Even after reporting a better than expected quarter in addition to Bain investing $750 million for growth initiatives, Nutanix (NTNX) has seen their stock continue to pull back. Q4 revenue grew only 9%, though subscription revenue, which represented 87% of Q4 revenue, grew an impressive 65%. Investors should start to pay more more attention to subscription revenue growth since this will drive the company forward over the long-term.
In addition, the $750 million investment from Bain could help NTNX invest more into their growth opportunities. By recently becoming FedRAMP certified, NTNX has a greater ability to sell directly to the federal government, whose contracts tend to be stickier and long-term. In addition, NTNX has a significant growth opportunity internationally and the Bain investment could help kickstart the initiative to expand overseas.
After quickly popping over 30% after stronger than expected quarterly earnings and the $750 million Bain investment, the stock has retracted quite a bit and is now down slightly since earnings. With the stock still down nearly 35% year to date and valuation now ~2.8x my estimated 2021 subscription revenue, I believe long-term investors should be optimistic about building a position.
Subscription revenue was nearly 80% of 2020 revenue and 87% of Q4 revenue, meaning this revenue stream is likely to represent around 90% of revenue in 2021. With a majority of their revenue now being highly visible and recurring, revenue growth will become more stable and faster. When comparing NTNX to other subscription-based companies, their forward revenue multiple of only ~3.2x is cheap and long-term investors should take advantage of this dislocation.
Q4 Earnings And Guidance
During Q4, revenue grew over 9% to $327.9 million, which was nicely above expectations for ~$319.5 million. Nutanix continues to push forward on the journey to becoming a subscription-based company, with subscription revenue now representing 87% of total revenue, up from 65% in the year ago period.
Source: Company Presentation
Since moving to subscription revenue, the company has seen their revenue growth drastically decelerate and share price take a huge hit. For subscription-based companies, investors are very focused on billings growth. While total company billings only grew 5% during the quarter, subscription billings grew an impressive 29% to $341 million and represented 88% of total billings.
Source: Company Presentation
Gross margin came in at 83.0%, which was above the 80.0% seen in the year ago period. The company also generated $3.6 million in operating cash flow, and while this is still far away from normalized levels, this was better than the -$9.7 million operating cash flow loss in the year ago period.
One important aspect of the company is their ability to maintain customer success, even during more challenging economic conditions. At the end of Q4, the company had 17,360 customers, including 920 in the Global 2000 and maintained an impressive 96% customer retention rate. Some key Global 2000 wins in just the last quarter include AIB Group, Cadence Design Systems, Dongfeng Renault, MayBank Singapore, and QBE Insurance. I believe the company’s ability to maintain their strong customer base will help with investor confidence in longer-term revenue growth.
Other Notable Company Changes
The two other big changes to the company were the announcement of the company’s CEO, Dheeraj Pandey, intent to retire from the company. The company is currently conducting a search effort to identify the replacement CEO. In the meantime, Dheeraj will remain Chairman and CEO until the new CEO is selected and appointed.
In addition, Nutanix also announced a $750 million investment from Bain Capital Private Equity in the form of convertible notes. Nutanix intends to use these proceeds to invest in their growth initiatives, which could ultimately lead to a higher revenue and billings growth rate over the long-term.
The $750 million capital investment from Bain provides a strong base of capital to invest for long-term revenue growth. In recent quarters, NTNX achieved their FedRAMP certification, thus enabling them to sell directly to the US federal government. This is just one area of growth that NTNX could invest in via the funds received from Bain. In addition, the company will continue to invest in expanding their revenue base internationally. Now that they have moved past the license model, the company will look to grow more in international markets, which remains a relatively small portion of the company’s current revenue.
This is a rather large investment for a company whose market cap is just over $4 billion. I believe this also signifies Bain’s confidence in the long-term prospects of Nutanix and believes by investing a lot in the near-term, this will result in higher growth rates in the future.
In addition, Bain was also given two seat on the company’s Board, which will be filled by David Humphrey and Max de Groen. With the investment and Board changes expected to become effective in September, the company could potentially start to see benefits in early 2021.
For the past several quarters, this transitioned has put a lot of pressure on the company’s growth numbers, primarily revenue and billings. Legacy license revenue would be a large upfront revenue input, which ultimately helped improve revenue growth. However, subscription revenues have much higher visibility and are more recurring, thus providing more stable cash flows. While the company is largely behind this massive transition in operating models, I believe the company remain undervalued given current valuation levels.
With the company become nearly 90% subscription-based in terms of revenue and billings, I believe the company should start trading like other subscription-based companies. In the past, companies like Adobe (ADBE), Autodesk (ADSK), and Splunk (SPLK) have transitioned from legacy license/hardware companies into subscription-based companies. All three are examples of stocks now trading at higher revenue multiples, given the highly recurring and visible nature of their revenue streams.
The company has a current market cap of $4.30 billion and with ~$910 million of cash/investments and ~$460 million of debt, the company has a current enterprise value of ~$3.85 billion.
While the company did not provide formal guidance for the year, management did note they expect run-rate ACV to grow in excess of 20% in Q1 2021, which compares to run-rate ACV of 29% growth in Q4. During fiscal 2020, subscription revenue was $1.03 billion, representing just under 80% of total revenue and grew and impressive 59%. Given the rapid transition to subscription revenue and the company’s focus on this, I decided to only value the subscription revenue when determining valuation.
Assuming the $1.03 billion of subscription revenue remains healthy and grows another 35% in 2021, the company could see subscription revenue of nearly $1.40 billion. Using the current enterprise value of ~$3.85 billion, this implies a 2021 EV/subscription revenue multiple of only 2.75x. Typically, a company with over 80% of revenue being subscription in addition to 80%+ gross margins would receive a higher valuation multiple. Compared to the above peer group, NTNX’s stock screens very well.
I believe the two biggest things holding NTNX back are negative operating margins resulting in weak cash flow and minimal revenue growth over the past several quarters. The low revenue growth can be explained by the company’s decision to transition away from license/hardware revenue. However, investors will continue to look for operating margins to expand before placing a higher revenue multiple for valuation purposes.
Given the continued pullback since the company reported earnings, I believe long-term investors should look to add to their positions as the company remains poised for strong long-term revenue growth and margin expansion. The company still has room to grow internationally and within the Global 2000 base (NTNX has 920 customers in the Global 2000). Over time as revenue grows at a higher, more stable level, the company’s valuation could also expand.
Risks to the company include increased competition from larger players in the market. Typically, larger players can offer lower pricing because of their economies of scale, which could cause increased pressure on NTNX’s sales group. In addition, valuation can be challenging for companies who are valued on revenue multiples. If the company were to continue to experience low revenue growth and uncertainty remains around their subscription revenue transition, the company’s valuation may remain low.
Disclosure: I/we have no positions in any stocks mentioned, but may initiate a long position in NTNX over the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.