- The Nutanix IPO has been a roaring success, with post IPO gains mounting to 178% as of 3 October.
- The stock is now trading at ~13.5 times Trailing Twelve Months (TTM) sales.
- We look at the pros and cons of buying Nutanix shares following the explosive IPO.
Shares of San Jose, California-based Nutanix have made explosive gains since the company's IPO on 30 September. Nutanix shares are now up a staggering 178% from the company's IPO price of $16. We covered the Nutanix IPO days before the stock debuted on the NASDAQ, calling it an attractive opportunity. But with Nutanix valuations swelling to ~13.5 times TTM sales, should you still consider buying into the stock?
First, the good part
Nutanix gives tech investors what they seek most, growth. And the company has healthy gross margins to boot, implying that it can become profitable if it decides to put a lid on costs.
Nutanix is growing at a stellar pace. The company closed its fiscal year 2016 on 31 July, recording a Year on Year (YoY) growth of ~84%. What investors would also have loved, is the fact that growth accelerated in Q4, touching 89%, 11 percentage points higher than the preceding quarter. Albeit off a relatively small revenue base, Nutanix's growth is impressive. For the fiscal year 2016, Nutanix raked in sales worth ~$445 million, up from ~$241 million in FY 2015.
It's also worth noting that Nutanix has managed to grab a sizeable chunk of the market. Industry analyst IDC estimates that the hyperconverged products market more than doubled this year, to $982 million, implying that Nutanix has bagged a huge market share. That can be a good thing and a bad thing, because some might worry about the upside room, but this market is estimated to grow to $4.8 billion over the next three years. And Nutanix has a customer base of 3,768 customers, including the likes of Toyota Motors, Best Buy (NYSE:BBY) and Nintendo.
Nutanix also manages impressive and improving gross margins. During its fiscal year 2016, Nutanix delivered an average gross margin of 62%, up from 58% in the preceding year, and 52% in the year before that. Healthy gross margins imply that Nutanix could potentially turn profitable if it decides to cut costs. But, that doesn't seem likely to happen anytime soon.
What Are The Risks?
Nutanix is a fast growing company, but it's still pretty small. With the market for hyperconverged products expected to grow at a fast clip, it's unlikely that Nutanix will be able to cut Sales and Marketing (S&M) spends drastically, implying that it's not likely to turn profitable soon. Nutanix spent an average of 65% of revenue on S&M in FY 2016, and that hasn't reduced significantly from ~67% in the preceding year.
R&D (research and development) spends have declined from ~30% of revenue to ~26%, and G&A (general and administrative) spends have fallen from ~10% of sales to ~8%. Combined with the improvement in gross margins, these changes have brought net losses (margins) down from ~52% to ~38%, which is great. But Nutanix is still losing a lot of money. Even if you assume that Nutanix has some elbow room to cut S&M spends, being the market leader, the company is unlikely to do so at this stage in its life cycle. One would imagine that the priority will remain growth, and cutting S&M substantially to become profitable could hurt the company's growth trajectory. In fact, given it's current dominance, it seems likely that Nutanix will continue to chase sales growth aggressively.
Other Key Trends
One positive for Nutanix is that operating cash flows have started to turn positive, with the company recording $3.6 million in operating cash flows during FY 2016. That compares with negative operating cash flows of ~$46 million in FY 2015, and ~$26 million in FY 2014. Free Cash Flows (FCF) have also shown an improving trend, standing at a negative $39 million, down from a negative $65 million two years ago, and a negative $49 million one year ago. These are positive signs, which indicate that Nutanix is using its cash more efficiently every year. That said, as long as FCF remains negative, Nutanix will continue to dip into its cash reserves to fund capex.
Also Read: Delaying The Airbnb IPO Is A Smart Move
Summing It Up
After a couple of fabulously successful days on Wall Street, Nutanix is now valued at just over $6 billion, implying a price to sales ratio of ~13.5. That's not outlandish for a tech company that's just gotten listed, but it's still steep. The narrative here is a very familiar one for those who have followed tech 'unicorns' over the last few years, stellar growth, heavy losses and steep valuations. But Nutanix, now seen as the torch bearer for upcoming tech IPO's, seems to have a few things going for it.
First, it's a market leader, with significant market share in a fast growing industry. It's improving cash flow metrics indicate that Nutanix may not be your traditional cash guzzler. Given the stickiness in sales and marketing spends, Nutanix seems unlikely to turn profitable soon. However, if Nutanix can continue to cut operating losses by continuing to expand gross margins, there could be a really big opportunity here.
Last but not the least, it's worth noting that not long before the company's IPO, Nutanix CEO Dheeraj Pandey forfeited $17.5 million worth of restricted stock, to be returned to the equity pool. A move that gave Nutanix the flexibility to redistribute these stock units to current and future employees, saving investors from additional dilution of equity to that extent. We've seen the likes of Jack Dorsey of Twitter and Jeff Weiner of LinkedIn do this. But what's different is the situation. These moves came at a time when Twitter and LinkedIn were languishing, to restore the morale of employees and investors. In contrast, Pandey's move comes at a time when the company was headed for an IPO. And given that IPOs often make promoters a lot of money, Pandey's move is worth taking note of.
All put together, at these valuations, Nutanix is a risky investment option, no doubt. But Nutanix doesn't come across as your traditional unicorn. At this point, conservative investors would do well to watch the company for a while before investing in it. For the more adventurous investors, waiting for corrections and buying on dips could be a better way to enter the stock.
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