PSTG Incredible Net Expansion Rate

Investment Analysis Clubs Saul’s Investing Discussions
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I’m pitching Pure as part of a stock pitch competition for TMF and wanted to share this quick highlight.

Two ways we like to evaluate our SaaS type companies other than rev growth.

  1. Net Expansion Rate
  2. NPS Scores

Pure doesn’t provide a net expansion rate, but on slide 102 of their Accelerate conference investor presentation (from May 2018) we get the best idea possible.

Important Note. These numbers are for their Capex, or mostly hardware product sales. This does not include numbers from their new Evergreen Storage (subscription model) which I expect will have better net expansion.

anyways,
Here’s how repeat purchases look based on how long customers have been with Pure. I think this is # of repeat purchases not necessarily rev growth:

12 months: 1.9x
24 months: 3.1x
36 months: 5.2x
48 months: 7.8x

And this (to the best of my knowledge) is their net expansion rate:

45% Y/Y Avg Growth among all cohorts…so I THINK that’s the equivalent of 145% net expansion rate.

An add on to these numbers from their most recent Q3 19 Earnings:

36% Y/Y customer adds (more repeats coming in)

$11.00 in incremental purchases from top 25 customers within 18 months of initial purchase of $1.00

Greater than $2.00 of incremental purchases from all customers within 24 months of initial purchases of $1.00

so that’s 11x or…1,000% (is that math right?) Net Expansion for their top 25 customers in 18 months of initial purchase and 200% Net Expansion for all customers within 24 months of initial purchases

*those numbers aren’t on going, but just from initial purchase…but based of the repeat patterns above, they should repeat pretty reliably.

With an unheard of 86.6 NPS (only seen Nutanix’s 90 as better).

And these are for their hardware or CapEx purchases.

The company is moving more and more (never fully) to a subscription or OpEx model which tends to drive better customer satisfaction, more repeat sales etc.

Also… the company just released a software/subscription based Cloud Data Services line of products in partnership with AWS which increases their TAM substantially.

I’m not a value investor, but I think Pure Storage might have 40% revenue growth and 70% gross margins in store in 2019 or 2020 and I think the market is missing it. I also think the market’s missing Nutanix so take that for what it’s worth. We will see how that plays out in the short term with Nutanix’s results tomorrow (might be a great time to report based off the market today).

Link to Cloud Data Services Stuff:

Announcement:
https://www.purestorage.com/solutions/cloud/data-storage.htm…

White Paper:

https://www.purestorage.com/content/dam/purestorage/pdf/Solu…

Link to Accelerate slide show: https://s21.q4cdn.com/687136699/files/doc_presentations/2018…

Link to actual Accelerate presentation (highly recommend): https://event.on24.com/eventRegistration/console/EventConsol…

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Great analysis.

The numbers indicate it is very undervalued and continues on a solid growth trajectory.

I remain invested longer term.

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I’m not a value investor, but I think Pure Storage might have 40% revenue growth and 70% gross margins in store in 2019 or 2020 and I think the market is missing it.

The market is expecting the legacy storage providers to keep their leading positions. I believe that Pure is introducing a new storage paradigm (I’ve written about it at the NPI board). In truth storage is the incumbents’ market to lose and I think they will. Legacy players have a hard time switching paradigms. Tinker makes the argument that disruption comes from below and that is not the case with Pure storage – a valid argument.

The share price is set by the market and until it catches on PSTG will continue to have a hard time. Until then PSTG is not likely to be a “Saul stock.” I’m long PSTG and holding. I’ve offset some of the losses with covered calls.

Denny Schlesinger

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CMFALeiberman- I went through the slides too. They certainly look interesting. A while back I wrote a few posts on the ins and outs of revenue retention rates. I’ve copied some of that into this post so that you know exactly where I’m coming from and to benefit other people who are just entering in the conversation. You are calling it Net expansion rate (NER) and i’m calling it dollar revenue retention rate(DRRR) below. This is a non-standard GAAP metric hence each company defines and calculates this differently.

we have the dollar revenue retention rate . Each company calls this something a little different. I like to think of this as how sticky the company’s revenue is. This is calculated by taking the beginning of year recurring revenue + upgrades from existing customers – churn – downgrades from existing customers divided by beginning of year revenue.

A while back cloudera was reporting their Net expansion rate (NER) was 136% but somehow they only grew their revenue about 20%. It turned out that they were cherry picking only their largest best customers to calculate their NER. As an opposite example paycom (PYC) reports “revenue retention rate” of around 90%, which seems bad until you read their quarterly report, “Dollar-based retention excluding the benefit of upsells, based on GAAP subscription revenue” So basically they have excluded upsells which every other company I know includes.

So a few comments about applying DRRR/NER to PSTG.
1)Revenue retention rate specifically applies to recurring revenue. I.e. subscription revenue. It is fundamentally measuring a different product than what PSTG is so I’d be very very careful pulling putting any analysis into saying PSTG’s NER is better or worse than any other company. I think it is only useful to compare cohorts within PSTG.

2)PSTG hasn’t told us (that I can find) how they are choosing their cohort. I fell for this with Cloudera, allow me to copy and paste my post on CLDR back when they imploded
Buried in the analyst questions they drop the bomeshell that the 136% net expansion rate is only for their largest customers. WHAT? So basically they have been cherry picking the very best cohort to calculate NER on and reporting that information.
PSTG could very easily be only showing us customers that continue to be customers so we would have a very falsely elevated NER

3)As you pointed out they are showing you repeat purchases, not a dollars. I guarantee they would be showing you dollars if that number was better.

So a little sanity check, Lets say you are growing your customers 36% a year, and each customer is increasing their spend 45% a year. You should get revenue growth that is well in excess of 60% a year….but we aren’t. This shows you that they are cherry picking which numbers to show us because they “only” grew revenue 34%. I mean, 34% is still quite good. If they really were showing us all customers in their cohort analysis then we should see growth closer to 40% (that is off the top of my head, i haven’t actually crunched the numbers) So how are they cherry picking? Well, like i said, we don’t know how they choose the cohorts, they are giving us # of purchases not dollars spent, and they have doing the classic subtype analysis to show us some impressive numbers but ultimately what we care about is their total revenue growth…which is 34%.

I’m not a value investor, but I think Pure Storage might have 40% revenue growth and 70% gross margins in store in 2019 or 2020 and I think the market is missing it. I also think the market’s missing Nutanix so take that for what it’s worth. We will see how that plays out in the short term with Nutanix’s results tomorrow (might be a great time to report based off the market today).

On slide 12 of their earning call slides they show us their long term financial model they think they can achieve which is 63-68% gross margins, 15-20% operating margins. I’d be suprised if they are able to accelerate revenue growth to 40% especially in light of the tarrifs but who knows. Your guess is as good as mine. I would think their margins are going to take a hit here soon because of the amazon collaboration but I haven’t looked into it in detail.

A while back i wrote this.
“with 35% growth they should be over 2 billion dollars in 2 years, with 15-20% operating margin that is 300-400 million dollars in earnings (Obviously I’m painting with big strokes here and not including things like debt payments, lawsuits, etc). “

That would be 1.50 or so in earnings, so with very very broad strokes you can back calculate based on P/E. P/E of 15 gives a share price of 22.5, PE 20 , price 30. So yeah, I think PSTG looks good right now but i think the market is discounting them because people don’t believe they have a better mouse trap, storage is generally considered a commodity at this point, and we having looming tariffs that will probably affect capex of many companies.

Thanks for the great discussion!

Ethan

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saw something right after I posted. FY21 profit range of 6-10% on slide 105. If we say 2billion revenue then earnings should be 120 million to 200 million or 60 cents to 1.20 a share. Again broad strokes but not as broad as before. I’d hope that can beat that by 10-20% which they would if they can maintain growth in the mid 30s, revenue would be more like 2.3 billion.

-e

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