Pure Storage

Investment Analysis Clubs Saul’s Investing Discussions
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Hey everyone,

I really enjoyed all the ideas about which companies could possibly double in the new year. So thank you all! One that caught my eye that a lot of people brought up was Pure Storage (PSTG). I’d like to open a conversation on this company because I think there is some potential here. I’ll just highlight some facts and then we can go from there.

Overview
Market cap: 3.47 billion
EV: 2.93 billion

What it does: sells flash storage for enterprises
I’m not too clear on this space and how it is different from hyper converged solutions like Nutanix that include compute plus storage. I don’t have a solid footing how Pure fits in, but anyway…

Facts:
Revenue growth: 41% YoY to 278 million last quarter so run rate is well over 1 billion
Last quarter sequential rev was up 24%
A year ago, for the same quarter, sequential growth was up only 21% so there seems to be acceleration

Non-GAAP operating margin
FY16 Q3 -21%
FY17 Q3 -9%
FY18 Q3 -.7%

Good operating leverage though gross margins are 66% which aren’t super high. Seems like Arista where they are labeled a hardware company but are differentiated by superior software. I read some reviews on Pure’s product and they are glowing. Customers are happy.

Over 4000 customers. Two years ago, Pure had 1350 so this is impressive but not as impressive as Nutanix’s customer acquisition.

Pure’s main products are FlashArray and FlashBlade. FlashBlade is newer and supposedly it has increased Pure’s TAM in unstructured data. The company also has a joint venture with Cisco called FlashStack. It is hard to nail down specific TAM numbers but going after the data center has proved profitable for a lot of companies on this board.

Risks
SBC
High stock based comp which was about 16% last quarter. This doesn’t bode super well for profitability but the company is close to breaking even nonetheless. Free cash flow positive as well.

NAND and DRAM price fluctuations
These are the inputs for the flash storage products so if prices increase it will obviously affect Pure

New CEO
The CEO actually seems to fit well for this stage that Pure is in. He is an ex-VC guy and executive at Cisco. He is also on the board of Arista.

Conclusion
Pure has high customer loyalty, smart management, good financials and seems to be innovative. On the other hand, the storage space is crowded and investors might be wary of eventual commoditization.

However, I think the software might be the differentiator. Unlike Arista, I don’t have the same degree of confidence in management though. I don’t know insider ownership levels either. Pure’s TAM should not be a problem but I don’t have a great handle on the possible moat.

The current forward EV is under 3x sales so either, investors are underestimating the moat or there isn’t much of one. If the moat is stronger than everyone thinks, this valuation could be a steal and a double would be very possible.

Hope this opens some conversation on this company. Thanks so much!

Best,

XMFish

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Hi XMFish

Thanks for raising this - I agree. I have covered Pure Storage in my portfolio reviews this year and pre-christmas I called out PURE in terms of its progress towards profitability as well as its potential to be a 100% gainer for 2018. I think it is undervalued, given it is going to be profitable in Q4 and 2018, is growing way ahead of the market and has no legacy non-flash storage business dragging on its results. I like the new CEO as well as the pre-existing board.

I don’t actually think the SBC is that high for pre-profitability tech and it should shrink going forwards.

Ant

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Bert Hochfeld has written extensively on Pure Storage and is long pure storage.

https://seekingalpha.com/author/bert-hochfeld/articles#regul…

The link from an earlier post on the board is a must read:
https://blog.purestorage.com/ai-industry-needs-rethink-stora…

From the above link:

The big bang of AI has been fueled by a perfect storm of three key technologies: deep learning (DL), Graphics Processing Unit (GPU) processors, and big data. Deep learning is a new computing model using massively parallel neural networks inspired by the human brain. Instead of experts handcrafting software, a deep learning model writes its own software by learning from lots of examples. A GPU is a modern processor with thousands of cores, well-suited to run algorithms that loosely represent the parallel nature of the human brain. Both are major breakthroughs that have completely upended traditional approaches.

As shown below, within just two years, the amount of compute required by leading deep learning algorithms jumped 15x while the compute delivered by GPUs jumped by 10x. This leads us to the third piece in the perfect storm of AI: big data. While the volume of unstructured data is exploding, legacy storage housing that data largely ceased innovating decades ago. Even though deep learning and GPUs are massively parallel, legacy storage technologies are not- they were designed in the past era of serial processing. And the performance gap between compute and storage continues to widen.

You can think of this as a play on AI.

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I have looked at Pure Storage and have passed thus far. I can’t get comfortable with a company that is going to have revenues of $1 billion and still not profitable. It looks like they will be next year.

Some other notes:

-Spends twice as much (on a non- gaap basis) on Sales and Marketing as R&D.

  • Sales and marketing expenses will be about 1/2 a billion dollars this year. wow.
  • Sales and marketing is growing faster than Rev. growth, R&D is up about 10% (on a non-gaap basis).

So the main question is can they stop spending so much on Sales and Marketing, improve their profitability, and maintain strong Rev. growth?

I always question how great a product is if they have to spend so much on Sales and Marketing (in this case half of Revenue).

I would be interested in a case study where this has been done before, where a company stops land and expand and becomes very profitable. (sales above $1 billion, spending half on S&M, able to slow S&M spend and become really profitable while maintaining growth).

I always compare to Arista, which had sales of $1.1 Billion last year:

  • Sales and Marketing of $130 Million (1/4 of Pure) and growing S&M less than rev. growth
  • R&D spend of twice S&M
  • very profitable

Jimbo

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I can’t get comfortable with a company that is going to have revenues of $1 billion and still not profitable.

- Spends twice as much (on a non- gaap basis) on Sales and Marketing as R&D.
- Sales and marketing expenses will be about 1/2 a billion dollars this year. wow.
- Sales and marketing is growing faster than Rev. growth, R&D is up about 10% (on a non-gaap basis). [Bear: I don’t think this is accurate. Revenue is up 40% in the TTM and S&M is up 34%]

Jimbo,

You’ve said before you are long Nutanix (NTNX). Looks like Pure compares favorably to them in this regard.

In the TTM:


NTNX Revenue: 876M
NTNX S&M:     517M

PSTG Revenue: 913M
PSTG S&M:     445M

Bear

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Hi Bear-

Good catch on my typo. I meant to say Sales and Marketing expenses are growing much faster than R&D growth, R&D is up about 10% (on a non-gaap basis).

My point is Pure is getting to profitability by cutting R&D growth, not S&M, the opposite of what I would want to see.

I would say S&M is growing about the same as rev. growth. Looking at the first 9 months of this year, Product revenue growth (the part of rev. from S&M) is up 33%.

I sold my NTNX the first week of December, part of which was from this same reason. I posted about the other reasons I sold.

Thanks,
Jimbo

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My point is Pure is getting to profitability by cutting R&D growth, not S&M, the opposite of what I would want to see.

I would say they’re getting to profitability by growing revenue. Don’t get me wrong: I’m looking for S&M to taper down, but that’s pretty much exactly what they’re going to have to do to hit their projections, which I trust.

In fact, I could see them beating in a big way. If S&M was up from 129M to, say, 140M next quarter, provided they hit their revenue they’ll have less than half of the GAAP operating loss they had this past quarter. It would be down from a $42M loss to just 15 or 20M.

That’s what I’m targeting, and things only get better from there unless the story changes. Not saying they’ll become Arista tomorrow, but they’re on a good path.

Bear

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Market cap: 3.47 billion

At $16 share price, 279 million diluted shares the market cap comes to 4.46 billion.

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Risks

The existing vendors like NTAP, EMC have a long presence in the enterprise space, with deep relationships. This will be a head-wind in revenue growth, and margins.

On the other hand, the flash adoption is in early cycle. The company need to figure out how to limit the share count growth.

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