Commentary on Aspen Technology (AZPN, Financial):
During the past quarter, the Fund built out its position in new holding Aspen Technology and added to nine others. The Fund sold out of 13 stocks, as referenced before and trimmed many others.
Aspen Technology, Inc. is the leading provider of engineering, design, operations and supply chain management software to the energy and process industries. Aspen’s software helps customers increase productivity, reduce operating costs, enhance capital efficiency and decrease working capital requirements. We took advantage of the stock’s sell-off as energy prices have come in, and we are continuing to build out our position as oil continues to decline.
Aspen was founded 30 years ago in a lab at MIT, gained scale through a series of acquisitions in the early 2000s, and recently completed a complete re-architecting of its software and business model. Today, Aspen is a market leading vertical software business that offers customers a growing portfolio of 70 unique applications. Its customers include the world’s largest energy, chemical, and engineering and construction companies that depend on Aspen to run their businesses every day. As such, Aspen’s tools became deeply embedded in customer workflows, leading to near-perfect retention rates, five to six year contracts and annual price increases.
Aspen will generate just over $400 million of recurring revenue this year, which we think represents less than 20% penetration of its existing opportunity. We think that recurring revenue can compound at close to a double-digit rate organically, though this will likely tick down in the shortterm. Much of that growth comes from deeper engagement from existing customers. The company recently introduced the concept of “tokens” as a means to encourage wider adoption of its software. We think this was a savvy move. Aspen’s customers increase their token consumption when they use additional modules or allow more users to adopt the suite. Given the high ROI of the modules, the inevitable result is that customers need to keep coming back to Aspen to purchase more tokens as their use of Aspen technology expands. Growth should also be driven by an upgrade cycle to its newest platform, better integration of modules which should drive more token usage, and the consistent release of new modules. We think the company’s investments in analytics and asset maintenance will meaningfully expand Aspen’s opportunity over time
Like many vertical software companies, Aspen’s business is highly profitable and extremely cash generative. Margins are already in the mid-40% range, and we think those will work higher over time given the company’s high incremental margins and strong cost control. The company converts around 75% of its EBITDA to free cash flow, which it uses to repurchase stock and make acquisitions. The company just made an accretive acquisition of a publicly traded UK provider of strategic consulting and software that serves the same customer base. We believe the deal is accretive and strategic and on plan to enable deeper penetration of its clientele and to build out its capabilities.
We believe Aspen’s business is super high quality, its mission is critical to its customers and, for the most part, is mostly insensitive to energy prices. We are impressed with the company’s recent performance in this difficult macroeconomic environment, its revenues grew 10% organically and margins expanded so earnings and free cash flow grew faster. The stock now trades at 12 times our estimate for 2016 EBITDA and 15 times 2016 earnings, multiples that we expect will deservedly expand over time. We foresee a long runway of strong organic revenue growth, margin expansion to over 50%, free cash flow to be used for share re-purchases and/or acquisitions, which has the potential to lead to a triple in the stock over the next five years.
