NTNX: Fast grower at a low valuation
This post is a write up about NTNX. I first learned about NTNX from Saul on Sunday morning. Saul said he learn about it from Bert Hochfeld. I started researching it that same morning. Here are some articles written by Bert:
Sept 5, 2017: https://seekingalpha.com/article/4104089-nutanix-puzzling-pr…
June 5, 2017: https://seekingalpha.com/article/4078766-nutanix-lots-contro…
Mar 20, 2017: https://seekingalpha.com/article/4056551-king-hyper-converge…
Oct 5, 2016: https://seekingalpha.com/article/4010460-nutanix-rockin-boat…
These articles from Bert are definitely worth a read if you are considering investing in NTNX. They will give you a very good overview of the company as well as some of the issues that the company has faced and is facing.
What does NTNX do?
Here’s an overview of their business from their Q3 FY2017 report (note: NTNX just reported Q4 FY2017 results on August 31st but the 10-K is not yet available):
We provide a leading next-generation enterprise cloud platform that converges traditional silos of server, virtualization and storage into one integrated solution that can also connect to public cloud services. Our software delivers the agility, scalability and pay-as-you-grow economics of the public cloud, while addressing enterprise requirements of application mobility, security, data integrity and control. We provide our customers with the flexibility to selectively utilize the public cloud for suitable workloads and specific use cases by enabling increasing levels of application mobility across private and public clouds. We have combined advanced web-scale technologies with elegant consumer-grade design to deliver a powerful enterprise cloud platform that elevates IT organizations by enabling them to focus on the applications and services that power their businesses. Our invisible infrastructure provides constant availability and low-touch management, enables application mobility across computing environments and reduces inefficiencies in IT planning.
We were founded in September 2009 and in October 2011 began selling the initial version of the Nutanix Operating System, which pioneered hyperconverged infrastructure by providing block storage for virtualized environments on VMware. In 2012, we released a new version of our software which included support for file storage, high availability and enhanced security. In 2013, we released several versions of our software, which added our intuitive Prism interface, built-in disaster recovery, deduplication, compression, and additional hypervisor support for Hyper-V and KVM. In 2014, we added enhanced resiliency, One-click Upgrade, Cloud Connect backup to Amazon Web Services, or AWS, and Cluster Health Analytics. In 2015, we rebranded the Nutanix Operating System as Acropolis and introduced the Acropolis Distributed Storage Fabric, Acropolis Mobility Fabric and Acropolis Hypervisor.
Our solution can be delivered either as an appliance that is configured to order or as software only. When end-customers purchase our platform, they typically also purchase one or more years of support and maintenance in order to receive software upgrades, bug fixes and parts replacement. Product revenue is generated primarily from the sales of our solution, and is generally recognized upon shipment. Support and other services revenue is derived from the related support and maintenance contracts, and is recognized ratably over the term of the support contracts.
To put what they do in a nutshell: NTNX provides “invisible infrastructure” to firms enabling them to easily use applications across diverse computing environments such as internal networks as well as public cloud environments.
NTNX has been in business for about 8 years and they went public last Fall at $16 per share. The shares rose as high as $46.78 a few days after the IPO and then quickly settle back down to the mid $30s. The shares stayed in a trading range (mid $20s to mid $30s) until February when they began selling off, after a disappointing quarter, reaching a low of $14.38 on May 1st. The shares are currently in the $21-22 range.
Where does NTNX get it’s revenue?
NTNX sells hardware appliances with software or just software. They also sell service and support and to a lesser degree they sell professional services. Here’s a description of their products and service (taken from the Q3 FY2017 10-Q):
Product revenue. We generate our product revenue from the sales of our solution, both delivered on a hardware appliance as well as software-only. Our revenue from software-only sales, which currently constitute a small portion of our product revenue, is subject to industry-specific software revenue recognition guidance and has typically been deferred and recognized over the contractual support period associated with the delivered software licenses. However, revenue associated with certain software licenses can be recognized upon delivery to our end-customers to the extent we have established VSOE for related support and other services.
Support and other services revenue. We generate our support and other services revenue primarily from support and maintenance contracts, and, to a lesser extent, from professional services. The majority of our product sales are sold in conjunction with support and maintenance contracts with terms ranging from one to five years. We recognize revenue from support and maintenance contracts over the contractual service period. We recognize revenue related to professional services as they are performed.
Revenue recognition
NTNX has been public only a short time They have been reporting results only for 4 quarters. A large portion of their billings have been deferred which has lead to a growing balance of deferred revenue. Referred revenue, as I understand it, has come from 2 main sources: software sales and service/support contracts. Support and maintenance contracts are from 1-5 years and the company must recognize this revenue over the period of the contracts.
On August 1, 2017 (start of the 2018 fiscal year) NTNX will change it’s accounting for deferred revenue. Basically, NTNX will be recognizing all/most of its sofrware revenue upfront. With the change the company has recalculated its financials for the past 8 quarters. I was able to get FY2015 financial results because they are available in the S-1 which was filed prior to the IPO. I asked investor relations if they could provide the restated numbers for FY2015 but they would not provide that. With the changes, the billings will be unchanged but the reported revenue will be higher primarily due to reduced deferred revenue.
Since Bert’s articles provide much of the useful information, I will not repeat any of that in this post. Instead, I will focus on providing and analyzing some of the financial metrics. I will also point out some of the things that I like about NTNX.
Revenue and revenue growth
Here is the revenue for the past 3 years (old accounting method):
FY Q1 Q2 Q3 Q4 Total Growth
2015 46.1 56.8 64.5 74.1 241.5
2016 87.8 102.7 114.7 139.8 445 84%
2017 166.8 182.2 191.8 226.1 766.9 72%
2018 245(E)
I used the old accounting numbers so that we can look at growth for an extra year. As you can see, the growth over the past years has been very impressive. Later, I will also show the numbers under the new accounting method.
Now let’s look at the growth on a yoy basis rather than a full year over full year basis:
Q116 90%
Q216 81%
Q316 78%
Q416 89%
Q117 90%
Q217 77%
Q317 67%
Q417 62%
Q118 47%(E)
The growth has decelerated a slightly but it is still very positive. The Q1 2018 growth of 47% is based on the midpoint of guidance. However, the guidance factored in a government shutdown in Sept 2017 so I think it will be easily beaten.
Now we must also remember that revenue is comprised of commodity hardware (low margin), high margin software sales, and support and maintenance. The blended gross margins have been in the high 50s. Now we must remember that high memory prices have increased COGS and led to margin compression. Bert thinks that the doubling of DRAM prices will reverse. Here’s what I think is even more relevant: high margin software revenue has been steadily increasing as a percentage of total revenue. Here are those figures:
Q114 2%
Q214 2%
Q314 1%
Q414 2%
Q115 3%
Q215 4%
Q315 5%
Q415 8%
Q116 9%
Q216 11%
Q316 12%
Q416 14%
Q117 15%
Q217 15%
Q317 16%
Q417 17%
Management’s goal is for software-only revenue (probably has 90% or higher gross margin) to reach 33% of sales. So the company is halfway there, and, as the company moves the mix more and more toward software-only sales, there will be pressure for margins to go higher.
Before I move on, I want to show the revenue under the new accounting.
FY Q1 Q2 Q3 Q4 Total Growth
2016 100.5 116.4 126 160.5 503.4
2017 188.6 199.2 205.7 252.5 846 68%
2018 265(E)
And the yoy growth:
Q117 87.7%
Q217 71.1%
Q317 63.3%
Q417 57.3%
Q118 40.5%
Growth numbers are about 5-7% lower than under the old accounting method but not so different that it affects my investment decision.
Customer growth
Here are the numbers for customer count growth:
Cust Net New Seq 1YR
10/13 287
1/14 426 139 48.4%
4/14 583 157 36.9%
7/14 782 199 34.1%
10/14 923 141 18.0% 221.6%
1/15 1168 245 26.5% 174.2%
4/15 1412 244 20.9% 142.2%
7/15 1799 387 27.4% 130.1%
10/15 2144 345 19.2% 132.3%
1/16 2638 494 23.0% 125.9%
4/16 3111 473 17.9% 120.3%
7/16 3768 657 21.1% 109.4%
10/16 4473 705 18.7% 108.6%
1/17 5382 909 20.3% 104.0%
4/17 6172 790 14.7% 98.4%
7/17 7051 879 14.2% 87.1%
NTNX is adding customers at a rapid clip. Much higher than any of the other companies that I am invested in. How are they doing this? I think there are a couple of reasons that stand out.
First, NTNX is investing heavily into expanding its sales and marketing headcount. Here are those figures:
S&M Headcount
Q114 139
Q214 179
Q314 230
Q414 273
Q115 342
Q215 392
Q315 470
Q415 571
Q116 686
Q216 798
Q316 894
Q416 968
Q117 1127
Q217 1226
Q317 1299
Q417 1362
Bert mentioned in his latest article that NTNX has a Net Promoter Score (NPS) of 90. I’ve never seen such a high score. NPS is a measure of how your customers are recommending your products and services so you can say that a high NPS indicates that customers are satisfied and that they are recommending (creating word of mouth) inside your target market. NPS is based on a scale of -100 to 100 with 100 being the highest possible and indicating that ALL your customers are willing to recommend the products/services. Here’s a link that describes how NPS is calculated (http://www.medallia.com/net-promoter-score/ ). I invested in private start-up several years ago and the company’s product routinely has a NPS of 60. This score is totally awesome and has contributed to very strong word of mouth and very rapid revenue expansion. Word of mouth makes expansion less costly and more efficient. NTNX has a score of 90 which means that almost all of the customers love the product enough to recommend it. I’d say that customers are delighted. NTNX has been focused on growing revenue in the enterprise market. Let’s see how they’ve done there. NTNX reports customer count in the Forbes Global 2000 which is comprised of the 2000 largest enterprises. Here are those figures:
FY Glob 2k Seq Gr yoy Gr
Q114 41
Q214 66 61.0%
Q314 82 24.2%
Q414 109 32.9%
Q115 127 16.5% 209.8%
Q215 159 25.2% 140.9%
Q315 177 11.3% 115.9%
Q415 214 20.9% 96.3%
Q116 242 13.1% 90.6%
Q216 281 16.1% 76.7%
Q316 318 13.2% 79.7%
Q416 372 17.0% 73.8%
Q117 424 14.0% 75.2%
Q217 473 11.6% 68.3%
Q317 521 10.1% 63.8%
Q417 559 7.3% 50.3%
In 3 years, NTNX has managed to capture >25% of the 2000 largest enterprises. Wow! OK, next we can examine how much these customers spend. I got this information from the investor presentation which can be found here:
http://ir.nutanix.com/company/financial/
You will want to look at slides 8, 10, and 12. NTNX is trying to use the land and expand strategy where they get a customer and then over time they try to get that customer to spend more. Slide 12 shows the spending pattern for each of their top 25 customers; it just shows when they spent and respent but not how much. In aggregate their top customers have spent 19.4x the amount that they spent on their first order. Slides 8 and 10 show how much companies are spending initially compared to how much they have spent over time. The Global 2000 customers who have been customers more than 18 months spent 8.1x more than they did initially. The conclusions here are that their customers are repeat purchasers. I think this looks good for revenue prospects in the coming quarters because NTNX has added 241 enterprise customers in the past 18 months and if these customers continue to spend 8.1x (after 18 months of being a customer) the amount that they spent initially then there’s a wave of revenue coming still.
Valuation
I have compared these fast growing tech companies across several metrics:
https://docs.google.com/spreadsheets/d/1BM439p9c5y0FFq2JvYdr…
One of the metrics that I use to compare them is enterprise value / TTM sales. SHOP has a multiple of 20.4 (richly valued using this metric). TLND: 8.2, HUBS: 7.7, TWLO 7.5, WIX: 8.4. The faster the grower the higher the justification for a higher EV/Sales. So I went ahead and added a column for EV/ forward TTM Sales which normalizes for the growth rate or in other words shows what the EV/TTM Sales will be in a year assuming the prior year’s revenue growth rate is repeated. Another factor to consider is gross margin because revenue is more valuable the higher the gross margin is. NTNX’s gross margins are respectable at around 58%. Bert thinks they can go much higher.
NTNX’s EV/Sales is 3.5 and its forward EV/Sales is 2.1!!! Bert mentioned in one of his articles that EV/Sales for storage companies is around 2 so NTNX’s would be inline with this industry valuation standard. But is NTNX an ordinary storage company. I would ask what gross margins are like for other storage companies. On a margin basis, I think NTNX can be compared to SHOP, TLND, HUBS, etc.
Based on the above, I made the decision to take a substantial position in NTNX. The shares are about 2% lower since I purchased.
Chris