NTNX is a fast growth tech company. Over the past 12 reported months its revenue was $846M based on its new accounting method. According to Bert’s article, NTNX is being valued like a storage company (2x is what Bert claims storage companies are typically value). I have some open questions about this:
Why are storage companies valued at 2x TTM sales? Is it because they are growing slowly, it is because they have low gross margins, or is it because of some other reason?
It would be useful to analyze a couple of storage companies that are currently valued at 2x. The analysis of their financials, their growth rate, their margins, etc should yield the reasons why they are valued at 2x of sales.
The analysis in #2 above will provide us a basis to show how NTNX is different from these storage companies and give us reasons why NTNX should not be valued as a storage company. I suspect that we will be able to show why NTNX should be valued like a high tech software company which are valued at a higher multiple of sales (7-12x). This would give is a good idea for how much NTNX is mispriced (undervalued).
For now I will work on the second part of this analysis.
Of the $846M in TTM revenue, how much is software? Here is what was said at the investor conference last week (September 12th):
Question from analyst Sherri Scribner
Okay. That sounds very good. I know that you guys sell your solution on a commodity hardware stack, but the real secret sauce obviously for Nutanix is the software. What’s your mix of hardware sales versus software today and over time given your ability to sell software separately from hardware, how do you expect this mix to change and could you see the company being maybe 100% software seller some point in the future?
Here’s the answer from Sunil Potti
Yeah. I will start on that. It’s a great question. I think we probably, potentially done the sale, the service on this, because as you just heard, clearly, it’s 100% software company, that’s what we do…
And in the past we’ve given the statistics of bookings – percentage of bookings from software on a rolling four quarter basis, in last quarter that was 17%. But that – when we quote that software number, it simply a separate standalone SKU, but the fact is, today when we sell an appliance, our base operating system is bundled into that appliance. So we are selling a commodity appliance at 65% margin, almost if not all of that is because of the software…
So to put it in perspective, I think if you took our P&L and you said magically last year we sold no appliances and you say, you didn’t sale it a margin, you take the COGs out of the P&L and we can do that. We – the software is completely portable, Dell, Lenovo, IBM, HP, Cisco, SMC, customer choice again.
But if you ripped out those COGs, what would be remaining soon we built roughly a $1 billion last year which we did. If you took those COGs out, what would remain is about a $700 million or a $750 million software company, a pure software and support, going really rapidly, the leader in the space in $100 billion market. That’s what the company would be. So, I think, going forward, what you’ll see from the company specifically is more education and probably a somewhat quicker shift to software throughout FY18.
So what we have is a software company valued at a hardware company. Of the total revenue it’s 75% software and 25% hardware. The software part is growing very fast(SW bookings grew by 96% last quarter (yoy)) and has high margin(>90%). The hardware is jest a way to sell more software. Software margins are 90% while hardware margins are pretty much nothing.
So to value NTNX, let’s remove the hardware part. 75% of $846M is $634.5M. So now we get the EV/Sales:
EV= market cap less net cash: $3.4B - 0.35B = $3.05B
EV / sales = $3.05 / $0.6345 = 4.8
Now let’s compare NTNX to other fast growing tech companies with high margins:
NTNX SHOP TWLO HUBS TLND EV/Sales 4.8 21 7.6 8.1 8.2 Rev Growth 96% 80% 58% 42% 43% GM 90% 81%/36% 56% 79% 76%
Based on the revenue growth and the gross margins, NTNX looks even better than our other fast growing tech companies. Yet the multiple is substantially lower. While I’d like to find out why hardware storage companies are valued on a 2x multiple, I think the revenue growth and gross margins of NTNX’s software business very much justify a valuation inline with our other high tech fast growers.
Since NTNX’s margins and growth is better than these other companies, its valuation should be higher. I’d say at least a 10x multiple is warranted.
That would give a share price of about $46.50 or a 108% upside from the current price. This is why I took a large position in NTNX.