Initial Thoughts On Nutanix

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About: Nutanix (NTNX)
by: Sniper Fund
Summary

Nutanix has hit the ground running with strong billings growth.

The duration of this growth will depend on competition.

The next few quarters will be high risk due to uncertainty over competition.

Nutanix (NASDAQ:NTNX) is a recent IPO and listed on the Nasdaq on September 30, 2016. NTNX price action has been very volatile since it started trading. NTNX is an early leader in the fast-growing Hyper Converged Infrastructure (HCI) market. Gartner is bullish on this space and mentioned in the 2016 Magic Quadrant for Integrated Systems, "Twenty percent of mission-critical applications currently deployed on three-tier IT infrastructure will transition to HCISs by 2020."

Today we will focus on the HCI market where Nutanix competes and not the Converged Infrastructure market.

If we break down the three tiers in detail, these are Servers, Storage and Virtualization. NTNX's S1, page 5 mentioned the following statistics on the three-tier infrastructure:

  • The x86 server market, which according to Gartner, is expected to be $44.9 billion in 2016.
  • The storage systems markets, which according to IDC, is expected to be $43.7 billion in 2016.
  • The virtualization software market, which according to Gartner, is expected to be $4.4 billion in 2016.

Based on the Gartner 20% prediction, it's fair to say $16 billion of spend will likely be disrupted and at risk. This doesn't mean the HCI market will be worth $16 billion as customers would require a lower cost of ownership to transition to the new technology.

Companies at risk - Server

The server market is dominated by HP, Dell and IBM (NYSE:IBM), which own over 50% of the market. A weak server market is nothing new for these players as they all face fierce competition from the original design manufacturer (ODM) targeting hyper scale customers directly. Expect these players to closely monitor the HCI market and introduce their own solutions over time. In the case of Dell, they have an OEM relationship with NTNX.

Companies at risk - Storage

EMC, which recently merged with Dell to create Dell Technologies is the worldwide leader. HP, NetApp (NASDAQ:NTAP) and IBM also feature in the top 5. Clearly, DELL, HP and IBM will see a threat from the HCI market on both their Server and Storage businesses. EMC and NTAP will be looking very carefully at the HCI market. EMC has already hedged its bets with the introduction of VxRail in Feb 2016, a direct competitor to Nutanix.

Companies at risk - Virtualization

VMware (NYSE:VMW) and Microsoft (NASDAQ:MSFT) are the largest players in this space. The common thread amongst Server, Storage and Virtualization is Dell Technologies and it's worth understanding where Dell fits in.

Dell - Key Risk 1)

Firstly, Dell Technologies is a leader in the Server Market, and leads in the storage market through newly acquired EMC and finally is the leader in the Virtualization market through its ownership of VMware. The newly refreshed VxRail is now based on Dell Servers and is a direct competitor to NTNX. For companies already using Vsphere and EMC storage, the VxRail could do well in competitive back-offs.

Dell - Key Risk 2)

Dell is an OEM partner of NTNX and has extended their partnership to 2021. Ultimately, however, if EMC and Dell decide to sell their own solutions over NTNX then this may harm their business. The S1 indicates Partner B is 20% of revenue, however the name of the partner is not disclosed and it's unclear how much concentration is tied up to Dell.

Positives so far

Clearly, NTNX has a lot of things going for it including the following;

  • Solid revenue growth with 87% billings growth.
  • $900m annual billings run rate based on most recent quarter.
  • Operating cash flow from operations.
  • Increased deferred revenue.
  • Introduction of NTNX hypervisor Acropolis.
  • Early leader in the HCI market.

What to Look for to gain conviction in NTNX

Why not dive in and buy the stock? For the moment, it is prudent to sit on the sidelines until we have more clarity on the following;

  • Assess the competitive landscape over the next few quarters, with a keen interest on the competitive win rates vs. EMC Dell's VxRail. It's also worth keeping an eye on other storage and server players.
  • Dell and NTNX have extended the OEM agreement until 2021. It is worth keeping an eye on the relationship to ensure Dell continues to sell NTNX. Dell and NTNX are both partners and competitors. Although the level of concentration of revenues is unclear, what is clear is NTNX will need Dell to keep growing their billings.
  • NTNX aspires to add additional tiers into their platform, namely Networking and Security. This would increase their TAM and differentiate themselves from some of their competitors.
  • NTNX will need to meet their free cash flow target by Q4 2017. Given their billings run rate is $900 Million, they should be free cash flow at this level of scale.

If NTNX can navigate the key challenges ahead then shareholders will likely be rewarded and NTNX will be a free cash flow multibillion-dollar business. For now, it is best to be a fence sitter as the next few quarters will be high risk due to higher levels of uncertainty around the competitive environment.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within 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.