Nutanix: This Rather Complicated Duckling Is Now Becoming A Swan
Summary #Nutanix announced the results of its fiscal Q1 last week. The results were substantially above prior expectations, and further above those expectations considering the elimination of some hardware sales. #Nutanix’s EPS overattainment was partially driven by the inability of the company to hire to its plan. This might continue for a quarter or two. The company formally announced its pivot to an almost pure software model, with an impact on gross margins. Nutanix’s EV/S ratio of less than 5X is far below the valuation of other infrastructure software vendors such as Splunk, which have slower growth. Was that Nutanix leaping a tall building in a single bound? Nutanix (NASDAQ:NTNX) reported the results of its first fiscal quarter on Thursday evening. It was an exciting way to end November. Nutanix shares, as most readers probably realize, have been on a tear over the past three months, rising by a bit more than 50% prior to the earnings release as many investors have become more familiar with both the Hyper-Converged Infrastructure (HCI) opportunity, as well as the leading position this company enjoys in that space. The company, as had been advertised in advance, announced its intention to eliminate 80% of its pass-through hardware business over the next year so that the vast preponderance of its revenues will come from software and services. The transition started in this quarter as the company eliminated 9% of its pass-through hardware business. In point of fact, as I will discuss later in the article, the beat, large as it was, was actually less than an apples to apples comparison might indicate. In addition, the company, like many other tech vendors these days, did not spend its opex budget due to the timing of new hires. As a result, the earnings beat of $.10/share on a base forecast of $.26 was probably greater than had been anticipated, even in the context of very positive expectations for this company. What should investors do? Sometimes, stocks actually reflect accurately what is going on at a company. In my view, this is one of those times. Growth is accelerating, and so is visibility. While the company isn’t pushing profitability to any great extent, that is understandable given both the magnitude of the opportunity and the land/expand strategy that I discussed in an earlier article. HCI is one of the more seminal trends in the IT space at this time and should continue to be so for some time to come. This is the leading vendor in the space. The pivot to pure software and recurring revenues, while not really changing the value proposition for customers, will provide investors both better forward visibility and higher gross margins, and usually factors in promoting a growing valuation. I continue to hold my position and expect to continue to do so for some time to come. I think the shares, despite their recent journey, are very much worth buying and holding. Changing from an appliance vendor to a software vendor in a single year without missing a beat, and then also changing to a vendor with a SaaS business model, is perhaps the equivalent of leaping a tall building at a single bound. The company said in response to a number of specific questions during the conference call that it had prepared the ground both contractually with its partners as well as with its sales people, and that effective the company’s fiscal Q3, commissions would no longer be paid on zero-margin pass through hardware. In addition, as will be detailed a bit more later in this article, Nutanix is developing cloud offerings of its solutions that will allow it to pivot its revenues to a SaaS basis. Over time, it seems self evident that the company will pivot its business so that most of its revenues will be coming from subscription and other recurring revenues streams and from almost all software and support. Ditching commodity hardware will change the parameters of this company’s financial optics, but it will not change the actual business model or expectations for growth, earnings or cash flow. Over a rather brief time span, it will achieve gross margins that are typical for SaaS software vendors – in the 80%-plus range for software and about 55% for other revenues including services – albeit on somewhat lower revenues. Nutanix is ascribing about 26% of its current revenues to commodity hardware, but that has started to decline. The CFO said that the company will recast its planned business model early next year, but overall gross margins should reach the mid-70% range sometime before the end of calendar 2018. It plans to eliminate at least 80% of its pass-through hardware-related revenues by the end of the current calendar year. High-growth software vendors with a recurring revenue model can achieve extraordinary valuations. It seems likely that over time this will to happen to the company.