diamond in the rough
We believe we have come across a ‘diamond in the rough’ of sorts and the stock in question is Altium Limited (ASX: ALU), a software design company currently located in San Diego, California. The company creates software that is used for the development of plastic circuit boards.
Altium software has probably helped design some of the circuit boards in the products you use in your everyday life. From car parts (by BMW, Volkswagen & Toyota) to computer devices (by Microsoft, HP & Belkin) and even medical devices (by Cochlear, Philips & Resmed), Altium allows engineers that make Printed Circuit Boards (PCB’s) that drive these devices to move from concept and into mass-production.
Importantly to us, not only does this represent a true need with the ‘internet-ing of everything’, but the firm has demonstrated improving economics and using its sticky products has delivered its shareholders a 2,500 per cent return on their investment since 2010. Naturally of such a meteoric rise – we ask is there anything left? Well we believe there is reason to be optimistic.
The Business case.
Altium currently offers a licence to use the latest version of Altium Designer (which sells for $7,500 US per licence) and on top of this, users are charged an annual subscription of $1,750 US p.a. Included in the subscription offering are frequent updates, access to a library of pre-made board templates and full customer support.
Computer applications are often known to be “sticky” in that once you start using them, it’s a lot of effort to switch to a competitors application. In this case, the sheer inconvenience of switching in terms of training cost/time is rarely worth it. This stickiness promotes a growing subscriber base (as of December 30 2014, approximately 27,000 subscribers) and hence revenues become increasingly more “annuity” like in nature to the point where they now account for almost half of Altium’s revenues (and this number is growing). This for obvious reasons is a highly desirable investment characteristic.
Further to this, Altium has recently increased prices with apparent little pushback given they are still significantly cheaper than their competitors, and with ongoing reinvestment back into their product and continuously added demanded features, the firm has been taking market share (6 per cent in 2011 to north of 10 per cent in 2014) with seemingly more to come.
This growth in market share is translating into impressive financial results. One measure of profitability is a firm’s EBIT (earnings before interest and tax) margin and it’s risen from -23 per cent to almost 24 per cent over financial year 2010 to financial year 2014.
Another highly desirable feature is that the business requires little additional capital to expand in its traditional market and in this scenario we would see the stock being worth approximately $4.00-$4.50 (the share price as I write this is $3.30). An upside to this valuation clearly lies in the fact that the company has raised funds for expansion into other parts of the software design market (by acquisition), however this scenario lies outside of our base-case valuation.
Overall, Altium appears to be a high quality company with bright prospects for the future. A great new addition to our funds.
The Montgomery Fund and The Montgomery Private Fund hold positions in Altium Limited.
This article is for general advice and educational purposes only. Before you commit to any investment decision we strongly recommend you seek the counsel of a licenced investment adviser.
Scott Shuttleworth is an analyst at Montgomery Investment Management. To invest with Montgomery, find out more.
This post was contributed by a representative of Montgomery Investment Management Pty Limited (AFSL No. 354564). The principal purpose of this post is to provide factual information and not provide financial product advice. Additionally, the information provided is not intended to provide any recommendation or opinion about any financial product. Any commentary and statements of opinion however may contain general advice only that is prepared without taking into account your personal objectives, financial circumstances or needs. Because of this, before acting on any of the information provided, you should always consider its appropriateness in light of your personal objectives, financial circumstances and needs and should consider seeking independent advice from a financial advisor if necessary before making any decisions. This post specifically excludes personal advice.INVEST WITH MONTGOMERY