NTNX - Nutanix: Slow Progress
2023-06-14 08:35:01 ET
Summary
- Nutanix's business is proving resilient, despite the tough macro environment.
- Recent strength must be weighed against the temporary tailwind from supply chain improvements and slowing customer growth.
- Nutanix's valuation is modest, but this has not been sufficient to drive the stock higher in the past. Continued growth and a transition to profitability will likely be needed.
Nutanix's ( NTNX ) business and stock have had a difficult multi-year period, due to both a volatile macro environment and the company undergoing a business model transition. Supply chain constraints are no longer a headwind, and the business transformation is a clear success. While it has taken the market a long time to recognize what was obvious several years ago, much of this is now embedded in the stock price. Despite the recent move higher, the stock still isn't particularly expensive, although a deteriorating macro environment and inflated revenue growth are downside risks.
Market
Nutanix is facing the same headwinds as many software companies, although the company has probably been somewhat sheltered for several reasons. Deals are facing increased scrutiny, causing the elongation of sales cycles. Nutanix also believes that customers are sweating existing assets to delay making purchase decisions.
While this should be impacting growth, Nutanix's server partners have faced supply chain bottlenecks in recent years, which have caused a backlog to form. These constraints appear to have normalized, meaning Nutanix's business is no longer being negatively impacted. Nutanix's growth has also likely accelerated as it begins to work through this backlog. Management stated that they had a record backlog at the beginning of 2023, which is benefitting both revenue and ACV billings.
The volatile macro environment is also causing customers to put more thought into what is deployed in the cloud versus on-prem. Businesses are continuing to prioritize digital transformation and data center modernization, but the focus on hybrid deployments has likely increased, potentially benefitting Nutanix.
There appears to be two schools of thought regards how the economy will evolve going forward:
- The recent slowdown has been due to a supply chain bullwhip effect and rapid rise in interest rates. The economy will reaccelerate in the second half as supply chains normalize and businesses and consumers adjust to rates.
- The economy is still working its way through backlogs and stimulus from the pandemic, which has muted the impact of monetary policy. The economy will continue to slow going forward as monetary and fiscal policy become tighter and consumer balance sheets weaken.
Markets appear to be expecting the first scenario and a significant improvement in profits in the second half of 2023. Within technology, expectations are also being impacted by the hype surrounding LLMs. The rebound in semiconductors is viewed by many as an early sign of the likely impact of AI on the technology sector more broadly.
Most signs are pointing towards an ongoing slowdown rather than a reacceleration though, and this reality could negatively impact many stocks in the second half of the year. While Nutanix's valuation and expected growth are modest, it is unlikely to be immune if the broader market pulls back.
Table 1: Nutanix Analyst Revenue Growth Estimates (source: Created by author using data from Seeking Alpha)
Nutanix
Nutanix's business is based around trying to abstract IT complexity for users, with a growing focus on storage and databases. Nutanix is also focused on extending its technology across environments.
New products include:
- Nutanix Data Services for Kubernetes - brings Nutanix's enterprise class storage, snapshots, and disaster recovery to Kubernetes applications.
- Multi-Cloud Snapshot Technology - delivers cross-cloud data mobility by enabling snapshots directly to cloud native storage.
- Nutanix Central - cloud-delivered management solution that provides a single console for visibility, monitoring and management across environments.
- Project Beacon - a hybrid multi-cloud PaaS offering that aims to decouple applications and data from the underlying infrastructure. This allows developers to build applications and run them anywhere.
Nutanix also recently sold its Frame business unit to Dizzion, a Desktop-as-a-Service vendor. Frame enables the streaming of applications and desktops from the cloud to a web browser and was acquired by Nutanix in 2018. While this business was beneficial during the pandemic, Nutanix's strategic focus appears to be shifting.
Financial Analysis
Nutanix's third quarter results came in ahead of guidance, causing the stock to surge. While growth is currently solid, there is a question regarding how large an impact the backlog drawdown is having.
Table 2: Nutanix Q3 FY2023 Growth (source: Created by author using data from Nutanix)
Q4 guidance is for 23% revenue growth YoY, although the comparable period in the previous year was weak. Nutanix's sustainable growth rate at the moment is probably more in the low to mid-teens, particularly when accounting for the impact of backlogs.
Figure 1: Nutanix Revenue (source: Created by author using data from Nutanix)
Sequential total customer growth has softened significantly over the past year, which will likely begin to pressure growth at some point. This is probably more indicative of the underlying state of the business than revenue or ARR growth.
ASPs have reportedly been stable, which could indicate that increased competition has not been a factor. Nutanix are also been trying to engage with service provider partners more. This channel has been underutilized in the past, but management believe they are now beginning to gain traction. This could help to support customer growth going forward, particularly when the macro environment improves.
Growth of customers with more than 1 million USD ACV remains strong, indicating that Nutanix is having success selling a broad portfolio of solutions. Nutanix's NRR is also still in the 121-125% range, demonstrating solid expansion amongst existing customers.
Figure 2: Nutanix Customers (source: Created by author using data from Nutanix)
The number of job openings mentioning Nutanix in the job requirements has been solid in 2023, which could be indicative of customer demand. There appears to be some cyclicality to this data though.
Figure 3: Job Openings Mentioning Nutanix in the Job Requirements (source: Revealera.com)
The true economics of Nutanix's business are now starting to become more apparent as the renewal business continues to perform and becomes a larger part of the business mix. The burden of operating expenses is slowly declining, and this will continue as Nutanix further scales its business.
Figure 4: Nutanix Operating Expenses (source: Created by author using data from Nutanix)
Valuation
Over a longer period of time, the stock should do well as Nutanix continues to grow and improve its profit margins. Based on discounted cash flow analysis, I estimate that Nutanix's stock is worth roughly 40 USD per share.
Nutanix's valuation is still fairly modest given the company's growth rate and margins. It is not really clear what could cause the discount relative to peers to close though, given that Nutanix doesn't have a strong narrative to sell investors.
Investors also need to consider the value of Nutanix to a strategic acquirer. Broadcom's ( AVGO ) attempted acquisition of VMware ( VMW ) demonstrates that there is interest in the area. Takeover rumors have circulated around Nutanix for a number of years and yet nothing has eventuated, which likely reduces the probability of an acquisition at this point.
Figure 5: Nutanix Relative Valuation (source: Created by author using data from Seeking Alpha)
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Nutanix: Slow Progress