Pivotal - I Like It

Investment Analysis Clubs Saul’s Investing Discussions
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Having a tough time keeping up with everything lately. Just finished reading Pivotal’s call and I’d encourage others to take a look.

Let’s try to quickly summarize the bear case.
#1 - Look at the very small number of customers (377) and additions (9) this quarter. This isn’t a real company if they can’t add more customers than that every quarter.
#2 - Reliance on Services Revenue. The product doesn’t sell itself and takes a significant amount of effort to sell, let alone get up and running.
#3 - They aren’t showing any signs of penetrating the mid-market customer.
#4 - Lumpiness
#5 - Guiding only 36% sub growth
#6 - Dell ownership (I will not comment further on that here).

Now let’s look at the quarter and the bull case.

Subscription revenue grew 50% this quarter and 55% for the year. New customers grew 32% this year versus last. The net expansion rate is 149%! Gross Margins increased to 68% from 59%!!! Based solely on the subscription revenues, the EV/S is 12.4 and about half of that on total revenues. That is right in the range for multiple expansion. Yes, yes, go ahead and bring up Nutanix if you must.

The conference call seemed very positive. I believe everyone is afraid of having only 9 new customers in a quarter. First, new customers this year grew 32% and combined with the superior expansion rate, this sets up very nicely. Second, the risk/reward scenario on customer growth seems favorable. SI partners will help fuel this growth. We don’t hear of Pivotal’s customers being unhappy with their service and, in fact, agile software development appears to reap vast rewards. I think it was Ford or another auto maker who had to pare back usage or some such thing which I will call FUD. They are diversifying their verticals quite well. Read the call for further info.

PAS appears to be a more holistic buy-in for customers while PKS with a bit lower ASP may help gain new customers faster. But one may ask, who cares? They have penetrated 33% of the Fortune 100. Lots of opportunity left there. They are, in fact, growing customers quickly enough to see great revenue growth when figuring in the expansion rate.

Would love to hear why others think this is wrong.

Thanks,
A.J.

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A.J.

it’s not that I don’t think Pivotol will do good. It’s growing nicely and has lots of positives going for it, so buying today may very well lead to solid gains over the next few months/years.

I just think the other companies we follow will do better, more or less tied to the points you’ve noted in the bear case above which I think are less pertinent to the other SaaS companies.

It’s as simple as that. Pivotol isn’t a bad company to own, but my higher conviction level is elsewhere today.

-mekong

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Thanks, Mekong.

I’ve wrestled with the idea of high flyers that dominate my portfolio versus those who have the greatest room for multiple expansion. Yes, there is a reason the market values companies as they do. And we saw this with Nutanix. The market was right at least in the near term. That is not to say the market is always right though. I’m looking at you Twilio.

Twilio was beaten down around FUD and that was the prime time to invest. What I’m saying is, I believe there is room in a portfolio for companies who may provide vast multiple expansion. I generally keep those positions small and Pivotal is currently under 2% of my portfolio; however, it will be a bit bigger soon. Unlike some, I also keep cash in my portfolio so I can put that to use in this instance without sacrificing another position…but that is portfolio discussions that are persona non grata here.

I do believe Pivotal is worth a look, but certainly can appreciate your point as well.

Take care,
A.J.

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Thanks Phoolio. I really agree with your analysis. Over all growth is good. But they are not adding many customers or getting to the mid market, which to me, is a very big concern.

Right now, I’ve got a normal position in PVTL, and I’ve decided not to do anything. I’ll wait to see how their strategy goes over the next few chapters.

I do do some trading using options - I sold calls on part of my Mongo position, as I expect some volatility that I can profit from, and if some shares get taken away from me at this level, I’m not too worried as I’ll still have most of my position and have some concerns about over concentration in MDB.

Similarly, on a down day, I’ll pick up some LEAPS on PVTL, as I expect volatility and some significant improvement in share price over the next few months.

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But they are not adding many customers or getting to the mid market, which to me, is a very big concern.

Thanks for your thoughts, Steppenwulf. If you care, I’d like to go a bit deeper focusing first on the customer adds.

I wrote about the risk/reward scenario on customer adds and think it sets up nicely. Do we think Pivotal is going to slow down significantly? Remember, they just increased customer adds 32% this year and the dollar based net revenue retention is 149%. If we think customer adds will slow, then Pivotal will not be a good investment. But I tend to think the opposite. They are enlisting the help of SI partners though the call didn’t make it seem like that would have a huge impact on new customers. It will help services revenues decrease though. They are hiring more and that should help. Finally, with VMWare as part of the family, I believe customer growth will continue.

While they are focused on larger enterprises, at this point, who cares? There are still plenty left. 1/3 of Forbes 100 uses Pivotal. Plenty of growth left.

Further, PKS is a bit lower ASP. Maybe this helps with the mid-market, but it isn’t something we need to rely upon.

Steppenwulf, your original posts helped me get into Pivotal. I’d like to know what it is that you are seeing differently now?

A.J.

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@Phoolio

While they are focused on larger enterprises, at this point, who cares? There are still plenty left. 1/3 of Forbes 100 uses Pivotal. Plenty of growth left.

Further, PKS is a bit lower ASP. Maybe this helps with the mid-market, but it isn’t something we need to rely upon.

I am still very impressed with the Pivotal technology value proposition. They provide so much value that enterprises are willing to pay a lot for them. I’m also blown away by the entire Spring suite. There is hardly a Java team on the planet that doesn’t use that.

My concern is that they aren’t leveraging these amazing assets to do much bigger growth across the middle market as well as the top of the market.

Companies like Mongo have similar tech/mindshare advantages and leverage those advantages to grow so fast that they take away the oxygen from competitors. Mongo is so far ahead, that it is hard to imagine anyone catching up to them. Pivotal has unbelievable assets, but is not accelerating like that.

For one example, their net expansion rate is 149% which is amazing. But they are gaining customers by onesies and twosies with salespeople out in the field.

They own Spring which is a part of practically every Java project in the Universe. Why haven’t they yet found a way to leverage Spring to naturally increase Pivotal use, without needing sales people and marketing? Where is their revenue conversion from Spring? There are lots of ways they could get revenue from Spring, without poisoning the well of the open source community love. It takes care and strategy to find them - that’s what a management team is supposed to be for.

I totally get the innovation of Pivotal’s engineering team. They have created amazing technology, and they also kept ahead of the curve. When containers came out of left field they responded fast. Basically I’m wondering if PVTL management is lacking a similar innovative spirit.

I tend to have a longer term investment horizon than most people on this board, I think. I really plan to hold companies for 20 years, and hold my average investment for 3-5 years.

I do agree that Pivotal is growing well, but conservatively - they are landing and expanding, not combining it with the power of the internet to get viral growth. As such, I fear that in the long run someone else will come up with viral growth and beat them.

So I am in for now, and think they are a good bet for the near term. That’s why I’m keeping my investment, and may even trade a few LEAPS. But for now I look at them as a relatively short term investment until they prove they can take over a market that their product currently has a big advantage in.

Does that make sense?

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My concern is that they aren’t leveraging these amazing assets to do much bigger growth across the middle market as well as the top of the market.

Phoolio and Steppenwulf,

My concern is that management spent about 10 years as part of Dell, having customers just delivered to them without any S&M effort on their part, and they simply DON’T KNOW HOW!

Best to you both,

Saul

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I am still very impressed with the Pivotal technology value proposition. They provide so much value that enterprises are willing to pay a lot for them.

Well, a limited number of enterprises. And I don’t think it’s the cost that’s the problem as much as it’s the upheaval in an enterprise’s development team structure that limits sales. Going Pivotal isn’t like, for instance, deciding to use Confluence (a TEAM product, btw), which you can do without changing other things. Going Pivotal means going full agile, all the way down to pair programming. I think an enterprise has to have real problems to undergo such an upheaval, but maybe the customer data Pivotal has shows otherwise.

I’m also blown away by the entire Spring suite. There is hardly a Java team on the planet that doesn’t use that.

But, there’s NO Java team on the planet that pays Pivotal for Spring. The only way Pivotal makes any money on Spring is from Training, Certification, and Consulting. See https://spring.io/services

And now with Oracle doing what everyone suspected years ago they’d do when they took over Java by buying Sun Microsystems - that is, making people pay for Java - who knows how much loss of value Spring might have? Even Google got stung by this (read https://www.theregister.co.uk/2018/03/29/oracle_google_andro… for some background on the ~$9BILLION cost to Google).

That’s a reason why Google is switching over from Java to Kotlin. Of course, Kotlin has other advantages. That said, I’m sure Pivotal can help teams working in Kotlin, just that Spring won’t matter one bit.

I totally get the innovation of Pivotal’s engineering team. They have created amazing technology, and they also kept ahead of the curve.

Sure. But I learned a painful lesson long ago that best tech doesn’t come close to having the right business model. While I think working at Pivotal would be rewarding, and I think the companies that use Pivotal are happy, it’s just not the kind of business model that can easily scale or for which there will be a high demand.

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I think there might be a need for another board, one that analyzes companies like PVTL that are growing in the 20 to 30% range.

I’m completely serious. It seems that there is a need for it. Plenty of companies that don’t meet the criteria of this board like ANET and TLND, but still worth looking at and possibly investing in. I’m not sure SQ even fits on this board any longer.

Anyway just a thought. Seems like people want to talk about these companies enough to bring them to the attention of this board even though they don’t fit Sauls criteria.

Chris

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I think there might be a need for another board, one that analyzes companies like PVTL that are growing in the 20 to 30% range.

NPI

Denny Schlesinger

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@Saul My concern is that management spent about 10 years as part of Dell, having customers just delivered to them without any S&M effort on their part, and they simply DON’T KNOW HOW!

Hey Saul, you hit the nail on the head - this is my concern also.

Of course they are growing revenue fast, and subscriptions faster, but if they don’t know how to sell, their momentum will gradually slow as their launch momentum wears off.

If they are smart, they will learn how to sell, or hire people who know how to sell, or both. With their great technology, I’m willing to wait another quarter or two to see if they can blast off, but they do have to make moves to show they can sell.

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“NPI

Denny Schlesinger”

Yea was thinking more along the line of what Saul has set up here, not the Wild West and the political attacks by the Michael Cohen type fixer on that board.:wink:

Saul has well placed rules that for the most part people follow here.

Chris

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I think an enterprise has to have real problems to undergo such an upheaval, but maybe the customer data Pivotal has shows otherwise.

Of course, the baseline here is that virtually every company that develops software, whether for sale or for internal use, has major, major problems. Otherwise, we wouldn’t have documented 1000 to 1 productivity differences based on language, tools, and experience. Take the huge number of companies that still have huge amounts of COBOL code in production and who produce more new lines of COBOL than any other language just in maintenance (of course, it takes lots of lines of COBOL to do anything … although I also learned some valuable lessons from COBOL in using data structures to solve problems). No up and coming programmer of talent wants to be stuck writing COBOL, so who ends up maintaining these systems is old hacks … old enough to be retiring and hard to replace. The right language, the right skills, the right tools can replace these aging systems for a cost not that far from the cost to maintain them and once replaced the cost to maintain and/or the flexibility to make the system better goes way up. But, this requires a leap of faith.

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Yea was thinking more along the line of what Saul has set up here, not the Wild West and the political attacks by the Michael Cohen type fixer on that board.:wink:

Since you have an idea of how such a board might work, try it. Setting up a new board is easy, just click on the

“Boards Home | Best Of | Favorites & Replies | Customize | Start a New Board”

link. Over the years I started three boards. Give it a try!

Denny Schlesinger

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Steppenwulf: My concern is that they aren’t leveraging these amazing assets to do much bigger growth across the middle market as well as the top of the market.

Saul: Saul My concern is that management spent about 10 years as part of Dell, having customers just delivered to them without any S&M effort on their part, and they simply DON’T KNOW HOW!

Steppenwulf: Hey Saul, you hit the nail on the head - this is my concern also.

Saul: If you think about it, most of our little IPO’s are companies who were independent little companies, struggling and learning for years and growing until they got big enough to IPO.

Pivotal was a service and research division of Dell for 10 or 12 years, as I remember. They had clients sent to them by Dell or VMWare (part of the Dell system). Pivotal is still mostly owned by Dell, by the way. If you think back to when they IPO’d they showed almost zero S&M expense. They didn’t have any. They were given their original customers by Dell who decided to do a partial sale of Pivotal to raise some money, I guess, and to make believe that Pivotal is an independent company. However after a dozen years as a service division for Dell, Pivotal’s management just doesn’t have S&M and growth in their DNA. That’s the way I see it anyway.

Saul

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Pivotal was a service and research division of Dell for 10 or 12 years, as I remember. They had clients sent to them by Dell or VMWare (part of the Dell system). Pivotal is still mostly owned by Dell, by the way. If you think back to when they IPO’d they showed almost zero S&M expense.

I don’t disagree that adding new customers is the number one area the company needs to focus on. I doubt they have blinders on in that regard. In their prospectus just before IPO, they had annual revenues of $509M and S&M expenses of $221M or 43%. It is not as if they didn’t have a sales department. This quarter S&M was 41% of expenses.

Littered throughout the call is mention of hiring additional staff and focusing on SI partners. Yes, the company doesn’t have an easy sale and this may be reason enough to run for the hills for some.

However, if we can see the need to focus on sales, I’m sure they have seen it for some time. I am a bit fixated on the expansion rate as the underpinning of the risk reward set up. The last four quarters are 149/150/150/156. They added 18% more customers this year. That isn’t great, but against an expansion rate of 149%, it doesn’t spell disaster. In fact, it sets up quite nicely for continued sub growth around 50%.

One thing I don’t understand is the low ball guidance beset against that type of expansion rate. We will see how that plays out. If the expansion rate decreases significantly, it will not be pretty. However, if they do ramp sales and are able to gain customers a bit faster while attaining that rate, the upside is quite large I believe.

PKS is a new offering with a bit lower ASP that may help in on boarding customers. It is funny that Dell/VM are mentioned above as they just seem to be ramping up more with VM based on what I read in the call. I believe PKS has a lot to do with that. There is another product release (PFC???) for the end of the year.

I believe companies are, in fact, seeing the benefits of agile software development. Pivotal is allowing developers to spend most of their time developing rather than dealing with keeping something they created up and running. Pivotal is taking care of the laborious aspects of software development. That seems like a critical service to me.

A.J.

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Great post, AJ. It got me thinking…are they adding (enough) sales staff?

I checked out their career page. They have 318 openings.

  • 31 AE or Sr Account Exec positions - scattered around the world - a few in London, DC, Germany
  • 3 Business Development Execs - London, NY, Chicago
  • and a lot of technical expertise (45 software or Senior software engineers not to mention DevOps, etc)

How many accounts can an AE cover?

Putter

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How many accounts can an AE cover?

THanks for the info on open positions and it does jive with what we heard in the call.

How many can they cover? No idea, but I’m assuming those aren’t needed to cover existing accounts and their main focus is new accounts. They only signed 9 this quarter. So even 1 account signed per AE would be enough. No clue how many they have currently.

A.J.

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Saul: Pivotal was a service and research division of Dell for 10 or 12 years, as I remember. They had clients sent to them by Dell or VMWare (part of the Dell system). Pivotal is still mostly owned by Dell, by the way. If you think back to when they IPO’d they showed almost zero S&M expense.

Phoolio: I don’t disagree that adding new customers is the number one area the company needs to focus on. I doubt they have blinders on in that regard. In their prospectus just before IPO, they had annual revenues of $509M and S&M expenses of $221M or 43%. It is not as if they didn’t have a sales department. This quarter S&M was 41% of expenses.

Hi phoolio, I guess some don’t want to acknowledge what’s really wrong with Pivotal. Look at the table below:

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

Subscription Revenue went from $95 million to $260 million in two years, almost tripling.

Cost of Subscription Revenue went from $34 million to $30 million in the same time. That’s ridiculous on the face of it.

Will you agree with me that, on the face of it, they had no real S&M department and that their subscription customers were just handed to them???

That $228 million total cost of revenue that you were talking about wasn’t sales and marketing at all. Only $30 million was. $198 million was the salaries that they paid their service teams to bring in $250 million of Service Revenue.

It couldn’t be clearer! They had no need, pre-IPO, for sales and marketing, as their customers were handed to them. They don’t have a clue how to do sales and marketing as they have no experienced sales teams with five or ten years experience, or even one-year experience. And management has no experience running a growth company. They used to be just a service division for Dell. That’s why they added only nine customers in a quarter! They are just selling more to the companies that had been handed to them for free.

They may get themselves together but there’s no indication of it, and no guarantee.

Best,

Saul

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Saul, are you expecting the S&M cost of subscription revenue to be refected in the Cost of Subscription Revenue figure above? I wouldn’t. I am used to seeing Revenue - Cost of Goods/Services = Gross Margin and then having S&M costs deducted along with R&D and operating expense to get Net Revenue. My inclination would be to interpret the figures above that there is a small fixed cost to providing subscriptions and that it is largely independent of the revenue coming from subscriptions. Indeed, if I look at their financials, Sales and Marketing is a sub-head under Operating Expenses along with R&D. Indeed, for the latest quarter, S&M is $76M while Cost of Subscription is only $8M.

To be sure, I don’t see any dramatic rise in S&M cost either.

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