There has been a lot of discussion on NTNX on this board, over last few quarters and its increased with latest earnings report.
While I have been somewhat confused on NTNX, on what it does to how it reports to how its perceived by this board over last few months, my working conclusion was that transition out of the hardware is diluting their results and in a couple of quarters they will start accelerating revenue. However, dialogue on this board with last conf call and subsequent exits by Bear and Saul made me stop and pay more attention. I couldn’t get enough time during the week and finally I read through conf call transcript and slide deck today.
I wanted to answer few questions as part of this study. Here they are with my thoughts.
Question 1: Whats going on with Nutanix - is my working conclusion above still holds or something has changed?
In short - as they complete transition away from being HW+ SW to pure SW company, they are starting transition from fixed license (they say non-portable) SW to subscription SW.
Both of these transitions are such that they dampen revenue in short term but pay off much better in long term.
And NTNX is achieving this (so far) while continuing to grow reported revenue and even growing cash flow. As an investor, I absolutely love this - you want management to be proactive on business transition while balancing reality of the day. And these guys are achieving it with amazing execution.
With some more background:
Dheeraj (CEO) explained that NTNX has grown to $1B+ revenue in less than 10 years of existence. He claims this has been faster than any other company, including SalesForce and WorkDay - two of the exemplary success of SW business in recent times. I haven’t gone and checked this - to me just the fact that they achieved $1B revenue in less than a decade is a huge accomplishment.
We have known the transition out of HW for a while, so no surprise there. For whatever reason, we on this board were surprised with the new transition to subscription SW, but the company seems to have been working on it for a while.
I have not gone back and checked if they did communicate this in the past but I do see it as “right thing to do” in the interest of the business and so I am not too worried about it in long term.
In the short term, I did worry that this transition may dampen reported revenue growth (I have experienced this before with SPLK and others and seen short term impact on stock price), and to my surprise I find that NTNX is actually executing this very well… My measure here is the fact that their software revenue overall grew this quarter and non-subscription revenue remained flat (vs dramatic drops I have seen in the case of the companies when management tries to abruptly change the model). I do not know how this will pan out - I am only saying so far its been well executed and their guidance seems to be continuing on the same path.
Question 2: Is Nutanix growing its business - revenue or billing or deferred revenue, whatever the right metric is, is the underlying business growing at a pace that is interesting in light of investment opportunities like TWLO, AYX, SQ and so on?
My answer to this is resounding yes. Nutanix has become software company and therefore, its total software revenue is what counts and its growing rapidly. SW and support revenue grew 44% Y/Y. And it is not a one-off, its growing for may quarters and years.
Question 3: What is the right metric to measure successful execution?
I believe two measures going forward will help
- What counts today: Total software and support revenue growth: this is important because that it allows to compare the past performance. This quarter, they grew this by 44% y/y. This is not a slow growth or mature company… There is nothing average about this.
There is a challenge with this measure due to transition to subscription model. However, we need to see continuous progress with reported revenue. - What counts in future: Total deferred revenue growth: This is the slide 15 on the deck - this becomes lot more important with subscription business and they are growing this at astonishing rate of 71% in latest quarter.
I would watch subscription revenue growth, billings growth, cash flow etc. but these 2 are more important for me - specially deferred revenue growth.
Question 4: Why Nutanix calls and investor discussions come up as confusing?
I read through the transcript and also listened to the interview with Cramer. And I found that I could understand and relate to most, if not all, of points Dheeraj was making; and I am not a SW engineer or IT person. Rather I have HW background and basic idea of cloud and such.
However, I did find that Dheeraj treats his audience as knowledgeable in his space - I guess dealing with a lot analysts who are watching this space closely, he takes every question and explains as if the other guy understands the space well and will not like a high level response without convincing detail behind it.
In fact, viewing his interview with Cramer, Dheeraj went out of the way to avoid capitalizing on softball question and went into describe in detail why he is enthusiastic about Nutanix.
I agree that this comes across as long winded or difficult to follow for those with no tech background, and thats ok. My point is - based on these two reads, I dont believe, Dheeraj is trying to hide or divert questions or pepper with his favorite statistics.
In fact I really like his style of providing the context and reasoning behind the answer and then giving the answer.
Can he do better (i.e. be crisp or more effective)? Yes, but I do not mind his candor and detail.
Question 5: Is Nutanix management sharing right information with share holders or cherry picking favorite statistics… and we all have this high up on our mind due to recent experiences with TLND, NVDA and such…
So biggest surprise was the subscription metric… After reading the transcript, it seems to me a legitimate transition they are making and they are being open and sharing more since the transition has started to become meaningful. This is not about showing large % of small base just to impress. This is what they will report for every quarter until they change (i guess in a couple of years or more depending on how business evolves.)
All in all, I thought NTNX shares a bit too much financial information that partly confuses people. However, it doesn’t look like a concerted effort to drive attention to something in order to hide something else. Its just that they like to share more because there is a lot of good info to share.
Question 6: Should I keep my mid size position or increase or decrease?
What I learnt in the process is that CEO also is responding to a lot of concerns expressed here - hard to understand the business, multiple / continuous transitions etc.
So, they created this tiered product structure - Core, Essential and Enterprise. Each tier with multiple products.
And he explains it well that he focuses on customer journey - Core being where a customer would start and add more depending on what customer needs.
As I grasp this, I am impressed with their focus on customer, ability to build and deliver new products, go through business transitions and continue to grow revenue and start to grow cash flow.
So to me, Nutanix looks like one of the best business one can buy today, specially with attractive valuation for long term.
I do believe that in near term - for next two quarters for sure, street response may be muted because HW transition numbers still play in the comp; but by mid to late ‘19 this can become a monster ramp similar to TWLO we have seen recently.
I am holding my mid size position and will take advantage of the time available to keep adding more in next two quarters in small steps.
Nilvest