December 22, 2021 - 11:21am EST by
2021 2022
Price: 149.04 EPS 0 0
Shares Out. (in M): 65 P/E 0 0
Market Cap (in $M): 9,800 P/FCF 0 0
Net Debt (in $M): 0 EBIT 0 0
TEV (in $M): 0 TEV/EBIT 0 0

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I believe that shares of AZPN are attractive in the $150/share range. The company is recovering from revenue growth headwinds driven by the pandemic. Additionally, the announced merger with Emerson Electric has the potential to create significant value, but has also added noise to the financial picture. I believe that these two factors have created an opportunity to buy a high quality design software business at a 4% forward FCF yield.


The company is a leading provider of process simulation software used by engineers to design, maintain, and operate industrial assets. It’s core software products are used during the design and operation of processing plants for a number of capital-intensive verticals (energy, chemicals, EPC, pharmaceuticals, etc.). Aspen also has a few higher growth product segments including a suite of asset performance monitoring tools which allow for predictive maintenance and digital twins of industrial assets. The software is sold on a subscription basis (>95% recurring) with term licenses and maintenance contracts. Aspen has over 1,700 employees and over 2,400 customers (top ~350 customers account for 80% of revenue). 


Krusty75 had a good write-up back in 2015 which did a good job describing the company fundamentals and explaining why it is an attractive business model with good secular growth prospects. In short, vertical software businesses like this tend to get very good economics over time because they go after hard problems and quickly build mindshare in their respective market. They typically can go deep from a feature standpoint and develop plenty of vertical-specific IP which is hard for competitors to replicate. They also enjoy the benefits of selling into concentrated and largely English speaking industries like chemicals, energy, and Pharma. The rolodex is only several hundred names and they all know who Aspen and AVEVA are (results in good S&M efficiency over time). Like other design software businesses, Aspen Tech’s products are characteristically sticky (only MSD annual attrition) because engineers tend to be unwilling to adopt change and generally use the products they have been using for the last 20+ years because that is what the have become accustomed to. These factors have driven a very high rate of profitability at the company with non-GAAP operating margins in the high 40s. Gross margins are around 90% and S&M expense is sub 20% which is very good for a software business. As a percent of annual spend, FCF is typically low 40s as similar to other software businesses, Aspen also enjoys the benefits of no inventory, minimal capital expenditures, and nice deferred revenue dynamics while also being a cash tax payer.


During the pandemic, dislocations in the O&G market and volatility of oil prices put pressure on the business as demand in the refining and chemical industries slowed. This resulted in annual spend growth slowing from the high-single digit range to the mid-single digit range (was 5.6% in the most recent quarter). This growth is considerably below the 12% FY21-25 CAGR provided at the Investor Day in early 2021. This underperformance was largely a function of increasing attrition in the O&G end market and deal slippage throughout the past year. Given the high operating leverage, the top-line growth disappointment also impacted operating margins which came below expectations throughout the year. I believe the end-market dynamics are improving and the company will see easier comps over the next several quarters. In 1Q22, the company delivered 30% bookings growth year-on-year and the MSC business got back to high single digit growth. The company sounded very optimistic about customer conversations and budgets over the next year. Additionally, between 1Q21 and 4Q21 we saw annual spend growth compress from 8.9% to 4.7% which should help optics over the next few quarters. Sentiment is very low on this name given some of the execution challenges, so I believe the inflection in the end demand is under the radar for many investors. Additionally, the merger complicates the P&L and the capital structure so many investors are likely on the side lines until that unfolds.


Pursuant to the merger agreement, Emerson will pay $6.0 billion in cash and contribute its industrial software assets to receive a 55% stake in the newly minted New AspenTech. AspenTech shareholders will receive $87 of cash per share as well as 0.42 shares of New Aspen Tech for each share of AspenTech. New Aspen will also receive OSI Inc., a provider of power distribution network management software which generates $220M of revenue (growing double digits). Additionally, New Aspen will gain a set of geological simulation software tools (Paradigm and Roxar) which help with simulate seismic activity for subsurface reservoirs and other geological formations ($130M of revenue). Combined, the Emerson industrial software assets will do $350M of revenue with low-teens growth and low-30s EBITDA margins. I believe that these assets have a natural fit within the AspenTech product portfolio and should enable a strong cross selling motion to the existing AspenTech customer base. Additionally, the combined entity will maintain a strong relationship with the broader Emerson ecosystem, allowing for commercial benefits over time (expanded go-to-market partnership targeting the large Emerson customer base). 


New Aspen will have 65 million shares and I believe that the FY23 (June fiscal year end) free cash flow will be $420M ($85M from Emerson & $335M from Old Aspen). At a 3% FCF yield the enterprise value would be $14 billion and the value of New Aspen would be $215/share. AZPN today is $150/share but we will receive $87/share as a special dividend so the real economic cost is $63 for 0.42 shares of New Aspen. The market is valuing New Aspen at $150/share or $9.8 billion which equates to an over 4% FCF yield which I believe is too low compared to other high quality design software assets. I believe the current fair value should be (~$215/share) which points to a ~43% upside at current levels. I find this compelling given that following the merger this will be a very strategic design software asset with the ability to compound intrinsic value at healthy rates over the next several years. If New Aspen can compound intrinsic value at 10% for the next 5 years (below the targeted annual spend growth and overall low given the high cash yield) then the fair value could reach $345/share so from $150/share today we can attain an 18% IRR over the next 5 years. I view this IRR as attractive relative to the risk profile here. The FY26 combined financial targets are for $1.5B of annual spend with likely $650M of FCF which I believe supports a $22B EV (3% yield) or a $345 share price at year-end 2025.


Overall, I view this as a very high quality company that is undergoing a transformative merger which should be accretive. The stock is trading at a discount to intrinsic value as the company has fallen out of favor with the investment community given a series of short term execution issues. The value here is being obfuscated by the complexity of the transaction and no one is paying attention to the ongoing end-market recovery over the next 3 quarters of easier comps. Accordingly, I believe shares will do well from these levels over the next few years. I would categorize the investment as medium to high expected returns with low fundamental risk.


I do not hold a position with the issuer such as employment, directorship, or consultancy.
I and/or others I advise do not hold a material investment in the issuer's securities.


Completion of transaction + end-market recovery

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