Intrinsic Value Assessment Of Ansys Inc (ANSS)

INTRODUCTION

ANSYS is an extraordinary industrial software company with a longstanding successful history and a bright future. It has found a specific niche and has an unrivaled market position. In this analysis, I’ll outline if this great business can justify its current stock price.

ANSYS develops, sells, and leases industrial software with the focus on structural analysis, Computational Fluid Dynamics (CFD), electronics, electromagnetics, and design optimization. Its customers include almost all relevant companies from the automotive industry, aerospace, energy, healthcare, construction, and much more. By offering its products to universities and other academic institutions by a very heavy discount (or even for free), ANSYS makes sure that its products are well-known by future engineers, guaranteeing product loyalty. Its most famous products include the structural mechanics software, Mechanical, which has been developed internally. By contrast, its two flagship business units CFD tools CFX and Fluent were obtained through acquisitions.

THE INTRINSIC VALUE OF ANSYS

To determine the value of ANSYS, let’s start by looking at the company’s history of free cash flow. The free cash flow is important because it represents the company’s ability to retain earnings and grow the business.

As one can see, the results in the past have been impressive. However, the rapid growth is likely not to continue at the same pace. Therefore, a conservative estimate of the future free cash flow is used. To build this estimate, we make use of an array of potential outcomes for future cash flows.

Each line in the above graph represents a certain probability for occurring. We assume a 20% chance for the upper growth rate of 4% per year, a 50% chance for zero growth, and a 30% chance for the worst-case scenario of -3% annual growth. This rather narrow band of possible outcomes reflects both the mature and robust position that ANSYS finds itself in: Neither a catastrophic earnings collapse can be expected due to its highly protective business model, nor explosive growth seems likely due to market saturation of its products. Therefore, the future of ANSYS is relatively easy to predict – which is a huge advantage for investors trying to evaluate the business.

Assuming these growth rates and probabilities are accurate, ANSYS can be expected to yield a -0.5% annual return at the current price of $150. Now, let’s discuss how and why those free cash flows could be achieved and if there is room for a higher growth to justify the valuation.

THE COMPETITIVE ADVANTAGE OF ANSYS

ANSYS possesses some unique advantages that will allow it to be very successful in the future:

• Quality/branding. If you want to do structural analysis and/or CFD in the industrial sector, then ANSYS is the one name that everyone knows and uses. It has a reputation for quality and reliability and is used globally by almost all important industrial companies.
• High Switching Cost. An engineer that has worked for years or even decades with ANSYS products will think twice before switching to another code. Experience in such complex software products requires a long time to acquire, making it very costly to switch. What is more: Customers often have established complex workflows based on ANSYS’ products. Replicating these with another software is very time-consuming and expensive so unless there are very strong reasons to switch (like significantly lower costs, better modeling capabilities, faster performance) an existing customer can be expected to remain loyal to ANSYS.
• Monopoly Power. While there are several competitors offering software similar to the ones from ANSYS, no other company offers such a wide range. Some firms sell software for structural analysis, while others have CFD software on offer. But only ANSYS has both on a large scale. Since simulations often consider both types of simulation, this poses a very important advantage for ANSYS. This very strong position is also reflected in its net profit margins, which have been above 20% throughout every year during the last ten Also, the balance sheet is very strong – the available cash & short-term investments easily top all of its liabilities.

OPPORTUNITY COSTS

When looking at various investing opportunities on the market today, let’s compare the expected return of ANSYS to other ideas. First, one could invest in the ten-year treasury bond which is producing a 2.1% return.  Considering the bond is completely impacted by inflation, the real return of this option is likely below 1%.  Currently, the S&P 500 Shiller P/E ratio is 30. As a result, the U.S. Stock market is priced at a 3.3% yield. If one were to invest in the S&P500, they might purchase a low-cost ETF to take advantage of this return.

MACRO FACTORS

Since ANSYS sells to customers in the industry, it is highly dependent on the success of these. During the financial crisis in 2008, car sales collapsed, and many automotive companies were short of cash. As a result, they cut back on expenses, including software licenses, which hurt ANSYS. Interestingly, the reverse can sometimes also be true. Software companies like ANSYS can gain revenue because of a crisis. The rationale is this: When a customer of ANSYS wants to develop, and test a certain new product (e.g., a car) then this can be done either with a computer simulation, in a real experiment (for example in a wind tunnel), or with a combination of both. Since experiments are very expensive, they are the first to go in a downturn. Unless the company wants to stop developing its products completely, it, therefore, has to do more simulations (which are usually cheaper than experiments) – and this can increase the business of ANSYS.

Judging from the experience of the 2008 financial crisis, the overall effect of a crisis weighs negatively on the revenue of ANSYS. This means that the reduction of available cash that can be spent by its clients dwarfs the increased business due to a focus on cheap simulations. If this will hold true in the next downturn remains to be seen.

RISK FACTORS

Several risks might limit the growth prospects of ANSYS:

• Market saturation. There are only so many industrial companies that ANSYS can sell to. Today, it is already standard practice to simulate engineering problems with a computer – meaning that the potential for new business is limited.
• Complexity and incompatibility of its products. The software packages distributed by ANSYS have mostly been created incrementally (which is normal for most codes): Starting from a software written for a rather specific application, the codes were afterward increased in scope, making them more complex. At a certain point, it gets very hard and also expensive to add new functionalities since the codes have originally not been designed for such a prolonged increment. What is more — Since many different codes have been acquired, it is very challenging to integrate them into a single framework. But offering several separate software packages has problems of its own: The codes might not work together perfectly, technical support structures might have to be duplicated, etc.
• While no competitor can match the width of ANSYS products, many companies offer simulating solutions for specific applications (like aerodynamics, electromagnetism, batteries). Due to their narrower range, these alternative codes can be very computationally efficient. The broader “do-all-codes” of ANSYS often cannot compete with these specialized software when used for such specific applications.

SUMMARY

ANSYS is an outstanding business that offers a wide range of industrially important software packages with high switching costs. Due to its very strong position, it can be expected to be very profitable for a long time to come. At the same time, the business is already in a quite mature state, limiting its future growth. The current stock price of $150 does not offer an attractive entry point for investors, and it might yield a negative return. Investors should keep the stock on their radar, but wait for a more appealing price to enter.

To learn more about intrinsic value, check out our comprehensive guide to calculating the intrinsic value of stocks.