A Toll Bridge Over a Wide Moat

01/07/2009 12:01 am EST

Focus: GLOBAL

Allan Nichols

Equities Strategist & Editor, Morningstar InternationalInvestor

Allan Nichols, editor of Morningstar InternationalInvestor, says a multinational software company has recurring revenues and a history of innovation.

Dassault Systemes (Nasdaq: DASTY) is a leading provider of product life-cycle management (PLM) and 3D computer-aided design software. Its products are used in the design and manufacture of automobiles, medical equipment, power plants, and consumer goods. Dassault derives about half of its revenue from Europe, a third from North America, and the rest from Asia.

We like Dassault’s dominant position, recurring-revenue model, and high returns on invested capital. The firm stands to benefit from the continuous adoption of PLM solutions in industries beyond traditional manufacturing.

Its software allows clients to reduce product-development costs and improve time to market by managing all the stages of a product life cycle—from conception to development, to production and maintenance.

While Dassault’s PLM solutions have long been used in the aerospace and automotive industries, companies in the consumer goods, apparel, and high-tech sectors are now adopting its technology to bring their products to market faster. Dassault has increased recurring software licensing revenue to around 50% of total sales.

The company faces strong rivals in Autodesk (Nasdaq: ADSK), Parametric (Nasdaq: PMTC), and MSC Software (Nasdaq: MSCS), but we believe its wide economic moat can fend off competition.

Dassault traditionally allocates 25% of total sales to technological innovation. [Also], a host of software partners have created hundreds of applications that complement Dassault’s solutions—a positive network effect. [Finally], Dassault’s clients face high switching costs, as do the clients of its rivals. Boeing (NYSE: BA) would incur significant switching costs if it moved the design of the 787 airliner to another PLM platform. This wide moat enables Dassault to consistently generate returns on invested capital in the [mid-20% range].

Dassault has acquired several new businesses, including MatrixOne in 2006, which have enabled it not only to profitably expand its revenue, but also to sell its products to new clients in industries such as high tech, consumer goods, life sciences, architecture, and construction.

Management has the ambitious plan to double 2005 revenue by 2010. We think further penetration in new industries and the recently improved distribution agreement with IBM (NYSE: IBM) put the company on track to achieve this goal. We project that operating margins will expand from 20% in 2007 to around 23% in 2012 as the company gains scale from its operations.

We are reducing our fair value estimate to $55 per share from $58, after updating our exchange rate assumptions. We model 9% average annual revenue growth over the next five years.

This is a high-quality firm that doesn’t trade at a reasonable price very often. (It closed at $45.40 Tuesday—Editor.)

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