I've been a little surprised by Autodesk's (Nasdaq:ADSK) performance over the past nine months or so. While I've long liked this company and thought it was significantly undervalued on a cash flow basis, I've been surprised that worries about macroeconomic conditions, the switch to a cloud/subscription model, and generally unimpressive top-line growth didn't overshadow that underlying value. With another disappointing quarter in hand and estimates heading lower, though, it may be a little harder for the value trade to support these shares in the short term.

Fiscal 2014 Isn't Off To A Roaring Start

Autodesk reported that revenue fell 3% for the fiscal first quarter (or flat in constant currency), missing the average estimate by around 2%. The miss was led by disappointing license revenue, as this figure fell 9% from last year (missing the average estimate by about 6%). Maintenance and subscription revenue was stronger, though, growing by 6% and surprising expectations by about 3%.

Margins were not impressive and contributed to the miss. Gross margin fell 160bp (though still at a very high relative level of over 90%), as the company saw a mix shift and absorbed costs related to building its cloud business. Operating income fell 6%, with the operating margin decline of 60bp showing some efficiency gains to offset the gross margin loss.

Ample Headwinds For Now

There are plenty of headwinds blowing into Autodesk's face right now. For starters, there's a generally weak IT spending environment to contend with, as companies all across the sector have seen delayed deals and trade-downs to cheaper offerings.

Macro factors are also hurting Autodesk and the sector as a whole. While architecture / engineering / construction (AEC) demand was up 4% and better than expected, it was still down 17% sequentially despite management's mention of improving demand in commercial construction. The company's platform/emerging segment saw sales decline 6%, while demand in the manufacturing vertical fell 5% and weakened from the prior quarter. It doesn't sound like the macro picture is improving very much at this point, and like Ansys (Nasdaq:ANSS) and PTC (Nasdaq:PMTC), Autodesk lowered guidance for the next quarter.

Last and not least, all of this is going on while the company is in the midst of a transition to a subscription/cloud model. As we've seen at Adobe (Nasdaq:ADBE) and Microsoft (Nasdaq:MSFT) this can create some turbulence in revenue as customers adapt to the new terms. While this transition could improve margins over the long term, I do worry that sell-side analysts are too optimistic about the margin contributions from this switch (particularly as most of the large players are all doing it).

The Big Picture Still Basically The Same

For better or worse, I don't see tremendous change coming in this business. As is so often mentioned with Autodesk, the company has essentially created the standard in CAD/CAM and thousands of engineers and other such professionals are trained on their systems in college. At the same time, the company has been working to develop more products like Fusion 360 which help deliver more functionality to small businesses at affordable prices.

The real question is how much this will be worth outside the company's traditional markets. Autodesk's reputation and history is arguably worth less in emerging markets, and it has yet to be proven that the company can establish itself there to the same extent.

The Bottom Line

While Autodesk is suffering from a weak macro climate and the transition to a new model, neither of these will last indefinitely. To that end, I believe Autodesk can still expect to grow its revenue at a long-term rate in the mid-single digits. Likewise, I do believe there is still some incremental margin improvement potential, and that can push free cash flow higher at a mid-to-high single-digit rate. With that sort of growth, Autodesk shares appear to be worth about $45 to $46.

Although that free cash flow-derived target doesn't suggest huge undervaluation, I do believe that Autodesk is likely to be treated as a proxy for the macro and IT demand environments. If the second half recovery still comes through, these shares could head higher through the end of 2013. On the other hand, if global demand stays sluggish these shares may struggle to break out of their current range.

At the time of writing, Stephen Simpson did not own any shares in any of the companies mentioned in this article.

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