2-3. Autodesk, Inc. (ADSK) & PTC Inc. (PTC) – We have been increasing our focus on software businesses for the last few years. Our thesis is that the good ones are monopoly like businesses with durable pricing power that can benefit meaningfully from the change in customer purchase behavior away from license and maintenance and towards subscription contracts. Microsoft Corp. (MSFT) was a successful investment in 2015 and Salesforce.com Inc. (CRM), which we wrote up in our year end letter for 2016, was one of our most profitable positions in 2017. We have been following ADSK for several years and are still kicking ourselves for not getting involved in the first quarter of 2016. At the time though we admired the monopoly position Autodesk enjoys in the architectural vertical we struggled to find grounding in a valuation framework as the transition the company was making to monthly service contracts resulted in declining revenues and negative free cash flows. Roll the tape forward to present day and we have greater confidence in the new leadership at ADSK, proximity to the inflection to positive FCF (which should occur in 2018) and an attractive entry point following a 20% pullback in the wake of the late November earnings report. We see FCF of $6.25 per share in 2019, which justifies a target price north of $160 given that we believe FCF could double from that level going out to We do not need to believe in a doubling in out-year FCF to justify our target – but we think it is a lot easier to peer that far into the future with a business of Autodesk’s quality. PTC is sort of the Autodesk for industrial applications. It is not quite that good, because PTC has some legitimate competitors in its market, but PTC also has a potentially big opportunity in the Internet of Things (IoT) that could be as big as the core CAD and Product Lifecyle Management businesses if the IoT franchise grows at the rates management expects. We got involved early in the fourth quarter after the stock had traded sideways for a few months following a minor setback in their Japanese business. We think EPS can hit $5 in calendar 2021 once the transition to a subscription model has stabilized. We have an undiscounted target price north of $100. We like the business standalone, but PTC also looks to us like an attractive acquisition candidate.
4.Northrop Grumman Corp. (NOC) – Our investment thesis for NOC is simple. When we take into consideration the accretion from the Orbital ATK (OA) transaction, which should close in the second quarter and the benefits from tax reform, our 2019 numbers are more than 25% above the Street. As a leading prime defense contractor NOC will also benefit from increased defense spending, which is now at a cyclical trough after years of little to no growth following the 2011 sequestration. We are estimating 2019 EPS of more than $20; at 20x we see a $400+ stock.
We will share our opinions regarding these three stocks in separate articles.