shootings, that picturesque setting is largely confined to the Detroit suburbs. Outside of that hellish landscape, you’ll find cities like Troy, Michigan, said to be one of the safest cities in ‘Murica, and home to a $2.3 billion software company called Altair Engineering (ALTR). Founded way back in 1985, Altair only recently began their journey as a publicly traded stock in November of 2017 when they debuted their IPO to an excited market which drove the stock up +40% on the first day of trading. Since then, the stock price has settled down while the company’s prospects haven’t.
In order to better understand what the company does, we need to understand a bit more about how software is eating the world.
Why Software Is Eating the World
Back before the tech world became obsessed over gossip-magazine-type “scandals” – like chastising a CEO for rightly calling an employee a brain-dead moron – focus was placed on more relevant things. In 2011, an essay was published by famed venture capital firm Andreessen Horowitz titled “Why Software is Eating the World,” which talked about how “more and more major businesses and industries are being run on software and delivered as online services.” Software is also eating up traditional business models and spitting out new “as a service” business models which make the complex business of selling software easier to understand. Simple metrics like “run rate” and “retention” make it easy to measure the success of any given software company in selling their product. For Altair, their software business, which accounted for 77% of 2018 revenues, can be broken down into the below sub-segments:
In looking at their regulatory filings, it’s impossible to see how each segment contributes to the total revenue number, but they all seem to be areas that complement one another while at the same time providing some diversification effects. Collectively, these software packages are used by more than 8,000 companies with no single client accounting for more than 2% of total revenues. Geographically, revenues are about evenly distributed between Americas, Asia Pacific, and Europe/Middle East. The company’s own enterprise software sales team sells direct to clients, with 60% of new revenues coming in the form of up-selling. Like PTC Inc., Altair is focused on moving to an annual recurring revenue (ARR) model and their latest conference call talks about how nearly 80% of software revenues have now been converted to yearly subscriptions. So, what exactly are they selling and to whom?
What Would Ya Say, Ya Do Here?
“Altair transforms design and decision making by applying simulation, machine learning and optimization throughout product lifecycles,” says the company, and their 2019 Analyst and Investor Meeting Presentation has some great examples of how this software gets used. Yesterday’s product designer may have developed a product in CAD, then created a physical prototype of the product to test the design in the real world. Using Altair’s “simulation-driven design” means that you can test multiple iterations of your product in virtual environments. Then, you can take those designs along with the test output and tell some machine learning algorithms to optimize the part according to a pre-defined set of key performance indicators (KPIs).
Just think of how many product design iterations you might be able to achieve in the virtual world compared to the physical world. (One of the world’s largest wheel manufacturers which produces 60 million wheels annually is trialing these machine learning capabilities and believes they could lead to a 50% reduction in scrap.)
Automotive is Altair’s largest market segment, representing 35% of software revenues and approximately 2,300 customers. Both automotive and aerospace combined made up over 50% of their 2018 billings, and their client list includes 15 out of 15 of the world’s leading automotive manufacturers and 10 out of 10 of the world’s leading aerospace manufacturers. Using the latest GPUs from companies like Nvidia, they’re able to create virtual wind tunnels where designers can optimize the shape of an automobile or the wing of an aircraft. Now, we can start to see how an automobile design team might collaborate by creating a “digital twin” of an automobile which responds in real-time to design changes. Even crash simulations can be conducted in these simulated virtual worlds.
Another interesting application of this simulation-driven design suite is predictive maintenance. A large automotive manufacturing firm had a team of over 16,000 robots engaged in assembly, painting, and welding. When a robot arm breaks down before its maintenance cycle, it stops production. With 23% of deployed robot arms breaking down before their maintenance cycle, production delays were costing the company $44 million a year. Using the Altair product suite, designers were able to input usage data, maintenance records, and design data, and model new parts that would prevent costly breakdowns.
It’s easy to see how you might be able to combine all aspects of the design suite we’ve talked about so far to predict failures during the development lifecycle, consequently saving companies millions of dollars by avoiding downtime. Production of parts can then be performed by whatever manufacturing method works best, perhaps 3D printing, perhaps not.
Diversification is what keeps retail investors from going dead broke by betting on the wrong horse. Investments should be diversified at an asset class level, then at a portfolio level, and finally at a company level in respect to revenue streams. For Altair, we see a diverse number of software products being sold to a client base that’s evenly scattered across the globe, though the automotive industry is over-represented. Acquisitions allow them to up-sell existing clients with new products while acquiring new talent without having to go through the painful process of finding great software engineers. For retail investors who don’t have a lot of time to focus on the technical details, ARR growth is a simple proxy for how well the whole thing is progressing. Software may not be the easiest business to understand, but Altair’s software business certainly appears to be in the right place at the right time.