When does the thesis play out? (NTNX)

Many of us have been pounding the table on NTNX being one of the most attractive buys of the stocks we follow. 6 months ago when NTNX’s price was 40 plus percent higher I wrote, ”still transitioning away from selling hardware, going to temp make revenue look not as appealing. Their customers love them, they sell a lot to their current customers. Starting to throw off cash. I wouldn’t be surprised if the stock falls no matter how good their earnings are. Their forward EV/S is somewhere around 6.5 despite growing in the 50% range. “ Apparently those words were a little bit more prophetic than I would have liked. NTNX is one of my largest positions and one of my largest losses as I’ve added at each big step down. I think it is important to have a general idea of when you expect a thesis to play out. With that introduction in mind I’ll outline why I’ve built up such a large position and why I’m willing to sit around losing money for a while.

The Numbers
I’m not going to go into NTNX in detail, just the main numbers that I think matter right now.


                17Q1    Q2    Q3    Q4    18Q1    Q2      Q3    Q4       19 Q1E
Revenue         188    199   205   252    276    287     289    304       305
% change                                  46     44      40      20       11

Egads, that revenue slow down looks terrible doesn’t it? The why of it is important in this case. NTNX moved away from counting hardware in their Revenue. They use to have about 25% of their revenue from hardware which was a 0 margin business. That means they were earnings NO money from hardware. In the future they expect to reach a steady state of about 5% of revenue being zero margin hardware. They will reach that steady state Q1 2019 (next quarter).

Thesis
Ok, so how do we get a general idea of how the underlying business is performing? NTNX provides a breakout of how their software sales and services are growing. This is the part of the business they earn money from. So lets look at that.

                     
                   17Q1   Q2   Q3   Q4   18Q1   Q2   Q3   Q4
Revenue              140  144  146  180  195    209  227  268
% change                                 39     45    55   48

Well, hot dog…that looks ALOT better. In fact, that looks like a company that is kicking some serious behind.

We should do a little double check, if the hardware pass through was 0 margin and it is going away then we should see margins increasing.


                    18Q1   Q2   Q3   Q4
Gross Margin         62    64   68   77

Looks pretty good, margins are increasing as we suspected they would.

So finally…how long do we need to endure the stock price getting hammered?
Lets do a very simply analysis just based off of the software sales and services. Lets use their estimate for q1, then grow at 45% q2 and then 40% and project that out over the next few quarters(I wouldn’t be surprised if they do better than this) . We will then add back in their 5% and use that as their total revenue. Note, 2019Q1 and forward are estimates


                18Q1   Q2   Q3   Q4   19Q1   Q2   Q3   Q4   20Q1
Revenue          195   209  227  268    305   318 340  393  429
% change                                11    11  18   30   40

NTNX began this transition in Q2 2018 and expect to finish next quarter, q1 2019. As we can see above we should expect total revenue numbers to be rough until q2 2019 but then then gradually improve until the year after they finish they transition. They will finish next quarter q1 2019…and as we can see from above their numbers are going to get better and better until being apples to apples in 20q1.

Conclusion
Assuming NTNX is able to keep their business performance going and market conditions don’t drastically change we should begin to see stock price appreciation in the next 3-6 months. The reason i’ve held and continued to buy through all this is one never knows when the market will catch up. Fingers cross and happy investing to all.

Best,
Ethan

P.S NTNX quarters don’t sync up to calendar quarters. I.E This quarter they are going to report isn’t q3 2018, they call it q1 2019.

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Great great post, Ethan.

Three things to add:

  1. While I completely understand why you chose to look at Revenue, which is what the headlines, algorithms, HFT’s will drive stock price appreciation, from a business perspective, I’d reiterate that deferred revenue and billings are a much better measure of their health. Deferred revenue increased 71% YOY and billings 66%. Seems like their business is pretty healthy…

  2. From a thesis standpoint, the announcement of Xi and any subsequent positive endorsement, will be a huge driver of the stock price (should happen in Nov). Not to mention any additional positive reactions about other products (DaaS, Files, etc.). It’s kind of crazy, and I think it gets lost in the shuffle, but NTNX is innovating at a crazy pace! They are launching new products left and right. Similar to NVDA and SQ, part of my thesis, is that if a few of these products are successful (Xi, DaaS, Files, Sherlock, etc.), their goal of $3B in billings in 21 months will seem conservative. Net net, it gives them optionality.

  3. Lastly, a general note about this board. It is one of my favorite things in life. Obviously not more than family and “real life” things, but from an intellectual standpoint, a group of like-minded investing nuts is hard to find. So thanks again Saul and everyone else who contributes!

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In my port (such as it is, if it is so still be definition) MDB at this marketcap is inviolable. I have been itchy on the other holding(s) I have. Not out of fear of loss but out of trying to be too perfect.

One rule I usually have is that never to buy anything “cheap” in the conventional sense, albeit “cheap” in the relative sense, but still pricey conventionally is the ideal.

I have taken to breaking that rule today. Nothing for timing, no big FUD event, no big 30-100% bounce of days of yore, but because, in the end, I just could not stand back anymore. It had to be done.

I have been in and out of Nutanix the last couple of weeks. Pretty much know it like the skin on the back of my hand (I could not pick it out in a police line-up but it is a well known phrase with clear meaning) and have been going through WHAT IS WRONG WITH NUTANIX!

On NPI, although little group work on this one, mostly me, it is clear what drove Nutanix down. It was not the leaving of their president, it was not the delay in Xi, it was not IBM mentioning their multiple cloud product, it was not anything else but the earnings call. The evidence is irrefutable in regard. It was on the earnings call, there and there only, when the share price started to descend in a frightfully spirally fashion, and continues to this day to do so.

But it cannot be that simple, can it? I mean Wall Street has access to near perfect information and there are no such incongruities between reality and information that is known to the market! That is what my finance professor taught and convinced otherwise he could not be. This from the #5 MBA program in the world.

But yes, it is true. I have seen this from vast experience. There are times that stocks get cheap based upon real things that we do not necessarily see but market players that count do. Never forget Lernout Hauset (however that is spelled - I did not invest in it, but it was so popular as it had so much going for it and yet was reasonably priced - was a total sham). But then there are times when things get cheap based upon nothing fundamental at all. Either through industry propaganda (as happened to both Qualcomm and Rambus - and those two towered as the FUD from the industry propaganda cleared), or the dressing is not correct.

Here, there is nothing wrong with Nutanix other than it is going through a transformational change yet again. Nutanix is reinventing itself again. Nutanix was here about this time in 2016 as well, as EMC was bought by Dell and VMWare became this conglomerate of “lets eat small fry Nutanix’s lunch!” And Nutanix had one moderate quarter with disappointing guidance (that quickly was exceeded). We are at a similar point not.

Yet what do we know? Nutanix is the leading HCI software vendor in the world, beating out VMWare. Nutanix software sales are growing like mad, deferred revenues cranking, billables running, and execution to the software transition going better and faster than planned (ie, wonderful execution), with new products on the cusp of being delivered that may be another game changing paradigm for local databases. And despite the momentum towards the public cloud, most AI will be done on local databases, connected to public clouds, because the cost of moving that data, and the security issues, are not minor concerns.

In addition, as I have seen with almost every great investment that I have ever been in, there are critics who are calling Nutanix out for being unprofitable and investing too much in the business and not trying to sustain the bottom line! Watch Square, Netflix, Amazon, Salesforce…it is a very long list.

Long way to say, NOTHING IS WRONG HERE. NO WATER BEING TAKEN ON. NO NEED TO TURN ON THE PUMPS. KEEP THE WATER BUCKETS IN THE CLOSET. Just make sure we have enough food rationed as the voyage will be a big longer than we like.

What I have noticed is that in cases like this big money leaves because there is a hiatus. Money managers get graded quarter by quarter. There is no need to rush into anything. And besides, they are mostly only interested in the last 20% of returns anyways. Better to reduce their risk. But they also act like herd animals. At some point the right person will say the right thing, and it will be after you have given up, that you want to sell, and then a few days more, and boom, suddenly the market turns around and announces how smart they are vs. you, as they find Nutanix is accelerating their growth! And then act on it.

Tinker

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To summarize, two important forces are in work here:

  1. Misunderstood numbers making NTNX look like it has steeply decelerating revenues.
  2. Herd mentality.

Both create a chimera for investors a scary illusion. Hopefully, in the not too distant future the chimera will be seen as nothing more than an illusion and the reality of this great company will replace it in the eyes of the greater investment community.

Funny thing about herd mentality, it’s been known to unpredictably reverse course at a moment’s notice.

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