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How to find the next 10 bagger (Part V)

In this series of articles, I am taking a look at the history of some of the ASX’s best performing stocks. In particular, I hope to address the following questions.

  1. What did these companies look like at the start of their rise?
  2. Is it possible to identify tomorrow’s 10 baggers?

Altium Limited (ASX: ALU) develops and sells software used to design printed circuit boards (PCBs). If you had bought $10,000 of Altium stock five years ago, it would be worth over $610,000 today plus you would have received $45,000 in dividends.

Back in 2011, Altium had announced substantial losses in its recent financial reports but was generating positive cash flows. Despite expensing most of its R&D, the company had high amortisation charges relating to acquired intellectual property and capitalised R&D from years gone by. In effect it was double counting R&D spend which artificially supressed profits.

Further hidden value could be found in its growing deferred revenue liability. This liability represented annual subscription fees paid upfront by customers and so a growing balance implied higher levels of recurring revenue in future periods.

Indeed, in an announcement on 19 July 2011 Altium said that 40% of 2011 sales were from subscriptions, up from 27% a year earlier. Similarly, the number of active licenses had risen to 18,000 by 30 June 2011, up from 11,000 in the prior period. Growing subscriptions signalled Altium’s transition from a traditional software company to a cloud based SaaS provider which would unlock operating leverage and drive earnings growth in future years.

Another clue that a turnaround was taking place was the acquisition in November 2010 of Morfik, a cloud application development company. In return for Morfik, the vendors received 13.3 million shares in Altium worth $2.4 million at the time. Morfik’s CEO Aram Mirkazemi was appointed Altium’s chief of engineering and is now the company’s CEO.

Altium was generating between $1 million and $2 million in free cash flows per year back in 2011 and had $3.4 million in net cash at 31 December 2010. Despite this, it had a market capitalisation of just $12.3 million.

No wonder the directors were aggressively buying shares at the time. Non-executive director Sam Weiss acquired 700,000 shares between September 2010 and May 2011. Not content with the 6.7 million shares he received from the Morfik sale, Aram Mirkazemi bought another 2 million shares in Altium at 13 cents per share in December 2010.

Since the transition to a recurring revenue model in 2011, Altium has gone from strength to strength and today its prospects look brighter than ever. The company always had excellent technology capabilities, but it was only when these were coupled with an attractive business model that it was able to thrive.

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Motley Fool contributor Matt Brazier owns shares of Altium. The Motley Fool Australia owns shares of Altium. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Bruce Jackson.

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