Pivotal, a moderately deep dive.
I had barely heard of Pivotal (thinking of it as just a subsidary of Dell that had spun off a few shares) until a couple of days ago, when SteppenWulf brought it to the board, but thanks to him getting me interested I looked into it extensively, and have taken a small to medium position.
This was SteppenWulf’s original write-up (all slightly edited by me):
I have huge conviction in Pivotal’s technology. It is must-have technology for all enterprises moving to the cloud. Almost all enterprises I know are using or transitioning to PVTL. They are moving away from direct AWS, Azure or Google Cloud to Pivotal, which provides tools to manage all cloud workloads, independent of vendor, and including private cloud or data center.
There are some complexities here in the ownership structure under Dell, but Dell will want to maximize the value of PVTL, and so I believe it won’t do anything to reduce its value in the marketplace.
This is technology that has already won, now it is just a matter of enterprises expanding it to all their IT, as they move to the cloud, maximize the productivity of their developers, automate their processes, and avoid vendor lock-in.
Just my take on what I think is one of the highest confidence cloud companies, by a cloud professional and exec.
Someone on board then asked:
So would that pitch Pivotal in direct competition with what Nutanix is trying to do with Xi? Or will Xi be for public cloud and Pivotal for private?
SteppenWulf gave this incredibly great answer:
Let me start my answer by describing the state of IT. First of all, IT is huge with a lot of different people doing different things. Like building a house, there are lots of parts with the appropriate specialists - brick layers, plumbers, electricians, carpenters.
In IT there are application and storage servers, networking, operating systems, software running on all those servers, application interfaces allowing the software to talk to each other, and end user devices and user interfaces allowing humans to talk to the machines.
As a bit of background about myself, my core competencies are as an application and enterprise architect - I deal with the software running on servers, how they talk to each other, and how they talk to humans.
Hardware has always been an annoyance in my job. I don’t care what machines my systems run on - I just want them to run and let someone else worry about the plumbing.
The cloud was built for me. With the cloud, I just wrap up my software in little packages. The cloud adds hardware when my software needs it, creates virtual addresses so I can talk to any piece of software on the planet, protects my software behind walls, and just charges me for what I use, instead of having to buy a whole machine.
Now there is another guy, the infrastructure architect. He cares about the machines we have, the cables linking them to each other, the switches and routers that move traffic to the right place, the firewalls that protect them, the air conditioning and building that houses them.
The infrastructure architect is being put out of work by the cloud, but not very quickly. Companies have lots of machines, they are moving to the cloud step by step, and there are some machines that may never move to the cloud, and even in the cloud you will need some (but not as many) infrastructure architects.
Pivotal is a cloud solution for me and other application and enterprise architects. It is like a machine that automatically builds a cloud application for me. I give it the design, and the latest version of the code. I tell it to build it on AWS, or Azure, or Google, or on my own machines. 10 minutes later - it is done, tested, verified, and running. I don’t even need to tell it - it checks my systems, and knows when I’m ready for a build, knows where I want it, and builds it for me. It speeds up my productivity immensely, and let’s me avoid any sort of vendor lock-in - and I no longer even need to know how to spell “server”.
Nutanix is for the infrastructure architect. Now I am no expert on hyper-converged infrastructure, but the way I understand it is what Nutanix does is take all the boxes that are in the company’s data centres and virtualizes them via software.
So Nutanix makes all the machines in my company’s data centre into potential destinations for the applications I develop with Pivotal.
As I said, hardware annoys me. The secret is that hardware annoys the infrastructure architect too - all he wants is that when I ask him for something, he gives me something and I shut up. With something like Nutanix, he can break up all his servers into pieces of different types, like bricks, hardwood, and metal. Then when I ask for a brick box lined with hardwood, with a metal clasp, he doesn’t have to pull out his hair. He just gets it from Nutanix with the resources he already has.
For companies with hybrid clouds, where part of the cloud is AWS or Azure, and part of it is servers in their own data centre, Nutanix can make it a lot easier for the infrastructure architect to pretend his servers are just another cloud. And the Nutanix server slices are then set up as a destination, in which Pivotal can build the application I want.
Sorry, I forgot to mention Nutanix Xi. Xi also works for the infrastructure architect, not the application architect. What it does is make the public cloud look just like the boxes in my own data centre. The most obvious business case for this is for me to do backups and disaster recovery on my own boxes, and put that info in the cloud. It could also let me quickly move some workloads on to the cloud if I need to in a hurry, and don’t have time to set up the boxes. I’m not sure of other business cases for it, as the point of Nutanix is that you want to keep (some of) your info in your own data centre.
I (Saul) was very impressed because Steppenwulf clearly knew what he was talking about.
Someone on board asked another question:
I’m sure you know what Terraform is given your background. Then there is Nutanix CALM. What is your take on whether or not CALM with Terraform is a competitive threat to Pivotal?
SteppenWulf respnded as follows:
Pivotal’s main competition are the cloud titans - Amazon, Microsoft, Google. But one of Pivotal’s primary value propositions is vendor independence, which is something the titans can never provide - they are aiming for vendor lock-in!
Nutanix and its partners solve such a different type of problem from Pivotal that it is hard to imagine they will ever be competition to Pivotal.
Think of it like Nutanix helps you make steel, and Pivotal helps you make a knife. The applications that are making steel (Nutanix and its partners) are never going to be competition for the applications making knives (Pivotal and the cloud titans). They are raw materials for it.
One of the original use cases for Pivotal was to be able to deploy applications to multiple clouds, or to virtual machines in your own data centre, the “hybrid cloud”. Pivotal doesn’t create the virtual machines. Pivotal was actually split off from VmWare (hence the Dell ownership). VmWare is famous for creating the most successful hypervisors which create/manage virtual machines. Pivotal was spun off partly so it could be virtual machine agnostic, and it supports all the popular implementations, not just VmWare.
Nutanix and its products are solving problems in creating and managing virtual machines. They take a physical machine, and using a hypervisor, divide it up into virtual machines and apply various operating systems and configurations on them. They do the same thing with complex hardware for databases called SANs (storage area networks) and NASs (Network attached storage). Then they take the virtual machines, and cut those up into platform segments to run applications on. This is the same thing the cloud titans (AWS, MS Azure, Google) do with their data centres to create the cloud. It is really hard and complex to do and keep up all the time, unless you have large dedicated teams and custom software like the cloud titans.
Pivotal doesn’t care where the virtual segments come from - AWS, Azure, VmWare, Nutanix. It just deploys the applications to them if that is what the application architect wants.
Bert had written about Pivotal after its IPO but he was negative because of its slow total revenue growth last year. Here is the post he wrote on Pivotal. Bert is very much a valuation guy:
Pivotal, a venture owned by Dell/EMC, but with a strong commercial relationship with VMWare as well, just IPO’ed. The results of the IPO was quite muted, with the shares advancing less than 5%. The IPO featured a two-tiered share structure with the buyers receiving shares with very degraded voting rights, such that Dell and its partners such as SilverLake have 96% of the voting rights even though it only owns 70% of the equity.
Part of the issue for Pivotal is that even though its solutions are considered quite advanced in terms of functionality, its revenue growth has slowed substantially, and was just 22% last year, down from 48% the prior year. Part of that revenue growth compression is the transformation of revenue away from consulting services and to product subscriptions. It is this transformation that is driving both the opportunities and the pitfalls of Pivotal’s business model.
Should you bite on this offering. Probably not. The valuation is a bit murky because of the transition. Presumably Pivotal will continue its growth, but the trajectory is not readily clear for reasons depicted below. It doesn’t generate cash. In fact its cash burn is quite substantial. It’s a long way from profitability. While 6X EV/S, about the current estimated ratio might seem reasonable, given the growth rate and the recent growth rate compression, valuation isn’t all that attractive.
And there are many companies who offer software tools to aid development. The specific differentiators that Pivotal offers are not readily discernible to me at this point. VMWare itself offers a suite of application development tools, as do Red Hat, Citrix, and Pega, all of which are essentially aimed at customers with the same kinds of problems, i.e. looking to create new applications to reside in the hybrid cloud.
One of the principle applications that are created by Pivotal tools is data management solutions for analytics. In that segment, Oracle, IBM and Teradata are considered to overlap with Pivotal. Pivotal’s most direct competitor is probably Red Hat’s OpenShift. We recently sold our Red Hat position, based on valuation and other portfolio management considerations. It is not immediately apparent to me why Pivotal’s offering is better than that offered by Red Hat.
Last quarter total revenues grew by 19%.
This growth rate was the result of a 60% increase in subscription revenues coupled with an 11% decline in services revenue. On a sequential quarter basis, subscription revenues increased by a bit more than 10% while services revenues declined by more than 7%.
Just why the services revenues are actually in decline, along with services margins is not really known based on the information in the prospectus. While Pivotal has a strategy to emphasize software sales, that doesn’t necessarily have to come at the expense of services revenues, or does it?
Pivotal reported a dollar based net expansion rate of 158% as of the end of the February 2018 fiscal year. That is one of the highest rates I have ever seen; the closest to it, amongst the companies I follow, is Twilio which on an adjusted basis has a 137% rate.
On the other hand, new customer acquisition, at just 44 last fiscal year was not at a level consistent with a growth-oriented long-term strategy. The prior year, the company acquired 95 new name accounts, and that compared to 105 new name accounts acquired in fiscal 2016. Pivotal should be able to both acquire new customers as well as focus on renewals and expansions.
I think both analysts and investors are going to focus on whether the release of the latest version will, in fact, reignite new customer acquisition growth. While perhaps there is some excuse for the decline in services revenue, the downtick in subscription revenue growth on a sequential basis, is not easy to accept and makes it more than a little difficult to recommend these shares.
Not surprisingly, subscription gross margins are far higher than gross margins on services. Gross margins on subscription revenues were 89% last quarter and that is up more than 1% basis points sequentially. Gross margins on services were just 15% this past quarter, down from 24% the prior quarter, and down from 20% in the same quarter in the prior year. The decline in services gross margins is quite concerning as it might mean that the company is having to heavily discount consulting in order to secure software sales, but again, whether that might be the case is not really known at this point.
It is the rapid transformation to software subscriptions that has made forecasting a bit difficult and has certainly caused investor caution about the shares. While overall gross margins are rising substantially because of both improved margins on subscriptions, coupled with a rapidly rising subscription mix, operating margins are not rising, and are not likely to do so in the short term.
This too, is a phenomenon associated with the transition as S&M expenses are much higher for subscription deals than they are for service. Last quarter, the S&M expense line grew by 13% sequentially, somewhat consistent with the sequential percentage growth of subscription revenues. Part of that is likely seasonal; commission accelerators are at their peak in the quarter that ended February 2nd and will most probably decline sharply in this quarter. S&M expense grew by about 25% last quarter on a year over year basis.
The shares are quite expensive, not perhaps in absolute terms, but because the growth of the business is just in the teens as a percentage and because it is compressing with no obvious potential to see a rebound. The EV/S of 6X means that investors have concluded that Pivotal lacks differentiation and sales execution sufficient to drive growth above 20% in the foreseeable future.
I sent Bert Steppenwulfs write-up.
Bert Responded: I wouldn’t quarrel with a thing the man said. The issue for me is the numbers. Yes, I have heard the same things about Pivotal. So, I was surprised with the slow growth. The man, as he says, is not a financial analyst. I wonder why the disconnect at present. Maybe that is the opportunity. And by the way, look at what he says about MongoDB. I have an easier time with that because of the hyper-growth. Could you ask him what he thinks about growth? If Pivotal were showing higher growth, even if the shares were higher, I would be recommending it.
So I asked Steppenwulf:
I know you are a tech guy, and a customer of Pivotal rather than an analyst, but I’m just curious whether you have any thoughts about why their revenue was only up 19%, with such widespread acceptance? Thanks for a great write-up, by the way!
He answered as follows:
Let me start by saying I’m not an expert on Pivotal’s business model.
I know their technology - it has no significant competition in the marketplace. As a serial former-IBMer, I can tell you that IBM which has the only competing product (which is actually a hard fork of the Pivotal product) has no chance. The battle in this area is over, and Pivotal has won. For the developers out there, Pivotal also developed the Spring framework, Cloud Foundry, and Apache Hadoop.
Every enterprise in the world that is moving to the cloud that wants either a hybrid cloud (i.e. some public cloud services, along with some of their own servers acting like a cloud, perhaps with Nutanix software) or wants to avoid vendor lock-in, is now using or will be using Pivotal. The only other real choice for enterprises is to lock-in with a cloud vendor, or be a pure container based development shop (which is still supported by Pivotal).
For revenue growth, I think the numbers are misleading. Pivotal is in a multi-year transition away from a services model to a subscription model.
Pivotal’s original business model was as a private consulting group, using the open source software they had developed as the base for a services business, helping enterprises transition to the cloud.
Back in 2012 they were bought by EMC. They have been switching, since 2015, to a subscription model, with services only as needed to support their sales. Thus their annually recurring revenue has been increasing, currently in the 50%+ range, while their services revenue has been decreasing.
Given Pivotal is rapidly moving towards subscription revenue, it’s helpful to look at the business on a quarterly-basis. They ended FY’18 at $300 million of ARR (Annual Recurring Revenue), which was up 58%, while total revenue was up only 18%.
The mix has rapidly shifted too, with subscription revenue representing 56% of total revenue last quarter, up from 33% in the quarter ended April 2016.
The gross margin on subscription has also reached 90%, while services gross margin is at 15%, both as of last quarter.
Pivotal’s dominant position in enabling enterprises to get on the cloud without vendor lock-in gives them enormous opportunities for growth and additional revenue. They have already got a large ecosystem of other cloud companies that are on their marketplace for their clients. They can go all the way up and down the stack providing tools for the cloud. For instance, it would be trivial for them to provide competition to the Xi product of Nutanix (but not Nutanix’s primary product of making data centres look like a cloud). We have to see if the management teams takes advantage of these opportunities.
For the business model, I’m hoping that others on this board can help me know when I should be adding to my position at PVTL - or stepping away if the business wastes the opportunity that this dominant technology provides.
(Saul here) Okay, I decided to do some digging for myself. In the IPO documents I found this:
Consolidated Statement (pre IPO) http://d18rn0p25nwr6d.cloudfront.net/CIK-0001574135/9c06e5fc…
**Fiscal year ended Jan 16 Jan 17 Jan 18**
**Revenue**
Subscription Revenue **$ 95 mil $150 mil $260 mil**
Services Revenue $186 mil $286 mil $250 mil
Total Revenue $281 mil $416 mil $509 mil
**Gross Cost of Revenue**
Cost of Subscription Rev $ 34 mil $ 31 mil $ 30 mil
Cost of Services Rev $ 154 mil $ 203 mil $ 198 mil
Total Cost of Revenue $ 187 mil $ 234 mil $ 228 mil
**Gross Margin Profit**
Gross Margin dollars $ 94 mil $182 mil $281 mil
Gross Margin percent 33% 44% 55%
**Operating Expenses**
S&M $187 mil $194 mil $221 mil
R&D $120 mil $152 mil $161 mil
G&A $ 58 mil $ 62 mil $ 67 mil
Total Operating Expense $366 mil $408 mil $449 mil
**Operating Loss**
Operating Loss dollars $273 mil $227 mil $168 mil
Operating Loss percent -97% -55% -33%
**Net Loss**
Net Loss dollars $283 mil $233 mil $164 mil
Net Loss percent -101% -56% -32%
I felt: Wow, that is really reassuring!
Subscription revenue up 174% in two years. The gross cost of that revenue is actually DOWN 12% in that two years!!! Down in TOTAL dollars from $34 million to $30 million! With almost tripling revenue! And that’s where the business is going: to Subscription Revenue.
Total revenue up 81% in two years. Gross cost of revenue is up only 22% in those two years.
Total revenue up 81% in two years. Gross margin dollars are up 199% in those two years.
Gross margin has gone from 33% of revenue to 55% in those two years.
Adj gross margin has gone from 41% of revenue to 58% in that two years.
Sales and Marketing expense is only up 18% in those two years. Just 18% !!! With subscription revenue up 174%, and total revenue up 81%.
R&D expense is only up 34% in those two years. With sub revenue up 174%, and total revenue up 81%.
G&A expense is only up 16% in those two years. Just 16% !!! With sub revenue up 174% and total revenue up 81%.
Subscription revenue growth was 68% in 2016, and 73% in 2017.
Assuming Subscription revenue grew just 60% in 2018 it would grow to $416 mil and dwarf Service revenue which would become almost irrelevant. At it’s 88% gross margin, they would probably be profitable this year!
For a more optimistic (and maybe more realistic) estimate, if the rate of growth of Subscription Revenue only dropped 8 points, from 73% to 65%, Subscription Revenue would be $429 million. At 91% gross margin, Sub Rev alone would produce $390 million of GAAP gross profit.
However given that the total gross cost of subscription revenue has been falling from $34 million to $30 million over the past two years, a stable $30 million cost would be just 7% of subscription revenue, giving them a 93% gross margin. Even a rise to $35 million would give them just a cost of 7.5% of subscription revenue, or a 91.5% gross margin.
GAAP Operating loss has fallen from 97% of revenue to 33% of revenue in two years !
Actual cash used in operations was just 23% of revenue.
Adj operating loss has fallen from 79% of revenue to 25% of revenue in two years !
Other Key Metrics:
319 Subscription Customers in 4 years
2014: 0
2015: 75
2016: 180
2017: 275
2018: 319
In fiscal 2018, we focused primarily on renewals and expansion of existing customer subscriptions, which resulted in fewer net additions relative to prior periods. However, with the recent launch of PCF v2.0, including the release of PKS, we intend to increase our focus on adding new customers.
Dollar-based expansion rate was 163% a year ago, and 158% now, which is enormous!
TAM estimated at $50 billion plus. Subscription revenue only $259 million. Long way to grow.
In its IPO Pivotal sold 38.9 million shares at $15 and General Electric sold 3.9 million, which is about 20% of their position. There were about 216 million shares outstanding, so there should now be about 255 million shares outstanding.
That gives a Market Cap of roughly $5 billion
The Fiscal Year runs to the end of January.
Deferred Revenue is $317.5 million, which is:
62% of total revenue
Up $75 million from $242.6 million a year ago
Up 31% from a year ago.
Cash after the IPO should be about $656 million.
Debt is zero
Subscriptions vs. Services: Customers purchase subscriptions of our software platform and choose where to deploy it. Options include a customer’s private cloud, a public cloud of its choice, or multiple private and public clouds. Our customers subscribe to use our software platform with pricing based on the number of workloads, such as applications, containers or other microservices. Subscriptions are offered typically for one- to three-year terms, and we recognize revenue from our subscriptions ratably (monthly) over the subscriptions’ term. We generally bill our customers annually in advance, although some customers even pay multi-year contracts in advance.
We expect that over time subscription revenue will become a larger percentage of our total revenue as customers continue to adopt and expand their PCF subscriptions, and as our systems integrator (SI) partner relationships ramp to directly deliver Labs-like services to our customers.
As a result, our Services revenue may continue to fluctuate; any services revenue growth is expected to be modest both in absolute dollars and relative to our subscription revenue growth… We expect to grow our services revenue at a slower rate than our subscription revenue as customers are enabled on our platform and increasingly use our partner ecosystem for their services needs. Our strategic services are typically priced on a time and materials basis with revenue recognized upon the delivery of the services. Services revenue decreased by $16 million, or 6%, from $266 million in fiscal 2017 to $250 million in fiscal 2018. The decrease primarily reflects the decline of maintenance and support contracts associated with certain historical software products sold on a perpetual license basis.
Revenue from maintenance and support contracts associated with historical software products sold on a perpetual license basis represented less than 10% and less than 5% of total revenue in fiscal 2017 and fiscal 2018, respectively, and is expected to represent a decreasing amount of revenue in future years.
• Public Cloud: We work with all three of the major public cloud vendors, Amazon, Google and Microsoft and drive large numbers of workloads to their public cloud platforms. We received in 2017 the Google Cloud Technology Partner of the Year for 2016 and an Azure Consumption Partner of the Year award from Microsoft for 2016.
• Systems Integrators: Leading enterprise technology providers have launched dedicated practices focused on implementing PCF and providing Labs-like services. These enterprise technology providers include Accenture (which recently announced the Accenture Pivotal Business Group), Capgemini, CGI and Cognizant. These SIs create leverage for us by applying our cloud-native platform agile techniques to help customers transform. They also have begun to deliver co-development, application transformation and PCF implementation services.
• Independent Software Vendors: Pivotal Services Marketplace (the Marketplace) has over 75 independent software vendors (ISVs) offering services integrated with our platform. These ISVs include Apigee, AppDynamics, Black Duck, Dynatrace, MongoDB, MuleSoft, New Relic, Redis Labs, Solace and Splunk, enabling enterprises to quickly realize additional benefits of our platform.
• Strategic Partners: We jointly market and sell our products and services with DellEMC and VMware and enjoy significant and mutually beneficial commercial and go-to-market relationships.
From Website:
Our cloud-native platform, Pivotal Cloud Foundry (“PCF”), accelerates and streamlines software development by reducing the complexity of building, deploying and operating new cloud-native applications and modernizing legacy applications.
• PCF customers can accelerate their adoption of a modern software development process and their business success using our platform through our complementary strategic services, Pivotal Labs (“Labs”). (This is their services unit. ) Labs software development experts deliver strategic services so that enterprises can accelerate their cloud-native transformation by implementing modern agile development practices. We help customers co-develop new applications and transform existing ones while accelerating software development and streamlining IT operations.
What is Cloud Foundry
(From a blog on AWS. This is 2½ years old, but it gives an idea what Cloud Foundry does).Cloud Foundry is an open source cloud computing platform originally developed in-house at VMware. It is now owned by Pivotal Software, which is a joint venture made up of VMWare, EMC, and General Electric.
And I went ahead and bought it. I hope this was interesting and a lot of help,
Best,
Saul
For Knowledgebase for this board,
please go to Post #17774, 17775 and 17776.
We had to post it in three parts this time.
A link to the Knowledgebase is also at the top of the Announcements column
that is on the right side of every page on this board
