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In the past, if engineers wanted to know if an idea worked, they would first have to build a real 3D physical model. The problem is not everything scales linearly. In 1628, when Sweden built the world’s biggest boat, the Vasa, it capsized before it left Stockholm harbour because it was too top-heavy. At that size, traditional designs that worked for smaller vessels ceased to function. The experiment lost the Swedish monarchy a lot of money and the lives of 30 sailors.
Bull points
- High switching costs
- Strong network effects
- Boost from government spending
- Good revenue visibility
Bear points
- High valuation
- R&D prioritisation might fade
If Vasa’s engineers had access to a software program that could have generated an accurate 3D model – a long stretch in the 17th century, granted – all this lost time, money and life might have been saved. Today, the leading 3D engineering company is Pennsylvania-headquartered Ansys (US:ANSS). Its cloud-based software product is sold to a spectrum of industrial companies, including aerospace, automotive, energy and semiconductors businesses.
Customers license Ansys’s software on fixed contracts. However, if they require larger computations, use more products or add more users, they pay more. Along with economic growth, the main macro indicator for Ansys’ success is total research & development (R&D) spend across the economy. If companies are designing, innovating and building more, then they inevitably use Ansys’ products more.
Government R&D tailwind
Current fiscal trends and focuses are therefore good news. The biggest economic legacy of 2022 has been onshoring supply chains and increasing military spend. This has been pronounced on both sides of the Atlantic, as the Chips and Science and Inflation Reduction Acts in the US, and the EU Chips Act on the other side of the pond, have concentrated minds and spending on the energy, military and semiconductor industries in a bid to increase security.
With countries racing to get ahead of each other, Ansys is feeling a substantial tailwind. In the second quarter, its biggest revenue contributors by industry were semiconductors at 31 per cent, aerospace at 23 per cent, automotive at 17 per cent and energy at 9 per cent. The rest was split between industrial equipment, chemicals and construction.
While a lot of business is domestic, Ansys is highly exposed to South Korea, Japan and Germany, all industrial countries that have announced big investments in their semiconductor industries. Last quarter, the US made up 44 per cent of revenue, with 8 per cent coming from Germany and 13 per cent from Japan. Around 10 per cent was from South Korea, with the rest coming from the remaining European countries. Reassuringly, given ongoing geopolitical tensions, less than 5 per cent came from China.
According to management, the increased complexity of semiconductors has boosted demand for 3D simulation. For example, graphics processing units (GPUs) are designed on a nanometre (nm) scale, to fit as many cores on them as possible, but are then stacked together with memory chips to form a data centre. This changing scale creates electromagnetic interference, which all needs to be simulated. Just like the Vasa, the cost of failure is high.
Ansys semiconductor customers include leading designers and foundries, such as Intel (US:INTC), Samsung (KR:005930) and TSMC (TW:2330). For example, Samsung certified Ansys’ Redhawk technology, which simulates thermal analysis to spot where there could be a voltage drop in the circuit, for its most advanced ‘2nm’ process. All three of these foundries have received billions of dollars of funding this year from the German, US and Korean governments.
Growth and cash flow
Even before the boom in semiconductor investment, Ansys had been growing consistently year on year. Between 2019 and 2022, sales increased 36 per cent to $2bn (£1.6bn) while operating profit was up 16 per cent to $603mn. The operating margin, having hovered at around 30 per cent for the past decade, is up there with the sector’s best.
A big strength is cash generation. Around half of sales come from licences, while the other half comes from maintenance and services. Customers have to pay upfront for the licences so there is a large amount of deferred revenue that isn’t recognised initially but comes through in the cash flow statement. Arguably, this means the profit figure is an underestimation.
Ansys’ second-quarter revenue rose 4.8 per cent to $497mn, however its deferred revenue and backlog – a better lead indicator of demand – jumped a tenth to $1.3bn. Most importantly, annual contract value – which is similar to recurring revenue – was up 10.4 per cent, or 12.3 per cent on a constant currency basis, meaning a good chunk of sales is almost guaranteed for the coming year.
As the market leader in 3D simulation software, Ansys has built high barriers to would-be competitors. Many engineers are already trained on Ansys’ products. This training starts before engineers even enter the workforce. Ansys has ties with Carnegie Mellon University and offers a course through Cornell. Like Microsoft’s Excel spreadsheet software, the ubiquity and quality of its software make it the default product for businesses and workers. These network effects are extremely powerful.
This doesn’t mean the company has rested on its laurels. To stay ahead of the competition, Ansys spends a lot of its cash on acquisitions. Since 2017, it has diverted almost all of the $3bn it has generated in free cash flow towards acquisitions. This year, it acquired German automotive simulation software business DYNAmore and American semiconductor simulation company Diakopto, whose software spots bottlenecks and faults in semiconductor designs before they are put into manufacturing.
Ansys’ own R&D spend is also ahead of the industry average. In the past 12 months, R&D was $465mn, which was 21 per cent of its $2.2bn of revenue. This figure has consistently been above 20 per cent for the past few years, while the software industry average is usually nearer 10 per cent. Combined with bolt-on deals, Ansys is investing heavily in its products, which is deepening the economic moat around the business.
Inevitably, these qualities have resulted in a premium valuation for Ansys’ shares. FactSet broker consensus is for revenue to rise to $2.53bn in 2024, given its strong backlog of work. The expectation is for earnings per share (EPS) to rise to $9.68, a rise of 21 per cent from 2022, which means Ansys’ 2025 price/earnings ratio is 29. This is expensive, but the fact its price to free cash flow is almost exactly the same, makes it look a little more manageable.
Even before the pandemic and Russia’s invasion of Ukraine awoke countries to the need for domestic industrial strength, global R&D spending had been rising. Now, the stage appears set for another acceleration. But even when there is lots of money being thrown at a problem, governments and companies still don’t want it to be wasted.
After the Vasa sank, the Swedish king Gustavus Adolphus launched an inquest into the accident to find the cause, or a scapegoat. No one admitted to any wrongdoing. When Arendt de Groote, the Dutchman contracted to build the ship, was asked in court why it sank, he said “Only god knows”. Ansys software would have known. And it would have known before construction had even begun.
| Company Details | Name | Mkt Cap | Price | 52-Wk Hi/Lo |
| ANSYS, Inc. (ANSS) | $27.7bn | $319.03 | $351.23 / $194.23 | |
| Size/Debt | NAV per share* | Net Cash / Debt(-)* | Net Debt / Ebitda | Op Cash/ Ebitda |
| $56.06 | -$404mn | 0.2 x | 92% |
| Valuation | Fwd PE (+12mths) | Fwd DY (+12mths) | FCF yld (+12mths) | P/BV |
| 34 | – | 2.6% | 5.6 | |
| Quality/ Growth | EBIT Margin | ROCE | 5yr Sales CAGR | 5yr EPS CAGR |
| 28.2% | 11.2% | 13.5% | 15.0% | |
| Forecasts/ Momentum | Fwd EPS grth NTM | Fwd EPS grth STM | 3-mth Mom | 3-mth Fwd EPS change% |
| -12% | 12% | -1.3% | 2.9% |
| Year End 31 Dec | Sales ($bn) | Profit before tax ($bn) | EPS (¢) | DPS (¢) |
| 2020 | 1.70 | 0.73 | 670 | nil |
| 2021 | 1.93 | 0.80 | 737 | nil |
| 2022 | 2.07 | 0.85 | 799 | nil |
| f’cst 2023 | 2.29 | 0.92 | 863 | nil |
| f’cst 2024 | 2.53 | 1.03 | 968 | nil |
| chg (%) | +10 | +12 | +12 | – |
| Source: FactSet, adjusted PTP and EPS figures | ||||
| NTM = Next 12 months | ||||
| STM = Second 12 months (ie one year from now) | ||||
| *Includes intangibles of $4.5bn, or $51.47 per share | ||||
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