Starboard loses first legal battle against Autodesk. The battle is just beginning

Company: Autodesk engages in three-dimensional (3D) design, engineering and entertainment technology solutions. The product offering is focused on the following categories: architecture, engineering and construction, AutoCAD and AutoCAD LT, manufacturing and media and entertainment. The products include AutoCAD Civil 3D, Building Connected, Autodesk Build, Revit, Computer-Aided Manufacturing Solutions, Fusion 360, ShotGrid and 3ds Max. Autodesk's product development and manufacturing software provides manufacturers in the automotive, transportation, industrial machinery, consumer products and construction products industries with comprehensive digital design, engineering, manufacturing and production solutions. It also offers Wonder Studio, a cloud-based 3D animation and VFX solution.

On June 17, Starboard sent a letter to Autodesk shareholders announcing it is filing a lawsuit to force the company to postpone its 2024 annual meeting scheduled for July 16 and reopen the director nomination period. This follows that of Autodesk deferred disclosure of a internal research to report irregularities that Starboard says have misled shareholders and potentially deprived them of their voting rights. The Delaware Chancery Court ruled against Starboard on June 20, but the activist still believes that Autodesk needs strengthening of its governance, as well as improved growth and profitability through operational performance, capital allocation policies and communications with investors.

But the cooperative, constructive scenario was seemingly undermined April 1st, when Autodesk publicly notified shareholders that its annual report would be filed late after information was provided to the audit committee, resulting in the launch of an investigation into free cash flow and non-GAAP operating practices company margins. Finally, the committee found that despite signaling to investors that it would shift its enterprise customers to annual billing, Autodesk had recently pursued multi-year contracts at levels that exceeded even their historical usage, allowing the company to achieve its FY23 free cash flow target.

To make matters worse, the company notified the U.S. Securities and Exchange Commission of these issues in early March, but withheld the information from investors until after the close of the nomination period, preventing a possible appointment of an activist director this year . Despite this, Starboard said it reached out privately to offer to work with Autodesk to improve governance, but the company declined. Therefore, Starboard requested that Autodesk reopen the nomination window so that shareholders could make a fully informed decision following the recent revelations, given the fact pattern. The company rejected that offer. Starboard filed a lawsuit in the Delaware Court of Chancery to force Autodesk to postpone its 2024 annual meeting, which was scheduled for July 16, and reopen the nomination window, which closed on March 23. The court dismissed Starboard's claim on June 20.

While the study's findings alone are concerning, we believe there are two issues that could elevate the study from an acute accounting problem to a much more serious governance problem. First, while Autodesk reports free cash flow as a key operating metric, this was actually the case a factor in the field of executive compensation. Second, the way the board and management responded to this investigation may be an even bigger problem. Here the board seemed to determine that Deborah Clifford could no longer remain as CFO. What happened next didn't exactly inspire a strong sense of board oversight and responsibility: Instead of firing her, Autodesk appointed Clifford as Chief Strategy Officer. While the first issue concerns management and its lack of alignment with shareholders, the second issue directly addresses the board's ability to oversee management and hold them accountable.

There is no doubt that these developments at Autodesk require changes in management. The degree of change needed will not depend on the company's actions, but rather on the level of commitment. Starboard does not yet know whether this situation can be rectified with a few board seats or a total overhaul of the board and management, but that will become clearer as more facts about accountability emerge. From our perspective, the company's response in terms of punishing management and informing and working with shareholders does not bode well for the 'small changes' scenario. The governance issue here is of paramount importance and must be addressed before Starboard can implement real economic changes that directly increase shareholder value.

Once that is resolved, a reconstituted board and management team can, as necessary, focus on improving operating margins and trading multiples. Improving margins by 1,000 basis points on its own could dramatically increase shareholder value, but applying a larger multiple to that will have an exponential effect. Currently, Autodesk trades at an EV/CY2025E earnings before interest, taxes, depreciation, and amortization multiples of 19.4x, compared to some peers above 30x and a peer average of 23.5x. A good argument can be made that a market leader like Autodesk should trade at a higher-than-average multiple, but just hitting the peer average would be highly meaningful to shareholders. This happens when shareholders have more confidence in the company's governance – when the board provides more transparency, oversight and accountability – and when management meets its targets rather than missing and lowering them.

Whether that happens will depend on a number of things. Starboard's loss in the Delaware Court takes the fast-paced scenario off the table. Although there is a proxy proposal this year that would allow 25% of shareholders to call a special meeting even if approved, the company may drag its feet on implementation so it wouldn't really be helpful before the next annual meeting. . This may have to do with how hard the board wants to intervene and how convincing Starboard and other shareholders can be. Otherwise, it will have to wait until 2025. The good news is that Starboard is an activist with the patience and conviction to wait until 2025. If that happens, the company's chances of profit would decrease dramatically.

One final note: This isn't the first time Autodesk has been called in by an activist. Sachem Head waged an activist campaign here between November 2015 and June 2017 and ultimately settled for three board seats and the appointment of a new CEO, Andrew Anagnost, who currently heads Autodesk. It should be noted that one of Sachem Head's appointed directors was Rick Hill, who has a very interesting relationship with Starboard. He was the chairman of Tessera when Starboard had a proxy fight there. At that time he fought tooth and nail and was the most outspoken opponent. Starboard eventually replaced a majority of the board while Hill remains on and ultimately become the company's biggest supporter. He has been with both directors since then Marvell technology And Symantec. He's no longer a member of Autodesk's board, but he could certainly be an informal advisor to Starboard – or a cautionary tale for Autodesk.

Ken Squire is the founder and chairman of 13D Monitor, an institutional research service on shareholder activism, and the founder and portfolio manager of the 13D Activist Fund, a mutual fund that invests in a portfolio of activist 13D investments.