Clearly Autodesk (ADSK) wasn’t as safe as I thought. The question of what to do with it now would be easier if the miss made more sense. Company claims $0.05 reduction in full year EPS is due to accelerated hiring in order to make “product investments.” But if the products are being enhanced, why isn’t the revenue guidance being increased for the full year?

Stock was already cheap (and is much cheaper today) but until the “investments” start to earn a return they are just “costs.” I’d like a better explanation of what’s going on before feeling comfortable with the name again.

Disclosure: No position held

This article is a reprint of my February 8, 2008 RealMoney column

One of my favorite investment themes is engineering and infrastructure software, which I think combines the high margins and cash flow stability of a software investment with the positive long-term trends in global infrastructure development. I think investors can profit handsomely from a potential 64% rise in Autodesk, the leading player in this market.

In November I wrote bullishly about Dassault (DASTY) and Ansys (ANSS), which I bought in January. Since those columns were written the stocks have performed in-line with the market, which is a nicer-sounding euphemism for saying they have gone down. I was more bearish about Parametric (PMTC), which has indeed turned in the worst performance of the three.

Long term, however, I still think the space has tremendous opportunity and think the overall market downturn is providing additional opportunities – most notably that of industry leader Autodesk (ADSK). Autodesk is best known for its AutoCAD software, a customizable and extendable computer aided design (CAD) application for 2D drafting, detailing, functional design documentation and basic 3D model-based design.

A common misperception is that AutoCAD is focused on architectural markets, and that a slowdown in construction activity could be disproportionately harmful. However, the largest end market is manufacturing (product design) and the civil engineering/infrastructure market is nearly as meaningful as construction.

The shares were downgraded by an analyst at Jeffries in January, who cited “anecdotal channel evidence of slowing manufacturing demand in Europe” and a “decent chance” that spending on computer-aided design software and related technologies will slow in both North America and Europe in 2008. Yet his less-than-2% trims to his EPS estimates, which simply brought them in line with the rest of the crowd, are more than reflected in the 25% decline in the share price since the December.

At any rate, Autodesk continues to meet or exceed earnings estimates and has seen modest positive revisions to estimates over the last month. Since its products are used in the early stages of the construction process, if the potential slowdown doesn’t show up soon it likely won’t show up at all.

Furthermore, with more of its customers migrating to a subscription-based model some of the uncertainty surrounding upgrade adoption has been mitigated and revenue growth and stability are more transparent. Subscription revenues are growing at twice the rate of license sales. Deferred revenues have grown 12% in the last nine months, including an 18% increase in long-term deferred revenues. All of this lends to greater confidence in the level of sales and earnings over the next year.

Autodesk generated $640 million in free cash flow over the last 12 months, which amounts to a free cash flow yield approaching 8% of enterprise value. With a 500-basis point advantage over Treasuries and a long-term expected growth rate of 16% (which is more than justified by the company’s high return on equity) the stock looks very attractive here.

If Autodesk grows in line with estimates and narrows the spread between its cash flow yield and the Treasury yield to a still-attractive 100%, its shares could rise to $63, for a potential return of 64%. The shares offered a similar spread to Treasuries as recently as December, when the shares were trading above $51. Meanwhile, short of a considerable decline from the existing level of sales and cash flow it is hard to see significant further downside.

Disclosures: Long Ansys (ANSS)

This article was originally published at RealMoney on November 6, 2007.

Parametric Technology (PMTC) develops software used for Product Lifecycle Management (PLM) and Enterprise Content Management (ECM). At a P/E of approximately 15x and a 5.3% free cash flow yield, Parametric appears cheap relative to other technical software developers. However, its earnings quality has historically been low and it faces more severe competition than some of its peers. With earnings quality improving and the valuation favorable, PMTC certainly bears watching. But for now I think Dassault Systemes (DASTY) and Ansys (ANSS) have sufficiently better prospects to justify their higher valuations.

Compared to companies like Ansys, which develops highly technical products and has relatively few competitors, Parametric has significant competition in each of its business segments.

PLM competitors include Dassault Systemes SA, Siemens (SI) subsidiary UGS, Autodesk (ADSK) and Agile Software (AGIL). They also compete with larger enterprise-solution companies such as SAP (SAP - Annual Report) that have entered the PLM market and offer solutions integrated with their other enterprise software applications.

ECM competitors include EMC (EMC - Annual Report) Documentum, IBM’s (IBM - Annual Report) FileNet, OpenText, Adobe (ADBE) Framemaker, and the Microsoft (MSFT - Annual Report) Office suite.

Parametric suffered mightily during the tech downturn, but since 2004 the company has been engineering a turnaround based on improved profitability and a return to growth. Current consensus growth estimates for the next five years are just 7%, or half the rate expected for the industry. The lower growth estimates are part of the reason for the cheaper valuation. However, they also make for a lower bar to clear, and the recent reversals of its deferred tax valuation allowance are a signal that the company is now “more likely than not” to earn sufficient income in future years to utilize tax losses from prior periods.

There are a few other issues that cause me to think Parametric’s low valuation is justified. For example, 58% of revenues are derived in North America, which faces an uncertain near-term economic outlook.

Another issue is earnings quality. Gross margins have been declining due to a higher percentage of revenue being derived from consulting and training rather than license and maintenance revenue. A bad debt charge-off in 2006 and increased customer financing activity are other signals that earnings quality may be low.

To get a feel for overall earnings quality, I calculated the accrual ratio, or the change in net operating assets divided by average net operating assets. This ratio describes the percentage of earnings contributed by discretionary accounting items rather than actual cash flows. An ideal accrual ratio would fluctuate around zero. Parametric’s has been all over the map, though it has been improving for several quarters.

Sources: Zacks Research Wizard, William A. Trent

If Parametric continues to improve its earnings quality, or if it gives back some of the stock gains it enjoyed post-earnings (or preferably both!) it could become an attractive buy candidate.  In the meantime, interested investors may find an option play worthwhile.

The January 17.50 puts were trading recently at $0.50/$0.75. If you could write the option for $0.60 it would offer a 3.1% 2.5-month return on the money at risk, which annualizes to nearly 15%. You’d be forced to pay $17.50 for the shares if they drop between now and then, but the option premium would give you an effective price of just $16.90. At that price, the 6.0% free cash flow yield would probably be enticing enough to justify a buy anyway.

Disclosure: Short naked put options on Ansys (ANSS)

William Trent currently has a short position in put options related to Office Depot (ODP).

This article was originally published at RealMoney on November 5, 2007.

Dassault Systemes (DASTY) is trading down nearly 6% after the company trimmed its earnings outlook by five Eurocents last week. The company now expects to earn between €1.96 and €2.00 in 2007, compared with earlier guidance of €2.00 - €2.05. With a solid overall business and a valuation that I believe looks reasonable, I think investors will ultimately find today’s price to have been an excellent entry point.

Dassault designs engineering software used for Product Lifecycle Management (PLM) (81% of 2006 revenue) and Mainstream 3-D design (19%). It has grown through organic growth and a series of acquisitions, including Abaqus in 2005 and MatrixOne in 2006 – each of which was in the order of $500 million consideration. It is 44.5% owned and effectively controlled by France’s Groupe Industriel Marcel Dassault.

Dassault offers software under several brands, including Solidworks for Mainstream 3D design and CATIA, DELMIA, SIMULIA and ENOVIA for PLM. However, a key aspect of its growth strategy is to combine the strengths of its various programs and allow customers to customize solutions using the company’s V5 platform.

The company generates 47% of its revenue in Europe, 31% in the Americas and the remainder in Asia. Although it blamed the lowered outlook on the weak dollar, the company’s latest annual report said its greatest currency exposures are between the Euro (its reporting currency) and the Yen, Pound and Korean Won.

More than half of the company’s sales are on a recurring (software rental or maintenance contract) basis rather than through perpetual license fees. With a largely industrial customer base, revenue growth drivers include business investment and industrial production in its end markets.

Competition

Dassault lists its primary PLM competitors as Parametric (PMTC) and Unigraphics, which was recently acquired by Siemens (SI). Its main competitor in Mainstream 3D is Autodesk (ADSK). The company also competes with Ansys (ANSS), Agile (AGIL), MSC Software (a href="http://stockmarketbeat.com/blog1/category/msc-software-mscs/">MSCS - Annual Report) and to a lesser extent Oracle (ORCL - Annual Report) and SAP (SAP - Annual Report).

The combined revenue of the nearest competitors and comparables, which I believe to be Dassault, Ansys, MSC and Parametric, has been approximately 11% annually over the last decade. Dassault has used its acquisitions and the opportunities provided by the V5 platform to grow at a faster rate than its peers.

In 2006 Dassault grew 24%, much of which was contributed by the Abaqus and MatrixOne acquisitions. On an organic basis sales grew 10% (12% assuming constant currency exchange rates.)

Risks

As I see it, the greatest risk Dassault faces is loss of a major customer. Although the company cites a customer base of 100,000 just 20 of those account for 25% of sales, with the largest customer accounting for 5%.

A potentially greater, though probably less likely risk is the company’s long-standing relationship with International Business Machines (IBM - Annual Report). IBM has a non-exclusive distribution relationship with Dassault and accounted for 45% of sales in 2006, so a rift between the companies could have a serious impact. The companies renegotiated the partnership earlier this year such that Dassault is taking responsibility for mid-market customers and IBM will serve enterprise customers. However, this adds a new risk related to maintaining a larger sales force.

Valuation

Dassault current market cap is approximately $7.3 billion, and with net cash on hand of nearly half a billion its enterprise value is about $6.8 billion. Given that it is on track to exceed its 2006 free cash flow generation of $300 million, the free cash flow yield of 4.4% compares favorably to the yield on five-year treasuries, and the 10% growth rate of recent years looks like a nice inducement for taking on the added risk.

By some common measures (5x book value and a P/E in the mid-20’s) the stock doesn’t exactly look like a bargain. But these measures overlook the cash flow generating power available to software companies. With essentially fixed costs and high margins, each dollar of sales contributes mightily to cash.

Although a recession or slowdown in Dassault’s key end markets or further dollar weakening could delay investor rewards, Dassault’s current valuation and long-term prospects appear to justify the wait.

Disclosure: Short naked put options on Ansys (ANSS)

Note: Set up high growth savings accounts and plan for your financial future today!

Stock market uber-blogger Charles Kirk said yesterday that despite the current rally, the U.S. market is looking Like A Bad Stock:

The U.S. market continues to act like a bad stock in a really great sector of the market. In other words, with the global boom worldwide and the gains seen across the globe, the U.S. market is moving higher along with everything else whether deserved or not. That’s also why we continue to see a huge migration toward companies that have international exposure. The more global the better and there’s good reason for that.

I thought the analogy resonated, and decided to dig a little for evidence in support of the idea. For this task I turned to some recent conference call transcripts of companies with global operations.

At least twice the growth overseas as in America for Autodesk (ADSK):

Revenue in America was $184 million, an increase of 8%. Revenue in the America was somewhat impacted by changes in backlog between years as well as the particularly tough compare in the first quarter of last year, which grew 39%.

EMEA revenues were $207 million, an increase of 26% as reported and 14% cost of currency. Asia Pacific increased 16% to $117 million. Revenues in Japan decreased slightly compared to last year, but increased significantly on a sequential basis consistent with historical trends.

(Excerpt from full ADSK conference call transcript)

Hewlett Packard (HPQ - Annual Report) also saw stronger growth overseas, but currency played a big role for them.

On a regional basis, revenue was up 11% in the Americas, up 14% in EMEA and up 16% in Asia Pacific. When adjusted for the effects of currency, revenue was up 11% in the Americas, 7% in EMEA and 13% in Asia Pacific.

(Excerpt from full HPQ conference call transcript)

BEA Systems (BEAS) is also seeing strength overseas:

As I mentioned, we saw a tough selling environment in the Americas. Our close rate in the first two months of the quarter was actually on track with plan, and then we were surprised when close rates weakened at the end of the quarter. Some large deals slipped out of the quarter. The slippage was generally due to poor execution on our part. A few of those deals have already closed in Q2.

Geographically, the Asia-Pacific region performed very well. We continue to see great performance out of China, Korea, and Asia. In Q1, China contributed more license revenue than any territory outside the United States, and we see no end to demand there. EMEA performed fairly well overall. We performed well in Italy, Northern EMEA and other places.

We’re seeing improvement in the U.K., and our new team there is trying to drive better results and better pipeline.

(Excerpt from full BEAS conference call transcript)

Finally, lest you think the issue may be confined to tech, Estee Lauder (EL) chimes in:

Geographically, our international business again led our growth this quarter. In Europe, the Middle East and Africa, despite coming off high single digit local currency growth last year, we grew net sales a solid 13% for the quarter. A few key businesses drove this performance, including travel retail and our largest market in the region, the United Kingdom, which posted healthy double-digit increases. Russia, one of our emerging markets, reported another outstanding quarter.

All countries in Asia-Pacific posted local currency sales increases, with the exception of Thailand. The increases generally reflect a strong economy in the region. Japan, our largest affiliate in the region, was up mid single digits in the quarter. New points of distribution in the region also added to sales growth.

In the Americas, net sales decreased.

(Excerpt from full EL conference call transcript.)

So all are in agreement: sales are better overseas. No wonder, then, that overseas markets have been stronger.

Disclosure: Author is long IShares MSCI Japan Index (EWJ) at time of publication.

Autodesk, Inc. (ADSK) reported record quarterly revenues of $509 million, an increase of 17 percent over the first quarter of fiscal 2007. The company, which makes engineering and architectural design software, is like all too many tech companies in that a probe into stock option practices means they don’t know how much they actually earned.

What is known about the results, however, looks pretty good, as analysts were only expecting $500 million in sales. Autodesk also raised estimates for the next two quarters and the full year to levels above the wall street consensus.

Growth indicators look solid:

• Total backlog increased $23 million compared to January 31, 2007.
• Total deferred revenue increased $21 million sequentially. Deferred maintenance revenues from subscription increased $34 million sequentially.
• Unshipped product orders increased by $2 million sequentially to $19 million at April 30, 2007.
• Channel inventory as of April 30, 2007 was below the normal range of three to four weeks.
• DSO decreased to 47 days.

Although I think Ansys (ANSS) has more potential, Autodesk also appears reasonably valued. Its $9.7 billion enterprise value is backed by nearly $400 million in free cash flow, an amount that is nearly double the level of two years ago. After they complete their options review, this one could be a stock to watch.

The Earnings Calendar is fairly light.

• Tuesday’s CPI is estimated at 0.5%, 0.2% ex food and energy.
• Wednesday’s Housing Starts are expected to come in at a 1.475 million rate.
• Industrial Production, also on Wednesday, is expected to rise 0.2%.

Earnings season is winding down but there are still a few important reports due.

• Applied Materials (AMAT - Annual Report) reports on Tuesday and is expected to earn $0.28 on $2.35 billion in sales. I’m stocked up on tequila.
• BEA Systems (BEAS) reports on Wednesday but has already preannounced. Their guidance for next quarter needs to beat the estimate of $0.14, but investors will probably be disappointed by anything short of a buyout.
• Hewlett Packard (HPQ - Annual Report) also reports on Wednesday, and preannounced in the other direction. Guidance for next quarter is as close to a lay-up to exceed current estimates (sequential decline and year/year deceleration) as one can typically find.
• Intuit (INTU) reports on Thursday. Both earnings and guidance are anyone’s guess, but the long and short of it is that we expect tax refunds will be put to work.

There are a few other companies reporting (Autodesk and Marvell among them) in which I am interested but don’t have anything pithy to say about.

Economic Releases

The Economic Calendar gets busy. We have durable goods (consensus = -3.0%) on Tuesday, preliminary GDP (consensus = 2.3%) on Wednesday, and ISM Manufacturing (consensus = 49.7) on Friday.
Earnings Reports

Ceradyne (CRDN) reports on Monday. It did not make it on any of our watch lists, but is nonetheless a name we follow. Consensus calls for $1.18 on $171 million in revenue, with forward guidance of $1.24 on $178 million.
Tech names Brocade (BRCD) and Marvell (MRVL - Annual Report) are also up on Monday. Brocade is expected to earn $0.10 on $215 million in revenue and guide to $0.08 on $337 million. Marvell is expected to earn $0.08 on $625 million in revenue and guide toward $0.10 on $650 million.
Autodesk (ADSK) reports on Tuesday. The company has some business overlap with Mid Cap Watch List (Track at Marketocracy) member Dassault Systemes (DASTY). Autodesk is targeted to earn $0.46 on $497 million revenue and guide to $0.44 on $500.
The big earnings news for the week will be Dell (DELL) on Thursday. Estimates call for $0.29 EPS on $14.9 billion in revenue, and for guidance of $0.28 on $14.3 billion.