Why I bought more PVTL

With PVTL continuing to drift down, I took advantage and bought more today even though it is already my largest position. Before Q1 earnings were announced on June 12, the stock was trading at 21.21. It then zoomed up to 31.24 two days later as analysts were caught off guard by the outstanding Q1 results and forecasted revenue. The stock has slowly drifted down reaching a low of 23.14 today, it’s lowest price after the ER. I already did a deep dive and Saul added some helpful financial tables, but I want to highlight why I bought more today.

For the deep dive on PVTL, see here: http://discussion.fool.com/let8217s-get-pvtl-33111511.aspx?sort=…

Here are the reasons I am so bullish:

  1. Subscription revenue is becoming a much larger part of the overall revenue. Subscription revenue was 44% of total revenue last year and is now 58% of total revenue. This is critical because investors may be overlooking the company seeing 28% total revenue growth and 64% margins, while the stock trades at a healthy valuation. With the low/no growth service revenue representing the majority of the revenue, it had a bigger impact on total revenue growth and margins. With the high growth subscription revenue now making up the larger part of the overall revenue, it will have a larger impact on overall revenue growth and have a bigger impact on margins. As PCF becomes a larger part of the total revenue, expect overall revenue growth to accelerate even if subscription growth slightly slows down its high growth.

  2. PVTL has been maintaining a dollar based expansion rate over 150% and coming in at 156% for Q1. This alone will drive a lot of revenue growth.

  3. There is a concern that PVTL is not adding enough new customers as they only added 44 new subscription customers. However, this was by design. During 2017 and 2018, they were focused on expanding PCF with current customers. This is the reason that S&M expense went up only 18% in 2 years, while subscription revenue went up 174% during the same period.

In their filings they stated: In fiscal 2018, we focused primarily on renewals and expansion of existing customer subscriptions, which resulted in fewer net additions relative to prior periods. However, with the recent launch of PCF v2.0, including the release of PKS, we intend to increase our focus on adding new customers.

Management discussed the increase in S&M during the end of 2018 which led them to add 20 customers, which is an acceleration of customer growth. You can see the increased S&M costs in Q1, which increased 33% from last year. Although they may not add 20 customers each quarter, they will likely add more customers in 2019 than they did in 2018. This and the 156% dollar retention rate should help to maintain the strong growth of subscription revenue.

  1. With subscriptions margins at 92%, profitability will grow quickly. Total gross margin was 64%, up from 54% last year. Subscription margin was 92%, up from 89% last year. Service revenue margin was 26%, which is flat from last year. As mentioned in point 1, with the subscription revenue growing so quickly, the 92% subscription margins will have a larger and large impact over time and the low margin revenue will have a smaller impact. Also, the subscription margins are still improving!

  2. In part 1 of my deep dive, I highlighted the company’s KPIs. There are only 2, which are the dollar expansion rate and subscription customers. They are very focused on increasing revenue as quickly as possible.

  3. Seeing the company focus largely on revenue growth may be red flag if they had debt and were losing a lot of money. With PVTL, they have no debt and $645M in cash. In addition, they are now cash flow positive, so they can afford to invest in growing the company quickly.

  4. Customers love PVTL. This is obvious from the high dollar expansion rate, but this is one of the most important points. I think investing in companies that have loyal customers that love the product is very critical. This can be seen in AMZN and NFLX’s stock price and revenue growth over the long term. PVTL provides such value to their customers that they are going to be long-term customers. This also gives PVTL pricing power. PVTL also convinced the burecratic IRS to become a customer along with the Air Force, so now that they are a government approved vendor which may open a large door to more government entities.

  5. Their TAM is large and growing quickly. Given projected revenue of $645.5M for this year, a $50B TAM is significant. Their TAM is expected to grow to $80.4B by 2021!

  6. The valuation is not overly expensive. At 23.30, the EV is now $5.355B ($6B market cap minus $645 in cash with no debt). With sales forecasted $645.5M for this year, that gives us an EV to sales ratio of 8.3 times. I think that’s cheap compared to other software names given the 69% growth in subscription revenue with its 92% margins.

  7. Their guidance is conservative and will be easy to beat giving us potential for some nice pops in the stock. From part 2 of my deep dive:

Looking at the full year guidance using the midpoint, total revenue is expected to be $645.5M and subscription revenue is expected to be around $382M. From this, we can expect service revenue to be around $263.5M.

Backing out Q1 revenue ($90M for subscription and $66M for service), you get average quarterly revenue of $97M for subscription and $66M for service for the remaining 3 quarters of the year. This would represent 47% growth in subscription revenue for the total year and 5% growth in service revenue.

To better assess management’s guidance, let’s look at past subscription revenue: Quarterly subscription revenue growth for the last 4 quarters is Q2 2018 – 22.6%, Q3 2018 – 2%, Q4 2018 – 14% and now Q1 2019 - 20%. I think their Q2 guidance of $92-93M for subscription revenue is pretty conservative as it is only 3% growth from this current quarter. Given that subscription revenue has accelerated in the last 3 quarters, it would be pretty disappointing if the average subscription revenue for the next 3 quarters was up only 7% in total. Also, given that they just landed 20 new customers in Q1 and their focus is on landing additional new customers, together with their 156% dollar expansion rate, I believe their subscription guidance is very conservative.