Q4 2019 Select Holdings
Stone Run Capital Partners has invested in EPAM Systems (EPAM) for nearly six years and the stock is up over six times since our initial purchase. With over $2 billion in revenues, EPAM is a global software development, digital platform engineering, and digital and product design company. EPAM employs over 30,000 engineers, software designers, and consultants, and has been growing at over 20% a year for the past ten years. Teams of employees develop work both onsite and offsite for clients—these include five of the ten largest global investment banks, nine of the top ten biopharmaceutical companies, and even the world’s largest software companies, Google among them. EPAM is known for top-tier software development, including conceptualization and design. We met with the entire management team in December, and were once again impressed by the breadth of talent, and especially the shrewd technology and business sense of the founder and CEO Arkadiy Dobkin—he was a major reason for our initial conviction in the investment. EPAM is a version of the new digital model of software as a service (SaaS), and the company is enabling the world’s digital transformation, which is a multi-trillion dollar market opportunity.
ANSYS (ANSS) is the world’s leading software company for simulation technology, and more than triple the size of its closest competitor. Diverse companies across the manufacturing and construction industries use Ansys software to design products and create simulations that test a product's durability, temperature distribution, fluid movements, and electromagnetic properties. In a rapidly evolving business segment, companies such as Tesla are working with ANSYS engineers to design and develop the technology systems that will enable autonomous vehicles. Ansys has over $1.5 billion in revenues across a highly diversified customer base, a recurring revenue model, and is growing at a double-digit rate. Third-party industry experts believe the simulation market will triple in the next ten years. We agree given the rapid digitization of the world around us—simulation provides companies with the ability to optimize designs at a much faster pace. We met with management in Pittsburgh this fall and conversations with a range of product development leaders reinforced our conviction in the business. The stock reflects much of this optimism at present.
Founded in 1985, PTC (PTC) is one of a handful of software companies that lead the global computer-aided design (CAD) market. CEO Jim Heppelmann is a technology visionary. Through a series of acquisitions in the past five years, he has built new software platforms focused on helping companies deploy Internet of Things (IoT) augmented reality (AR) applications. Broadly defined, IoT is the set of technologies that enables machines and systems to communicate across the Internet—autonomous driving will require significant use of IoT. A good example of a current IoT implementation is a jet engine that relays performance data back to both the pilots and the airline’s information technology system on a continual basis. In fact, a single-engine plane can generate nearly 1,000 terabytes of data in twelve hours, which is as much as twice the amount of data Facebook processes in a day. As shown in the accompanying market assessment “magic quadrant” produced by Gartner (also a Stone Run Capital investment), PTC is the leader in industrial IoT system software, and this aspect of its business is growing 30% a year. IoT revenues were over $175 million in 2019 and are now more than 10% of the total business. We think the market potential for PTC’s IoT revenues over the next five years is more than $500 million. The stock had been up 75% in 2018. Management did not execute as well as they expected in adding sales staff, and the company had two disappointing quarters in 2019. We used the last decline in the stock to increase the investment position by over 30%. On January 23, PTC announced results for the quarter ended December 31; the stock is up over 15% since these purchases. It appears management has communicated more reasonable expectations and is executing better. Our initial investment dates to the partnership’s inception, and we expect to maintain it—sometimes larger, sometimes smaller—for the next several years at least.
With a 165-year history in materials science, Corning (GLW) is the premier technology company in developing and manufacturing liquid crystal display (LCD) glass, fiber-optic cable, and ceramic substrates. In 1879, Thomas Edison asked Corning to create the glass casing for the lightbulb, and Corning became the sole supplier. While Corning moved on long ago from the lightbulb business, it has remained, remarkably, a technology leader. At the root of this success is the company’s deep expertise in understanding the properties of materials. The company invests $1 billion annually in research and development, which, at about 9% of revenues, is more than several times the average company in the S&P 500. Corning is vertically integrated, and, for example, takes sand through one of the most sophisticated manufacturing processes in the world to create ten-foot square pieces of glass that are the thickness of a business card, and flat to within 22 microns—less than the diameter of a human hair. Corning brings similar technology expertise to fiber optic cable, which it invented, enabling global digital connectivity from the cloud to individual homes; and to processing the ceramic materials for the particulate filters that control carbon emissions from light and heavy-duty diesel vehicles, as well as some gasoline system vehicles. We think the explanation for this capability is threefold: there is significant customer concentration in the LCD business and volatility in the LCD supply chain; there is a lack of a recurring revenue model—consumers could put off buying a new larger television in a recession; and there is a capital intensive element to Corning’s business, in that it needs to build manufacturing plants costing hundreds of millions of dollars in order to execute on its R&D innovation. This complexity also helps clarify why—as we have observed over more than ten years—Corning stock tends to trade at a discount to the S&P 500 on an earnings basis. We think the stock is attractive in part because it is undervalued; the dividend yield is 2.7%; debt is manageable at less than 2-times debt/EBITDA; and the stock is now flat for the past 2½ years, and, in fact, trades at the same price as it did in 2006. Given the higher valuations of many companies in the portfolio, we think Corning provides a good balance. We met with the management team and an array of product managers last June and took note of how management has been building value in new investment areas, like life sciences. We continue to assess the business closely and will double the position size if the right set of conditions unfolds.