Designing the AI revolution – Altium | Summer Series

Bryce: [00:00:13] Welcome to the Equity Markets Summer Series, proudly brought to you by CommSec, the home of investing over 12 episodes where deep diving into some of the most exciting, interesting and well-known companies from around the world. Episode. We're unpacking one company with one expert investor, and we'll be learning from their process and hear why they like the company. My name is Bryce and as always, I'm joined by my equity buddy, Ren. How are you? 

Alec: [00:00:38] I'm very good, Bryce. I'm very excited for this episode. We are officially halfway through the summer series. We've covered some really fascinating companies, but the thing that I really love about it is that we're learning how these investors approach a variety of different companies. Last episode we spoke to Tobias Carlisle about InMode and that was purely a value investor play. He had some questions about what the company did. but it was for him like the financials were compelling, the valuation was compelling. And you know that that analysis was one way of investing and one way of making money in the stock market. I'm pretty confident that this conversation we have with John Barlow is going to be the opposite. We're talking about Altium. Yeah, which has been an incredible Australian story. But this is not a value stock. This is a growth stock. And so the skills that you need to analyse a company in the way that you approach a company are completely different. And that's what I love about doing this Summer Series. We get to learn from some of the best in the business and talk about a variety of companies. So for people not familiar with Jun Bei Liu, she is a portfolio manager at Tribeca Investment Partners. And as I said, the company we're talking about today is Altium. 

Bryce: [00:01:50] Now, the Equity Mate Summer Series is proud to partner with CommSec, the home of investing. Often we get frustrated with the lack of access to international markets, particularly when there are so many great opportunities outside of Australia. However, with CommSec, those opportunities are a reality, with access to 13 international markets from the US to Norway, Japan and Germany. Invest in shares on the US market from just $5 USD. Brokerage. Download the CommSec app today or visit CommSec.com.au, CommSec T&Cs and other fees and charges apply. Investing in overseas markets exposes you to additional risk. 

Alec: [00:02:25] Now, before we get started, we need to remind you that while we are licensed, we are not aware of your personal financial circumstances. Any information on this show is for education and entertainment purposes only. Any advice in general? Now with that said, before we jump in with Jun Bei Liu. Let's unpack the company ourselves. We're talking about Altium. One of Australia's WAAAX stocks, which was, you know, remember that it was our acronym, probably like four years ago, like pre-COVID, I think, or maybe early days of Covid. 

Bryce: [00:02:58] Yeah. Wisetech Afterpay was still around. 

Alec: [00:03:01] Yeah. 

Bryce: [00:03:01] Altium. Xero. Three As, Altium, Afterpay and 

Alec: [00:03:10] I'll give you I'll give you a hint. It's an AI related stock, but it hasn't done well. 

Bryce: [00:03:19] It's going to annoy me.

Alec: [00:03:19] What was it, a train? We created training modules for the big, large language models. 

Bryce: [00:03:25] It was so hard. Knocked.

Alec: [00:03:28] Appen 

Bryce: [00:03:29] Appen that's it.

Alec: [00:03:31] So for people who didn't enjoy that weird guessing game, those five stocks were known as the Waaax stocks. And I was seen as Australia's answer to the Fang stocks, which were the big US tech stocks over in America. Yes, that was obvious because I said some of them have fallen away. Appen has not done too well. Afterpay got acquired and then I imagine if it was still listed it wouldn't be doing too well. Maybe it would follow a similar trajectory to Zip, but Altium is one where Wisetech has separated itself. 

Bryce: [00:04:04] Zero. 

Alec: [00:04:04] Zero Has done very well. Those two, Altium has done incredibly well as well, but it's probably the least known of the five.

Bryce: [00:04:11] It is Ren, Altium, ASX ticker ALU. It's an Aussie software company that develops and sells electronic design automation, as I call it EDA software. In layman's terms, they help engineers design and manufacture their software, helps engineers design and manufacture electronic products such as printed circuit boards. 

Alec: [00:04:33] Yeah, yeah, it's printed circuit boards. So for people who are unfamiliar, think of a, like a microchip. And with all the, like, little wires and transistors on it, their software helps engineers design those. 

Bryce: [00:04:47] Which are applicable and relevant to many industry. 

Alec: [00:04:52] Yeah. Yeah, all industries all the time. 

Bryce: [00:04:55] Well, media. Yes.

Alec: [00:04:57] Yeah. We are, literally we're using laptops. We've got cameras filming us and we're, we're recording into a rodecaster. So that's all with a microchip. Sports. Every athlete now was like a catapult tracker that has a microchip in us as well. Yeah. Well, yeah. Planes. Yeah. Yes. 

Bryce: [00:05:19] Marine science. 

Alec: [00:05:20] I bet you Altium stoked at how amazing that company that you jumped. Lewis, listen to this, right, right. This is great. Marine science. Yes. Every track, and anything that's collecting data on ocean currents or animals. 

Bryce: [00:05:35] Okay. So we'll. 

Alec: [00:05:37] Can we run from this? So, this software helps engineers design these printed circuit boards, and they've really just gone from strength to strength and really ridden the rise of the industry. They've made some acquisitions that we'll talk about in a second. But I think, you know, last year they were up more than 30% over the past five years, their share price more than doubled. It's been a pretty incredible Australian success story. And then now taking on the world.

Bryce: [00:06:09] Yes. So the business is broken up into a few parts. They have software that is obviously designed for this, circuit board, designing. They also have a platform for managing data. They're involved in cloud based supply chain management. And here you go. They have something called Circuit Studio, which is a free, circuit board design software for hobbyists if we ever want to give it a crack ourselves. Now, the business itself, the majority of the revenue, 82% of revenue comes from the software design. Close to 200 or just over $200 million a year. And then the second largest part of the business is that cloud product, which, delivers about $60 million in revenue. 

Alec: [00:06:53] Yeah. Now the cloud platform is called Octopod. It was acquired, I believe, in 2017 by Altium. And it's essentially, it's like a, it's, I guess, a marketplace or it allows engineers to search for electronic and industrial parts. So if you need something to go on your printed circuit board

Bryce: [00:07:15] Global search function. Yeah. Wow. 

Alec: [00:07:17] Yeah. So it aggregates, you know, different parts makers and distributors and manufacturers and helps you find what you need. Such millions of electronic components. 

Bryce: [00:07:28] Wow. 

Alec: [00:07:29] Yeah. It's a whole other world. 

Bryce: [00:07:31] It is a whole other world. I'm kind of thinking about this free software, and interested just to see what it even looks like. But anyway. 

Alec: [00:07:38] Do you want to know the challenge? 

Bryce: [00:07:40] Can I create?

Alec: [00:07:42] You know that free software is out of this world. Literally. 

Bryce: [00:07:46] Okay. 

Alec: [00:07:49] Because, NASA's Mars Ingenuity copter. The electronics on that were designed using Altium software.

Bryce: [00:07:58] There you go.

Alec: [00:07:59] Yeah. 

Bryce: [00:07:59] Well, applied to Altium. 

Alec: [00:08:00] Yeah, yeah, yeah. So, like, they're, they're right in the middle of a lot of megatrends. And I think that's probably the important thing to stress, because AI is the thing we think about. And, you know, they're obviously right in the middle of that boom. But, you know, like electric vehicles, electronics are now responsible for about 40% of a car's total cost. There's more silicon in cars than ever before. The cars are basically like a giant computer with a heap of sensors now and then, you know, Altium is right in the middle of that internet of things and smart devices, more and more silicon and all those altium's right in the middle of all of that. So they're riding a lot of great megatrends. And they positioned themselves like a tech company. And I find this interesting. I'd be interested to know. 

Bryce: [00:08:52] They are a tech company. 

Alec: [00:08:52] Just to just just hear me out. Tell me what you think of this. So they talk about some of the big tech companies of today, you know, Facebook, it's the biggest media company, but it owns no media. Netflix is the world's biggest movie producer or movie house, but it owns no cinemas. Uber is the world's largest taxi company, but it owns no taxis. Airbnb's world's largest hotel. Owns no real estate like that. That's it. And then they're like Altium, the world's largest platform for the production of electronic hardware. Owns no fab or factory. So that's how they sort of position themselves. 

Bryce: [00:09:31] Fickle. Not quite the trillion dollar valuation of some of the other companies. 

Alec: [00:09:36] Yeah, yeah, yeah. 

Bryce: [00:09:38] Isn't that just like, Nvidia though, isn't it? Like. 

Alec: [00:09:43] Well Nvidia design. 

Bryce: [00:09:44] Yeah. So the same thing here.

Alec: [00:09:47] Well yeah I'll tell you Nvidia probably fits this more. Yeah yeah. Anyway, who knows. I actually don't know if this is Nvidia or some of Nvidia's peers might design on Altium software. I imagine Nvidia probably don't get their own stuff going on. But look, to give you some of the financial metrics. So as you said, they did about 260 million in revenue last year, the year before that 220 mil the year before that, 180 mil. So they're growing at a pretty impressive clip, about 20% a year. Here's an impressive thing for small growing tech companies profit. They are profitable. And they've been profitable for a while, which is something that you like to say. The profit hasn't been growing up and to the right. So last year that its 66 million profit, the year before that, 55 mil the year before that, 100, just over 100 mil. So, you know, like the profit is variable. But I'm looking back from 2023 to 2016. They've been profitable every year. 

Bryce: [00:10:51] One of the biggest drivers of growth of that revenue line, Ren, is actually their cloud business. No surprises with the enterprise portion of that growing 143% in 2023. Similar to Mary's thesis on Alphabet with other revenue growth and business opportunities coming from the cloud. So. 

Alec: [00:11:14] Yeah. So it's a great story. You can look at their financials and look at the growing in a lot of parts of the world, which is really exciting to say. They also have a lot of cash on their balance sheet, about $200 million in cash on their balance sheet, which gives them some optionality. And it's good to see as an investor. So I think if we put a full stop here and obviously we're keen to speak to John by Lou about this and get her bull and bear case. But I think if you pause here, we've been pretty glowing about the company, despite us not really understanding the intricacies of circuit board manufacture. The question that investors always have about a company like this is valuation. So it's currently trading at a 60 price to earnings. It's a $6 billion company that does $260 million in revenue. You're paying for it big time. And so it's got to keep growing to grow into its valuation. It has been growing. So that's, I think, a key part of the conversation we should have with Jun Bei by about like, let's get through how great a company it is and how great an Aussie success story is. It is. And then talk about, well, if we're approaching it today as we start 2024, how do we think about buying it at its current price?

Bryce: [00:12:24] Now, before we speak to Jun Bei, if you're interested in exploring more investment opportunities, check out CommSec and the thousands of Australian and global listed companies available on the platform. Additionally, if you're looking for daily market updates, subscribe to CommSec Market Update, their daily podcast. Invest in shares on the US market from just $5 USD. Brokerage. Visit commsec.com.au for more CommSec T&Cs and other fees and charges apply. Investing overseas exposes you to additional risk. 

Alec: [00:12:52] We'll be right back with Jun Bei Liu after this short break. 

Bryce: [00:13:05] We're here with Jun Bei Liu. Welcome to equity markets. 

Jun Bei: [00:13:08] Thank you for having me guys. 

Bryce: [00:13:10] So to kick off how would you describe Altium. 

Jun Bei: [00:13:13] Look Altium is a company that focuses on the design of the circuit boards and the circuit board. Everyone would know it's a thing that enables a lot of electronics, goes into cars, and these days it goes through pretty much everything. And the company itself was started in 1985, and its main product, Altium Designer, is globally recognised. It's a global business and it dominates some of the SME space and a few others. But it is incredibly successful and to be around for a very long time in what it does. 

Alec: [00:13:41] Yeah, it's an incredible Australian success story. And then as well researching the company, they also have this, like the cloud platform, the what's it called, Octo parts or something. Can you tell us a little bit about that part of that business as well?

Jun Bei: [00:13:55] Yeah. Of course. So when I first started with those software businesses, all they did was sell the software. So people purchased the software and then, maybe pay a little bit of fee every year. But it's, you know, so initial money's all from selling the software. But now they've established this cloud where, you know, actually they've been building on this for many, many years now. And they managed to migrate a lot of their customers. You know, you pay a upfront fee, start up paying a lot more in terms of subscription. And they get a lot more, better functionality and they get live up update. You get access to so many things while the cloud is actually hosting, become a host, a platform or their needs, the design software needs. So, you know, it's a really you know, it is a software that actually has been designed for the future, enable the rapid change in terms of updates, and also enables the future of the need for, you know, adopting some of those AI functionality, you know, so the business has really been building towards it for a very long time. And then they kind of halfway through shifting a lot of their customers from the older sort of generation into the cloud business. 

Bryce: [00:14:58] So let's turn to the metrics. When you're looking at a company like this, a software company and one that is expanding. How do you think about the metrics to keep an eye on when you start forming your bull case, what metrics matter. And then also importantly, what doesn't matter. 

Jun Bei: [00:15:14] Yeah of course. So look at what metric really matters for a growth company is one is the addressable market. So how far you can go. And that's the ultimate goal how far you can go. And two is that you want to see that track record because are you really gaining share. Can you demonstrate your ability to really grow and capture some of those addressable market? And also for us, what's really important for those growth company also is that can you commercialise it? You are actually profitable. You're making money from it. You know, a few years ago when money was cheap, there was a lot of, you know, people sort of losing focus on those growth companies in terms of growth at any cost. Whereas, you know, we really want to see profitability. You're growing very fast and you make a lot of money and that's what's important. So, you know, looking at this company through the circuit board, printed circuit board, a sort of software space, just that current space. They dominate the SMB markets globally. And then they actually have something like 40% market share globally. That's quite incredible for, you know, a little Australian company that sort of just going global because their software is very well know, very well used. And then like many things, it's a little bit almost like a Adobe. But a lot of times people say, oh, why can't they use the copycat products and, you know, the Chinese copycat products, but because of the functionality and because the way the design as a trained on the software is, they don't churn. Once they start using it, they will use it. So the churn rate is very low. And then once they dominate that market, it doesn't, it continue to grow with the market itself. And then what they have done recently, they expanded the addressable market. They moved into the enterprise, which is a little bit larger space. And recently they have won a lot of contracts in that front as well. So, you know, they got Mercedes, NASA and Bravo, some of the big enterprise names that they want, you know, that is going to buy quite a lot of growth for that space as well. And the company itself, in terms of profitability, the company normally have a rule called 50% rule. So you know they want a top line growth. So for example, top line growth has been growing at teens. So say 16%. And then they want a margin that sort of sits in that 34,35%. So add them together. Should be a 50 rule. So the company does this 50% rule. And just means high single digit growth and over 30%, 30, 35% sort of margin. And that is incredibly profitable for a tech company here in Australia because Australia, you know, it's quite rare for a company that's growing so fast and still being very, very profitable. Yeah. So this, these are some of the metrics are it's a long way doji about what we, see in this company. 

Alec: [00:17:43] Yeah. It's actually great to look back on their history of their financials and see that they've been profitable for a long time while they're still in this growth phase. Are there any other aspects of the business that that really form the bull case in the thesis for you? 

Jun Bei: [00:17:57] Yeah, absolutely. So as we touched on before, strong execution, a huge addressable market and, you know, good cash flow. That's already underpin the bookcase, but I think there is something in the blue sky here because we are talking about, you know, in the whole AI revolution, obviously there's a rapid changes in growth across everything you got to think about, like as electronics becomes more advanced and, as AI take over, you know, design of many things you will need perhaps redesign in circuit boards that you will need, so innovation in this space potentially could be, you know, astronomical. And this company's very well positioned to really follow that growth and participate in that strong leap that is to come. But of course that's blue sky. But that is something that's very real. But that's not anyone's price, to be honest. 

Bryce: [00:18:45] So if that's the case, Jun Bei, let's turn to the bad. What are you concerned about with, you know, a growth company like this? Solid market share? What are the red flags that you're looking for?

Jun Bei: [00:18:54] So as a growth company, you have to watch a couple of metrics there, because if they disappoint, share price can for a lot. It's not only fallen by the earnings downgrade it's really fallen. Your multiple will shrink and the things can't go wrong very quickly. So the metrics we'll be looking for will continue to, we need to see the continued evidence of that, continuation of transition from, you know, the upfront revenue customers into the more cloud based. And so for all execution, all numbers looking very, very strong, we need to continue to see, say the enterprise market that they grow into continues to show that very strong trajectory. Right now, it's pretty much from the bottom left to the top right. We kind of need to see that that will be closely monitored, you know, in terms of how many customers you're adding and all of that. And it's looking very, very strong. And I guess in this environment, when things are growing very fast, we do need to kind of monitor the subscriber growth and then monitor the cost as well. Is it growth at any cost, you know, is the margin going to be impacted if there's competition suddenly picked up for those markets? Or maybe there could be new entrants. But, you know, our comfort is that this company's been around for a long time. And they operate in the industry in the space where, you know, so circuit board hasn't really been changed all that much. They got smaller, but they still haven't changed all that much. So as a design software, they really have really built entrenched themselves into the design process of this. And they are so well known, like Adobe, so well known that we just not really seeing the new entrant coming at threaten the market structure. You know, we have many new entrant like a lot of copycats and others people. They are never used to a material extent just because, you know, you don't get proper servicing, you don't get proper update. And now you're shifting to cloud, you lock in your customer. So all of that together, will be closely monitored. But I think, you know, over the long term trajectory, this company is very well positioned for that kind of growth. But we've got to monitor every time when there's updates, because sometimes if the update, say the subscriber, there might be slowdown in certain things affecting it. I think two years ago was the China had lockdown and things, and with the sub growth out of China was a little bit slower. And that creates buying opportunity because that's a short term impact. And then they caught up quite quickly after that. 

Alec: [00:21:09] Yeah. So I think most people have heard of Altium in the context of the WAAX stocks. And and you look at its financials, you look at the $200 million in cash it has on its balance sheet, like there's no getting around that. This is a great company. I think a lot of people look at Altium and ask the question is the valuation? I think it's trading at about a 60 times multiple at the moment. So how do you think about valuing this company and I guess get comfortable at where it's trading now? 

Jun Bei: [00:21:37] Yeah, I think you look forward to the next two, 1 or 2 years. The multiple jobs are significantly. But normally when you look at you look at the EBITDA multiple, and we compared this one with the likes of Zero, the likes of Wisetech and you know, pretty much these three. And you know our view is that compared this one with Wisetech, it is still significantly cheaper. Now Wisetech is a great company. But we do struggle a little bit with, valuation and particularly in the time when volume potentially will be a little bit weaker. So, you know, they kind of sit in that space where at the moment, you know, earning maybe a little bit softer and the valuation a little bit high. So it kind of seems to be the wrong time to be only wisetech. But it's great company for Forbes, maybe a good opportunity, but we've just compared this one with West Tech and we do feel earnings on the way up for Altium. It's still not well owned compared to, you know, the likes of Wisetech and Zero. And we think there's an opportunity for it to participate in all these blue sky I and the like. And it's much cheaper compared to Wisetech in terms of zero. I think, you know, we like Xero as well. And but we think this is bit cheaper than zero. And then, you know, Xero is at the moment a bit of a cost out story, in the next 12 months. So I think under the, you know, stewardship of the new CEO, I think Xero will do well. But just relative valuation does position Altium a little bit ahead of those names. So, you know, so when we look at our growth with our portfolio, we always have a little bit of everything we have. Little bit of growth company, a little bit of value company, a little bit of high tech healthcare. So in our tech space we kind of just see this one relatively look pretty good relative to, you know, some of the other names. 

Alec: [00:23:16] Yeah. Great. So I guess my final question when it comes to Altium, and I guess we've sort of touched on the long term competitive advantage they've built and they're maintaining around, the, the sort of design software of choice for people designing printed circuit boards. And they've got a global reach. And, you know, the whole industry is growing. And so you think about, all right, well, what could disrupt that? And, you've mentioned that there have been some cheaper competitors that have come along and they haven't really been able to dislodge Altium. It's been a sort of Adobe like, sustainable competitive advantage. And then I guess my mind goes to does the way that we design printed circuit boards change and does that disrupt them? And, you know, AI sort of the buzz word on everyone's lips. And is there a risk from there that, you know, we start getting I designed printed circuit boards and that disrupts Altium's position in the market. 

Jun Bei: [00:24:12] Yeah. Look at this is actually really interesting. Right. Because AI is coming to every industry and every industry is faced with opportunities and threats. So I think this absolutely it will change. Well, we have the AI tool is filtering to everything we do. Like, you know, we will use some of the things to streamline a process and the like. Now but remember, when they operate in that PCB design space, it's very sophisticated. It's not commoditized space that they operate in. So the commoditized design software space is where the AI most likely to be threatened because, well, people, you know, those low end designers, you kind of do still need them. And then the AI perhaps can do some of those areas. And that is a market where a lot of those commoditized product operating. So things like, you know, the copy versions of for decades, they sort of operate in that commoditized space. Now, when you go into more specialised areas where, you know, Altium operates in and then the largest competitor, which is Cadence, operates in, they have very specialised requirements. So that's not to say I will replace all designers. It's just that, you know, we'd like to think that human inputs into a lot of those designs are going to be more important now that you have the tool to help you to do a better tool is the AI and then co-design with the software. So I think for a company like Altium, it's incredibly important for them to understand the opportunity this presents, because this is market dominance. This is when you, you know, Altium is investing themself into the AI tools to make their product better. So the design that I can come up with and perhaps streamline the process, make it easier to put that idea on a sheet. And AI so far have been, you know, demonstrated that they can replace the designer to stop the idea. So it's really about streamlining the process and make it easier for the ultimate plan. And then also we see that because the overall processing might be simplified. And then, you know, all of that, we actually think it's a lot of opportunity. You might need a replacement cycle for those PCB boards significantly. Right. And then there's a lot more demand for those software. You know, we already seeing the share price for Cadence, which is the largest player in the US. And they operate in slightly different areas. But you know, share price is running very aggressively because of AI, because of the need for replacement of a lot of those things. And then we see Altium is, you know, very well positioned into that growth. 

Bryce: [00:26:29] So Jun Bei to close out then. We always like to look a decade from now and, and try and think about where the company would be. So from your point of view, where do you expect Altium to be if management can execute on their plans and maintain market dominance? What does the company look like in ten years time? 

Jun Bei: [00:26:47] Look at the company. Always significantly larger at the moment, 40% of the SME market, we expect to take quite a significant share out of the enterprise market. Enterprises are larger, more corporate ties the premium, and that's where they are actually at the moment. Start taking shit out of cadence. So, you know, the we see them growing quite substantially into that space. And even with the SME, because they are shifting customers into more cloud based, you'll see the earnings are much more, SaaS like type of earnings. You know, so that means just very consistent year in, year out sales, sort of cash flow coming through, very predictable. And then with price increases and then with your market share gains. So it's already a very profitable business. But from here on, we do think the company will become significantly larger as it grows into the enterprise space. But you know, obviously AI is another thing that could potentially double or triple this entire market opportunity. But that is you know, we're just going to follow them, see how they perform in that area. 

Bryce: [00:27:45] Awesome. Well Jun Bei that brings us to the end. Thank you so much for your time. We do really appreciate it. As Ren said, great to see a Home-grown hero taking on the world. Thank you so much Jun Bei. We really appreciate your time. 

Jun Bei: [00:27:57] Thank you so much for having me. It's great to talk about a great Australian company. Thank you. 

Alec: [00:28:01] Thanks, Jun Bei. But before we go, a huge thanks to our Summer Series partner CommSec, the home of investing. If you're looking for more support and resources to build confidence in the market, head to their content hub. Otherwise, you can get $0 brokerage on your first ten trades for Australian markets. When you join brokerage on US stocks from just 5 USD, and you can invest from as little as $50 through the Commbank up. Download the Commbank up today or visit commbank.com.au CommSec T&Cs another fees and charges apply. Investing in overseas markets exposes you to additional risk. 

Bryce: [00:28:36] Now, next episode, we're speaking with Oscar Oberg about Viva Energy.