Treasure Chest: Concerns Surface For Altium

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A number of concerns have surfaced for software designer Altium, which may inhibit income in the short term, although the long-term outlook is fairly robust

-Existing on-premises customers reluctant to pay more for cloud
-Licence fee revenue expected to start diminishing
-Small customers of a competitor have requested delays to payments
 

By Eva Brocklehurst

Despite many positive aspects surrounding electronic software designer Altium ((ALU)) there are some areas of concern, centring largely on how the move to cloud-based accounts is handled and based on peer experience.

The company sustained a strong performance into the end of the financial year and Citi noted aggressive promotions did not have a noticeable impact on license sales and Altium Designer.

Regardless, there is a niggling worry that demand may now have been pulled forward, which highlights the potential for disappointment in the first half of FY21. Furthermore, cash flow was weaker in the June quarter, and the broker suspects this may be the result of discounting.

The company is now starting to switch to a cloud-based delivery model, Altium 365, for its key product, Altium Designer. This business currently generates one third of revenue from licences that are at risk of being discounted, or even waived, and pricing may change.

Customers typically pay for the product through an upfront license fee and an annual subscription fee. The switch to cloud-based product is positive for the medium to longer term, as it lowers delivery costs and enables efficient upgrades as well as more flexible pricing.

Still, there can be negatives in the short term. Cloud-based product tends to be loss-making and existing on-premises customers initially are reluctant to pay more for cloud product until the additional benefits are known.

New customers going directly to cloud-based product tend to prefer software-as-a-service pricing, which generally does not have an upfront licence fee. Bell Potter points to many companies that have suffered in the short term when switching to the cloud before reaping long-term gains.

Peer Comparison

TechnologyOne ((TNE)) is a case in point, only now starting to obtain benefits from cloud-based product after launching this service several years ago. Licence fee revenue is suspected to start diminishing, largely because these margins are greater than the margin on the gains subscription revenue.

Again, Bell Potter cites TechnologyOne for which licence fee revenue peaked at around $60m in FY16 and is expected to continue declining over the next five years to a negligible amount. That company is also only gradually shifting customers, and it's currently unclear whether Altium will pursue a gradual shift to the cloud.

In order to achieve the aspirational revenue target of US$500m by FY25 Altium needs to increase its annual subscription fee for Altium Designer to well over US$3000, from around US$2000 at present.

The broker assumes Altium reaches its other aspirational target of 100,000 subscribers in FY25 but, even with an increased in an average annual subscriptions to US$3500 in FY25, calculations still fall short of the revenue target.

Nevertheless, Bell Potter makes no changes to forecasts, expecting revenue of $188.8m in FY20, consistent with guidance and estimates FY21 revenue of $218m, equating to growth of 15%. The broker, not one of the seven stockbrokers monitored daily on the FNArena database, retains a $30 target and a Sell rating.

SME Clients

Morgan Stanley has also pointed out potential headwinds for Altium, given competitor Cadence's recent results. That company has noted smaller customers have requested delays to payments as they experience liquidity challenges.

Cadence has signalled more than double the number of defaults in order bookings has now been factored into its full year guidance. Over the longer term, larger operators, being able to invest in the downturn, should be much stronger.

On this subject, Bell Potter notes Technology One has been able to put through material increases in subscription fees largely because its clients tend to be large and make big savings by moving to the cloud.

In contrast, Altium is dependent on SME (small-medium enterprise) customers so the cost savings are not likely to be as great and there may be more resistance if and when Altium tries to charge more for its Altium 365 update.

FNArena's database has two Buy ratings, two Hold and one Sell (Ord Minnett). The consensus target is $35.80, suggesting 9.0% upside to the last share price.

See also, Positive Trajectory Continues For Altium on July 15, 2020.

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