We recently researched Altium (ASX:ALU) in The Dynamic Investor, following a period of weakness in the shares. The latter stemmed (in part) from potential downside risk to both subscriber growth and new seat sales. We considered whether these market concerns were mostly factored into the share price. With the shares still off from their recent peak, we consider whether this presents an entry opportunity.

About Altium

Altium develops and sells software and hardware for the design and development of electronic products. The Company has three key products: i) Altium Designer: Software for the design of Printed Circuit Boards (PCBs); ii) Nexus: A collaborative, cloud-enabled PCB design solution; and iii) Octopart: An electronic parts search engine.

The Company sells its products globally, with >95% of revenue generated from outside Australia. ALU is one of the largest providers globally of PCB design software and has an estimated market share of around 25%.

Key Fundamental Drivers

Subscriber Growth Expected to be More Moderate

One of the disappointing aspects of the recent interim result was that subscriber growth was below expectations. This resulted mainly from COVID lockdowns in China and ALU exiting its Russian business. Aside from these one-off impacts, subscriber growth in recent halves was impacted by a material decline in upgrades/rejoins.

Subscriber growth is expected to have recovered in the 2nd half of financial year 2023 (2H23). This is because the Company has changed its license renewal policy. The total number of subscribers is expected to reach ~60K in FY23 (+6% on FY22), which is broadly in line with Company guidance. Importantly, the Company is unlikely to generate similar rates of subscription growth over FY24 & FY25. In particular:

• Price increases previously implemented continue to impact new Altium Designer licences, with a further impact expected in 2H23.
• Whilst Altium 365 website visits were down 4% in June 2023 (on a month-on-month basis), this likely reflects seasonality. Momentum continues to be strong overall, with visits up +80% on a year-on-year basis. However, this was mitigated by web visits to Altium’s digital sales page declining by 12% in June 2023.

Pricing Continues to Underpin Medium-Term Revenue Growth Expectations

ALU has generated steadily higher Average Revenue Per User (ARPU) on PCB subscriptions, as mainstream customers adopt PRO-level platform capabilities. Due to mainstream users looking to gain access to enterprise features, ALU has been selling enterprise features to mainstream channels. Growth in the PRO segment has helped improve monthly revenue per recurring subscriber and has continued to contribute to a trend of increasing ARPU.

Subscription ARPUs are expected to grow by ~10-15% in FY23 due to continued benefits from price increases and penetration of higher-value products. A similar rate of growth expected over FY22-26 on a CAGR basis, due to:

i. Recent price increases and movement away from aggressive historic discounting. However, the Company do not intend to implement consistent pricing increases in the long run (as inflation normalises).
ii. Steady transition of new licence sales from perpetual to term-based; and,
iii. Increasing customer take-up of higher-value products including Altium Designer Term, Enterprise and Altium Designer Pro, from approximately 21% of seats in FY22 to ~50% by FY26.

The Company has previously outlined an FY26 target of US$500m revenue, which ALU had expected would be achieved by reaching 100,000 subscribers by 2026. At the interim results release in February, ALU reiterated its FY26 target. Importantly, the Company commented that these targets can be achieved with 75,000 to 90,000 seats on subscription. This assumes that these seats are weighted towards higher-value products.

Higher Costs Likely to Temper EBITDA Margin Expansion – But Only Temporarily

At the 1H23 results release, ALU reaffirmed its FY23 guidance of revenue between US$255-265m and EBITDA margin between 35-37%, as well as the previously-outlined FY26 EBITDA margin of 38-40%.

A recent step-up in hiring activity indicates higher cost growth pressure in the short term, with further R&D expenditure also likely to be required. However, we continue to see scope for further EBITDA margin expansion. The key reason for this is that revenue growth is still strong enough to absorb higher cloud infrastructure costs and higher operating costs.

Fundamental View

ALU shares continue to trade below the lower end of the ~40-60x range that the shares have typically traded on over the past few years. The current multiple is also undemanding in the context of an EPS growth profile of +24% over FY23-25 on a CAGR basis. In addition, the shares are trading at a substantial premium to Electronic Design peers on an Enterprise Value (EV)/EBITDA basis which reflects a stronger growth outlook. However, this multiple is lower than its historical premium over the last five years.

Other factors supporting ALU’s fundamentals include: a strong balance sheet that positions the Company well for expansion via Merger & Acquisitions, and corporate appeal.

It is also worth noting that ALU shares tend to trade well ahead of result releases, especially when recovering from periods of weakness. The FY23 results release is due 21 August.

Charting View

ALU has been struggling since the February high. It looked like it was going to break higher in May but it has since gone back into drifting lower. There is a large area of support near $34 so investors can be patient and wait for the stock to possibly retest that area. Otherwise a break above $40 would make us more confident that is has cleared this trading range from the past 6 months.

 

Michael Gable is managing director of Fairmont Equities.

 

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