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In recent years, every software company has wanted to move from the boom and bust cycle of selling new releases to offering subscription services.

CTP

success. Now investors can reap the rewards as the company seeks to dominate the Internet of Things.

Two years ago, PTC (ticker: PTC), a maker of computer-aided design and product lifecycle management software, was just beginning its shift towards selling software as a service, or SaaS. Today, about 95% of its income is recurring. This has been good news for the stock, which has risen around 60% over the past two years to a market cap of $ 15.3 billion. But worries about what to do next have caused stocks to fall 5% in the past four months, even as the

S&P 500 Index

increased by 10%.

SaaS investments made by PTC over the past few years are delivering tangible results for investors, with free cash flow growing faster than bottom line. And the Internet of Things, which accounts for about 30% of PTC’s sales, is ready for prime time, with sales growth accelerating. The next two years could be even better than the last two years.

PTC software is not as familiar to consumers as

Microsoft

(MSFT) Word or

Alphabet‘s

(GOOGL) Gmail, but the idea is the same. Its Computer Aided Design, or CAD, and Product Lifecycle Management, or PLM, programs help industrial companies move products from research and development to prototyping and production. These two offerings represented roughly 70% of PTC’s $ 1.5 billion sales in fiscal 2020, which ended in September.

These products continue to grow at double-digit rates as the overall pace of innovation accelerates. Automakers, for example, are poised to design models faster as the penetration of electric vehicles increases and cars become smarter, with more software features. PTC is also gaining market share and increasing sales through acquisitions. The company bought Arena Solutions and Onshape to strengthen its cloud-based and SaaS-based CAD and PLM offerings.

The Internet of Things, or IoT, represents a new frontier for business. Like software as a service before it, IoT has been as much an aspiration as it is a reality. No more. An IoT software user can be a plant manager logging into the

Rockwell Automation

(ROK) FactoryTalk InnovationSuite, which is powered by PTC software and hosted on the Microsoft Azure cloud platform. InnovationSuite can do things like show a manager real-time production and quality statistics. These products represent the fastest growing portion of PTC’s business.

A few years ago, “there were still a lot of questions about the [IoT software] category, ”says Baird analyst Joe Vruwink. Now, “the pace of innovation is not going to slow down … industries are becoming more and more progressive in their technological considerations.

And the company still has room to grow, according to PTC CEO James Heppelmann. Most factories are only 60 percent efficient, he says, a number based on the difference between actual production and the theoretical maximum. PTC IoT software can identify inefficiencies and determine factors such as machine downtime, production bottlenecks, and employee issues, all of which can affect production. “Managers can now fix what they didn’t know was broken,” Heppelmann explains.

PTC came out of the pandemic recession stronger than it entered the recession. Over the next two years, Wall Street estimates earnings will grow at an average annual rate of about 21%, from $ 3.32 per share in 2021 to $ 4.89 in 2023. Free cash flow is expected to increase by 30%, compared to more than 20% per year, on average, before the pandemic. (Cash flow can grow faster than profits when cash investments made in previous years start to yield benefits.)

It is this growth in free cash flow that attracts Baird’s Vruwink. “This could be a model of 25-30% annual free cash flow growth,” he says, adding that PTC’s valuation is high, relative to the market, but not to the software industry. He has a price target of $ 167, or 29% above Thursday’s $ 129.58 close.

Still, the valuation might make some investors wary: PTC recovers about 34 times estimated earnings in 2022, a premium over the 31 times the S&P 500 software companies have. Expensive stocks have been hit recently, as investors have shrunk. turned from growth to value, and PTC, which has fallen slightly over the past month, has not been spared. In fact, the actions of many PTC software users, including

Ford engine

(F), did better as the economy emerged from its Covid coma.

Nonetheless, the factor leading investors back to stocks like Ford is ultimately positive for PTC: the industrial economy is booming. This provides PTC customers with the money and the drive to accelerate their digital transformation.

“The genie doesn’t go back into the bottle,” Heppelmann says. “There is more energy and enthusiasm right now in terms of bringing software into industrial companies than there has been at any time in the past 30 years.”

PTC has one more thing to do: the Internet of Things is attracting big buyers.

Aveva Group

(AVV.UK), for example, bought IoT software provider OSIsoft in March for around $ 5 billion in order to “accelerate the digital transformation of the industrial world.” Aveva’s price was about 33 times operating profit. Applying this multiple to PTC results in a stock price of approximately $ 155.

“Given the strategic nature of the asset and its attractive growth, PTC appears to be significantly undervalued,” said Michael Ware, managing director of Praesidium Investment Management, a $ 2 billion fund that owns PTC shares.

This makes it a good bet. b

Write to Al Root at [email protected]



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