Learnings from Nutanix [NTNX]

Friday 31 May. A 17% AH drop after their Q3 earnings report.

Nutanix is a perfect failure on my part. Here, I look back on my process failings, and try and analyse them so I can improve.

Saul (and many, many others) called Nutanix previously, and I ‘disagreed’. For example, Bears “things you need to believe” looked like:

  1. They will be able to find new customers that spend as much as current customers
  2. Subscription growth will continue (once all the non-sub revenue is robbed) for years at 30%+
  3. They won’t have to spend so much more on sales and expenses that they fail to profit
  4. HCI won’t be displaced by another technology for years
  5. The market will at some point also believe all this and value Nutanix more highly
  6. There’s a greater likelihood that all this is true than that your money would do better elsewhere

Tinker said: “However, it is clear the business model is broken. I won’t go into detail here as it is in the above link, but also another concern, and that is growth rate.”

It might be the American accents, but I didn’t get it. It wasn’t that they were pointing out that Nutanix did badly, that was obvious. What they were pointing out was that They didn’t believe management.

I ignored all of that. Even worse, as a tech person, I ignored some of my own thinking with respect to Nutanix, including being unsure of Dheeraj’s technical explanations for Xi delays, concern (posted on the board!) that they were trying to reinvent AWS, and disappointment in the “word storms” that the Nutanix conference calls involve.

My process gets worse. They had a bad quarter last quarter, which was the subject of numerous comments. Despite all the comments, I gave them the benefit of the doubt - sure, you can make a mistake, live-and-learn, hire some sales people, fire some peeps, move on and ride the HCI wave!

That’s fair enough, it’s a kind of reasonable explanation. The (massive/costly) mistake I made was not adjusting my probabilities based on the new information.

But it’s a more systemic failure than that, because I was stuck in “portfolio thinking” (these are my terms, YMMV)
Portfolio thinking: Risk and allocation are calculated as a percentage of the portfolio - Nutanix is 5% so small risk, no readjustment required.

Company thinking: The amount allocated to that company is all that’s important, not its relative size in the portfolio. Risk is dealt with by changing the allocation in that company. New information about that company should cause a readjustment of whatever capital is in that company.

When I look at Saul (in particular), my belief is his focus is almost 100% on ‘company thinking’. There’s a bit of ‘portfolio thinking’ (limiting stocks from getting too large), but he allocates on company news, and doesn’t let the relative size of the position in his portfolio impact his allocation decision. That’s why (I believe) he’s in so few stocks, because doing that for many would take up more hours than exist.

In hindsight, the process is simple:

  1. Do I have new information on the company?
    a. N: Do nothing
    b. Y: Is it positive or negative?
    i. Positive: Risk down. Look to allocate more capital (other valuation metrics might be valuable)
    ii. Negative: Risk up. Deallocate capital. Not negotiable.

The ‘negative’ deallocation is not negotiable. To not do that is to say “I have new negative information that I wasn’t expecting, but my belief in the company has not changed”. Huh?

Fear of missing out

My cost base for Nutanix is $42. I originally bought around $27, so was up substantially at points-in-time. Looking back, most of the rationale in higher value purchases was the fear-of-missing-out (FOMO). Everyone else was making big gains, I wanted in!

So Nutanix = Portfolio thinking + fear of missing out + a bit of anchoring.

Nutanix is now a 35% loss as at after-hours prices, which is not normal on Saul’s board. Fortunately, I’m not confident enough in my thinking to allocate large percentages to a single stock, so my Nutanix loss won’t kill me (portfolio thinking), but it hurts, mainly because I should have acted (because I had new information - company thinking) and didn’t.

I’m aware this is a report based in hindsight, and the emotion of a 20% drop in a stock. Tomorrow, I will sell a to-be-determined percent of Nutanix, possibly all of it. My underlying concerns (they’re trying to build AWS, and people aren’t buying) exist. There is still a possibility that the “we didn’t hire the salespeople” explanation will work out, but with 2 disastrous data-points, I have to readjust the company significantly.

Better late than never I guess. Hope this is helpful to others.

Cheers
Greg

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In hindsight, the process is simple:
1. Do I have new information on the company?
a. N: Do nothing
b. Y: Is it positive or negative?
i. Positive: Risk down. Look to allocate more capital (other valuation metrics might be valuable)
ii. Negative: Risk up. Deallocate capital. Not negotiable.

The ‘negative’ deallocation is not negotiable. To not do that is to say “I have new negative information that I wasn’t expecting, but my belief in the company has not changed”. Huh?

Greg, that is solid gold. I hope everyone reads it and adopts it. I agree completely. When we get new information, we have to update our beliefs. There was definitely enough new information in past CCs to at least lessen any belief that NTNX management could be trusted, and now it appears they’ve removed all doubt.

Sorry it didn’t work out, but this is a great lesson you’ve taken from it and shared with us.

Bear

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Just a great write-up Greg, and worthwhile courageous personal analysis. Two points that you might have underestimated is not wanting to sell a stock when it is down, and not wanting to admit (to yourself) that you had made a mistake. And a third is “hoping it will turn around”.

As Tinker said once: the turn arounds almost never do turn around. You remember the one (Netflix) that does, but forget the hundreds that don’t.

Best,

Saul

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Here’s the way I think about those decisions:

I don’t think “Nutanix is down $8 from when I bought it so maybe I should stay in and see if it gets back to breakeven”, or anything like that.

I think my portfolio is up 41% at present. My Nutanix position is a piece of my portfolio. In light of the new information, are there better places to put the money that I have in Nutanix?

Please note that that way there is no thought of what price I bought it at. I don’t care. It’s my entire portfolio that I care about, not whether a particular stock is up or down. It’s price is what it is. I can’t go back and sell it before the bad news came out (my time machine is in the repair shop). It seemed evident that with a bunch of great companies in my portfolio and being discussed on the board, that I could find a better place for the money than have it sitting around hoping.

Saul

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Yeah, I agree that is solid gold. I am fortunate that I unloaded NTNX after the first hit to management credibility. But I’m still holding others that could fall into similar categories, such as NVDA (to be fair, my cost basis is so low it doesn’t hurt THAT much).

But for every one of those, there is also one that I bailed too early on and maybe didn’t get the gains (ANET, for example – although their recent earnings didn’t do that gain any favors). It’s hard to KNOW, but I am learning, as you, that it’s better to be a little more cautious than to try to hope for that next 1% gain, or for it to “come back.” There are many investment fish out there, so when one starts to smell like fish, find a fresher one.

I should also mention that this kind of disaster makes other “less sexy” investments a little more interesting to the broader investment community, especially when competitors such as Pure Storage and Nutanix are faring far worse. NetApp, for example, is paying a 3%+ dividend at current share price, and that makes it compelling to income investors (plus, it still has a decent growth story). Not suitable for further discussion here, but because they’re in the same realm as PSTG and NTNX I thought I’d mention the associated impact.

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I think my portfolio is up 41% at present. My Nutanix position is a piece of my portfolio. In light of the new information, are there better places to put the money that I have in Nutanix?

yes, well said Saul!

Every portfolio can handle a hit from 1 or 2 stocks if properly allocated. Many of these stocks are now 4-7 multiples so if you hit a dud on occasion, it is minimally significant to your total portfolio returns. You can run a model portfolio and see the math for yourself.

I would also offer over a guideline I have espoused for many years which I think is near always true:

If a company disappoints even once, that is rarely the last.

More often, there will 2 or 3 more until issues stabilize…if ever.

Therefore, IMO, it is best to exit quickly and reallocate elsewhere until the dust settles. There are countless examples of this if you go back and consider.

Saul has mastered the exit quickly better than most…unemotional, no love affair with any stock.

Anyway, no worries, you will be fine and continue to seek opportunities and not dwell on costs!

Best:
Duma

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“But for every one of those, there is also one that I bailed too early on”

It’s nice to reflect upon all your trades and see what you are up to, but consider the opportunity cost: you probably did better with whatever you did with the ANET proceeds than had you just held ANET.

The way I look at it is like playing black jack (21) with a betting strategy that puts odds in your favor. You may not win every hand, but if you just stick with your discipline you come out ahead than doing random or emotional stuff. So you can’t look at any individual outcome and say you made a mistake. I sold NTNX within minutes of seeing the earnings report last quarter after hours. Based on the cockroach theory. If Nutanix put out a stellar report today and the stock shot up? I still did the right thing by selling last quarter. Just like right now the right thing to do is to sell. Cockroach theory says when there is one piece of bad news there is more hidden bad news you don’t see yet. So wait for good news before buying.

Of course there’s only one cockroach sometimes and Nutanix could have shot higher today because last quarter was a fluke, but ODDS are not in your favor, especially when last quarter management said this would be a multi quarter issue to get back on track to hit their rule of 40 target. That’s all I needed to hear. Several quarters (at least) of bad reports were likely in store. Nutanix could have shot up today and the house could have won, but I know the odds are in my favor if I keep playing my hand to the strategy that gives me an edge in this blackjack analogy.

Otherwise I know the alternative would have likely been to have a bunch of broken thesis stocks in my portfolio with a few new positions on the right track, and likely trailing the indexes.

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Hind site is 2020 and all that… i recall seeing some statistics from maybe 12 or 18 months ago that the vast majority of Nutanix sales were with VMware (on Dell hardware) rather than the Nutanix AHV hypervisor. I believe there are two things going on for which management has not been forthcoming. First is the long feared datacenter capex slowdown. It’s happening and I suspect it was clear to Nutanix management in 1Q. The other, I believe, is deteriorating business relationship between VMware and Nutanix. See this from January…

https://www.theregister.co.uk/2019/01/24/nutanix_and_vmware_…

There are all kinds of ways that Dell/VMware can stick it to Nutanix… and apparently that’s just what happened. I’ll continue to watch Nutanix but will not be buying until results improve and management is a bit more open with what is happening.

I should also like to point out that a company should not have several bad quarters because they did not calebrate their “lead generation” expense just right that it costs them SEVERAL quarters of growth! Especially when they did not cut S&M expense but actually increased it! How precise do they need to be on lead generation spend? And the way Panjay said it, the way he smacked his lips afterward, and the CFO did the same when it was his turn to speak, just gave me this body language impression they are pulling wool over our eyes and we are none the wiser. That was just my impression of the whole thing.

Maybe check in next quarter when their “lead generation” spend is back in sync to strong revenues again, but it doesn’t sound right to me. That’s why I stayed out after I sold.

In hindsight, the process is simple:
1. Do I have new information on the company?
a. N: Do nothing
b. Y: Is it positive or negative?
i. Positive: Risk down. Look to allocate more capital (other valuation metrics might be valuable)
ii. Negative: Risk up. Deallocate capital. Not negotiable.

Yep. But always compare A versus B. If B is better than your current position A then switch to B. Which one will do better from now on. Ignore your cost basis (of A)and ignore how much B has gone up already.

Chris

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Thanks all for your replies and words of wisdom. Saul is right with the “admitting I’d made a mistake” although it seems very easy to rationalise that away with the “I’m giving them a chance” rationale, which in my case seems to be a proxy for “turn off your brain”.

“If a company disappoints even once, that is rarely the last.”

This is great Duma, thanks for that.

With Nutanix, the thesis (in a nutshell) is: HCI market is a growing market + Nutanix has great software. If you can’t increase revenue in that environment, then that thesis is broken.

12x - I too like the blackjack analogy and the cockroach theory. “You may not win every hand, but if you just stick with your discipline you come out ahead than doing random or emotional stuff”. Exactly right.

Going forward, Nutanix may be a good investment, but it’s a complicated one with (as everyone else already knows) added cockroaches. I’ll go through the conference call and see if there are any insights I can glean, but will sell the position tomorrow.

Live and learn (hopefully!). Thank you all for the feedback.

Greg

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I love these insights you share Saul. Thinking of the overall portfolio performance versus individual stock performance seems so obvious but I think many, many people get hung up on this. I know I have in the past but I have seen a change in my investment style since following your board for years.

I did not post after your excellent post on growth rates and margin and how you explained that is a complete game changer. Your thought processes are excellent and your communication skills are even better. You really help me and many others in growing as investors. Thank you for all you do.

After Sauls post on why these companies are so different, I decided to sell NTNX out of my portfolio and bought some more ZS, based on growth rates and what I thought would be reported on recent earnings announcements. Turned out to be a good move (although buying more TWLO would have been better).

The one thing that I differ with you on is the use of cash for safety. I lean more towards how Bear thinks on this and manages his portfolio. I am not saying I am correct in my view point. However I bring this up because of your example of looking at overall portfolio performance and not individual stocks. I look at my cash and stock holdings as overall portfolio performance just as you mentioned in your post.

I can keep large cash positions and still get better than index gains. My gains are not as good as yours or others on this board, but they are still good (beating the indexes) and they are with a large safety net of cash. If a down turn were to happen today, I would cheer as it would be a buying opportunity. If the market gets hotter, I will continue to outperform the indexes(or I believe I would).

As a side note. I wish more posters would post monthly portfolio performance updates. Not to hold the posters feet to the fire. I learn SO MUCH when others share what they are doing and why they are doing it. It help clarify my thoughts on companies and what I may be thinking about opportunities to buy or sell. Additionally those that take the time to post their portfolio will find it is helpful to them to clarify thinking and to look back in future to understand and evaluate thought processes.

Thanks to all that share in the journey of investing. May we all continue to learn and prosper!

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I love these insights you share Saul. Thinking of the overall portfolio performance versus individual stock performance seems so obvious but I think many, many people get hung up on this. I know I have in the past but I have seen a change in my investment style since following your board for years.

I did not post after your excellent post on growth rates and margin and how you explained that is a complete game changer. Your thought processes are excellent and your communication skills are even better. You really help me and many others in growing as investors. Thank you for all you do.

The one thing that I differ with you on is the use of cash for safety. I lean more towards how Bear thinks on this and manages his portfolio. I am not saying I am correct in my view point. However I bring this up because of your example of looking at overall portfolio performance and not individual stocks. I look at my cash and stock holdings as overall portfolio performance just as you mentioned in your post. I can keep large cash positions and still get better than index gains. My gains are not as good as yours or others on this board, but they are still good (beating the indexes) and they are with a large safety net of cash. If a down turn were to happen today, I would cheer as it would be a buying opportunity. If the market gets hotter, I will continue to outperform the indexes (or I believe I would).

Thanks Retirementdough for your kind words. As I have mentioned a few times, I also have taken out cash for spending money and emergencies, but I consider this as permanently removed from my portfolio and not sitting on the sidelines, waiting for a better price. It is money I won’t redeploy. At most I normally have 1% of money in cash on the sidelines waiting to redeploy, if I sold something and haven’t fully used the cash yet. I feel I have no facility in guessing and timing the market.

Best,

Saul

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As Tinker said once: the turn arounds almost never do turn around. You remember the one (Netflix) that does, but forget the hundreds that don’t.

Best,

Saul

The best advice maybe I ever got on Wall St was:

‘Don’t buy turnarounds until AFTER they’ve turned around!’

cf. Netflix.

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