Bentley Systems: Valuation Is Too High Now

Overview

In my opinion, Bentley Systems (NASDAQ:BSY) is a fantastic software company that has a great chance of expanding its current foothold in the lucrative infrastructure engineering design market. I think the company has a number of long-term advantages in the market, including a large and dedicated customer base of over 40,000 owner-operators and design firms who have a retention rate of over 98%. BSY also provides a full suite of solutions for the lifecycle management of infrastructure assets, including experience in previously overlooked infrastructure sectors. In the long run, I anticipate 10% annual revenue growth for the company and a steady pace of margin expansion. This is predicated on the expectation that BSY will reap rewards from expanding government spending on infrastructure across the globe, especially in the United States via the IIJA. The ongoing shortage of workers in the civil engineering industry is also anticipated to increase demand for BSY's products, which will ultimately lead to better infrastructure engineering capabilities. Read my previous coverage on BSY stock here.

The results of 4Q22 added credence to my opinion that BSY is a solid business. BSY posted strong results for 4Q22, with Subscription Revenue and adj. EBITDA both exceeding consensus estimates. The company also provided guidance for FY23, excpecting12.5% FX-neutral ARR growth and 26% adjusted op. margin. Several significant new developments have significantly bolstered my bullish outlook (from a business point of view). Such examples include the increasing momentum from IIJA funding and the robust expansion of new pipelines in Europe and India. Moreover, BSY has maintained shrewd execution in retaining both its gross and net retention rates of 98% and 110%, respectively. In addition, BSY maintained down-market traction, as evidenced by another quarter of over 600 new Virtuosity logos, contributing 300 basis points to ARR growth and 47% to overall new business,. Finally, I believe that the success in converting to E365 accounts is a crucial lever in maintaining growth momentum. Though I expect China to have a negative impact on growth, I believe the strong trends in new business are conducive to ARR expansion at least in line with guidance. Overall, I think BSY is an exceptionally well-defended business that can profit from the civil infrastructure investment cycle that lasts for several years.

That said, the valuation is extremely demanding as well, at near 50x forward earnings, a lot of expectations has been baked into the share price (which has reached my target share price). I recommend a hold rating on BSY stock as the risk/reward is no longer as attractive as when it was early this year.

Strong secular trends continue to exist

As the world's population rises and more people in developing economies move to cities in search of work, the gap between the necessary and existing levels of infrastructure widens, suggesting that additional infrastructure spending is necessary to achieve the desired levels of urbanization. There is also the fact that infrastructure assets in developed economies are getting on in years, necessitating investment both to keep them running and to perform routine maintenance. Oxford Economics Outlook estimates that between 2016 and 2040, worldwide investments in infrastructure will total $3.7 trillion annually on average. In my opinion, BSY stands to gain from rising infrastructure spending thanks to the company's leadership in the Infrastructure Lifecycle Management market, its comprehensive platform that can accommodate a wide variety of use cases, and its standing as a market leader in the software market for civil works and industrial designs.

Competition

My assessment is that BSY has a solid footing in this sizable and expanding market. BSY's ability to offer a full suite of solutions that target different subsets of its target markets is a major strength that should help it increase its market share. In addition, BSY has a sizable installed base, especially among its most visible enterprise clients, which bodes well for its expansion plans. As BSY expands into the middle market, it can take advantage of its existing relationships with customers to increase sales and profit margins. Despite the abundance of large public vendors, BSY should be able to stand out and gain market share thanks to its large installed base, high-touch customer model, and comprehensive product offerings covering the entire lifecycle of infrastructure assets.

Valuation

The one thing that is pushing me to a hold rating is BSY high valuation. It is trading at – 50x 1Y forward P/E and 42x 2Y forward P/E. These are by no means cheap, both absolutely and relatively. If we compare BSY to other big players like Autodesk (28x 1Y forward PE) and Aspen Technologies (30x 1Y forward P/E), who are also expected to continue growing and expanding margin, BSY seems to trade at a huge premium. As per my previous model, BSY is not trading at my target price, and I believe the valuation today is fair valued. Any upside from here would mean that BSY needs to grow a lot faster, either via top-line or margin expansion, which are hard to forecast today. If BSY were to miss consensus in any form, we could see a sharp re-rating downwards.

Conclusion

I believe that BSY is a strong software company that is well positioned to benefit from the expanding infrastructure engineering design market. With a large and loyal customer base, a comprehensive suite of solutions for infrastructure asset management, and experience in overlooked infrastructure sectors, BSY is poised for long-term success. The company's recent strong financial results, expanding pipelines in Europe and India, and increasing momentum from the IIJA funding provide further evidence of its potential for growth. However, the high valuation of BSY is a concern, and I recommend a hold rating as the risk/reward is no longer as attractive as it was earlier this year.