Altair: Surprise Return To Growth

Altair Engineering (ALTR), the Michigan-based developer of computer-aided engineering software and one of the oldest software companies in existence, has surprised investors with strength in Q1 earnings that marked a rapid departure from the company’s usual sleepy trajectory. After growing at just 8% in its prior quarter (Q4) and 6% for the entire year FY17, Altair jumped to 19% y/y growth in Q1, helped by strong billings activity by major clients overseas. I haven’t always been the biggest fan of the company, but the bullish signals coming from Altair’s Q1 results have caused me to shift my assessment.

The market is taking note of Altair’s accomplishments as well. Rallying in response to the Q1 results, Altair’s shares jumped 7%, one of the company’s best one-day performances to date:

ALTR data by YCharts

We’re now more than six months past Altair’s IPO, which priced at $13 in late October. Altair’s lockup expiration date came and passed on April 30, and surprisingly, the company emerged unscathed (a very rare occurrence for technology IPOs that have appreciated more than 2x from their IPO price) and is now racing toward all-time highs. One word of caution here: just because a flood of selling pressure hasn’t hit Altair yet doesn’t mean it won’t come. With the lockup restrictions lifted, all of Altair’s shares are available for sale, and it’s more than likely that some insiders sitting on ~2.5x gains since the IPO will be wanting to cash out.

The question for investors is: does Altair have more upside from here? It seems to me that if the company can continue its current growth streak, it certainly does have room to appreciate more. Altair is, essentially, a smaller and cheaper-valued version of Autodesk (ADSK) – a useful rough comparison, though not entirely accurate as Autodesk specializes in computer-aided design (CADs) software. Practical applications of Altair are generally more technical than Autodesk, though they both serve similar functions in the engineering and design process.

A roundup on Altair’s new, higher valuation: at its post-earnings price in the mid-$33 range, Altair carries a market cap of $2.11 billion. With $63 million of cash and $1 million of debt on its balance sheet, the company’s enterprise value is $2.05 billion. Against the company’s refreshed FY18 guidance of $369-$371 million in revenues (11-12% y/y growth range, and up from a prior midpoint guidance of $364 million or 9% growth), this represents an EV/FY18 revenue multiple of 5.5x.

Figure 1. Altair FY18 and Q2 guidance

Source: Altair investor relations

Certainly, this is cheaper than most stocks in the software/SaaS sector, though Altair’s growth deficiency certainly does justify the discounted multiple. But with Autodesk also seeing sluggish or negative growth in recent quarters (though this is due to its planned cloud transition, not due to a fundamental slowdown in end-customer demand), and with Autodesk trading at approximately 12x forward revenues (see below), there’s a wide range of possibilities as to what Altair could be worth.

ADSK EV to Revenues (Forward) data by YCharts

This is especially true as Altair develops into a free cash flow story. FCF in Q1 grew a blistering 37% y/y to $25.0 million, up from 1Q17’s FCF of $18.2 million. Now, we can’t simply extrapolate that $25 million forward and say Altair is running at a $100 million FCF run rate, as the company generally accrues the majority of its FCF in Q1 (indeed, the other quarters tend to be negative). But with 37% growth in FCF outpacing Altair’s revenue growth, the company is well on its way to having free cash flow support its ~$2 billion enterprise value – especially seeing as very few software companies have achieved FCF positive status.

Let’s take a look at Altair’s full results for the first quarter:

Figure 2. Altair Q1 results

Source: Altair investor relations

As previously mentioned, Altair grew revenues 19% y/y to $91.7 million, starkly beating analyst consensus of $86.9 million (+13% y/y) by six points – a huge beat for a company whose growth rate is this modest. Not to mention the fact that Altair saw a huge acceleration over the 8% growth rate at which it exited Q4. Also note that all of this growth can be considered organic – Altair’s CEO mentioned on the earnings call that the company acquired two small companies, CANDI Controls and FluiDyna, in the quarter, but the associated revenue contributions were inconsequential.

Software product revenues saw even stronger growth of 26% y/y in the quarter to $68.1 million, overtaking a larger portion (74%) of the company’s revenue mix, versus 70% in 1Q17. The mix shift toward software is important as it carries the lion’s share of the gross margin. Software services, client engineering services, and other revenues are essentially performed at cost. Due to the stronger mix of software revenues in the quarter, Altair’s gross margin expanded 300 bps to 68.2% in the quarter, up from 65.2% in the year-ago period.

Alongside cost efficiencies achieved on the general and administrative spending front, the upside growth and gross margin boost helped to boost Altair’s operating margin to 4.6% in the quarter, up from -3% in 1Q17. A 4.6% operating margin might sound small, but in the context of the software industry where most companies of Altair’s scale are running huge losses, a positive operating margin of any magnitude is already an accomplishment.

Similarly, Altair turned a GAAP net loss of -$2.2 million in the year-ago quarter into a profit of $3.9 million this quarter. EPS of $0.08 in the quarter also showed huge upside to analysts’ expectations of $0.03.

Another useful nugget from the company’s earnings call is the fact that Altair saw healthy expansion activity in the quarter and expects to continue that trend going forward. For an established software company like Altair, expansion bookings generate much of the revenue growth as well as margin potential versus new business. This quarter in particular, investors have zoomed in on revenue retention trends as Cloudera’s (CLDR) warning on expansion bookings and associated soft guidance sent shares tumbling more than 40% in one day. Luckily for Altair investors, the signal on expansion opportunity from Altair’s CEO, Jim Scapa, is quite the opposite:

“One thing I’ll just mention is expansion is coming from more different customers right. It’s a large number of companies that are expanding and we see a lot of continued opportunity there. We’re not that penetrated in many, many customers. So there is a lot of opportunity I think to expand and companies are wanting to do more and more simulation. So it’s just – it’s just a good market to be in right now, good secular market if you will.”

In the quarter, Altair also signed a significant distribution partnership with General Electric (GE), which covers a multi-year exclusive distribution agreement for GE’s comprehensive system modeling software. With a well-known industrial brand like GE tying up with Altair, the company has a huge opportunity to chase more incremental revenues from a new suite of products.

How should investors react?

Relative to Altair’s outperformance this quarter, the company’s guidance range of 11-12% y/y growth for the year appears modest. There’s definitely room for upside as Altair continues to rediscover a mid-teens growth rate after stagnating for much of 2017.

Shares are probably a little too hot right now, coming off an explosive earnings quarter and with the risk of a recent lockup expiration still hanging over the stock. I’d wait for a pullback before entering a position in Altair, but the outlook for this company definitely looks much brighter than ever.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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