Why Invest in Nutanix Now?
Betting on Nutanix’s Transition to SaaS and the Hybrid Cloud
By Dana Iverson, Grace Hong, Raymond Xu, and Mittie Doyle
Our Investment Thesis
Nutanix has a customer-first culture and a best-of-breed software suite that allows it to capture share in markets bolstered by the largest macro trend in IT: the shift to the cloud. The market fails to give Nutanix due credit for its impressive software metrics because of its historical background selling hardware appliances through perpetual licenses.
As Nutanix is in the midst of product transformations and parallel subscription pricing, we believe the market underestimates the company’s potential to up-sell its installed customer base, as well as expand across its new public cloud partnerships with Azure and AWS.
The addition of industry experts, like new CEO Rajiv Ramaswami, and largest shareholder Bain Capital add further ability to Nutanix’s long-term execution towards revenue growth and profitability.
We believe that the company’s pivot to SaaS will re-rate its valuation to comparable SaaS multiples and drive its long-term growth trajectory. Nutanix is currently trading at about $30 / share, and we project it will reach a target share price of $77 in 5 years yielding 27% IRR.
About Nutanix (NTNX)
“Nutanix serves as the glue between enterprises’ data centers and increasingly multi-cloud environment.”–David Blumberg, Seed-Stage Investor in Nutanix
Founded by Dheeraj Pandey, Mohit Aron, and Ajeet Singhin in 2009, Nutanix is known as a leader in HCI hardware technology. Over the last few years, it has fully transformed into a software company offering an enterprise cloud platform to manage the hybrid and multi-cloud. Through one, easy-to-use interface, Nutanix’s software simplifies IT management, providing cost savings and operational efficiency to its customers.
Historical Stock Price Performance
Quick Metrics
- Market Cap: $6B
- Fiscal Year 2020 Revenue: $1.3B
- 2Q21 Gross Margin: 82.7%
- Customer Retention Rate: 97%
- Total Customers: 18.8K
- Net Promote Score: 90
- FY20 ACV Dollar-Based Net Expansion Rate: 125%
- Total Employees: 6,200+
Technology Overview
Leveraging hyper-converged infrastructure (HCI), Nutanix digitizes the data center to “make IT infrastructure invisible.” With Nutanix’s leadership and hardware innovation, HCI technology has disrupted the legacy data center. HCI unites data center hardware with intelligent software–allowing IT teams to focus on adding value to other areas of the organization.
What is Hyper-Converged Infrastructure (HCI)?
Legacy data centers were characterized by separate computing, networking, and storage silos, which increased cost and complexity to scale data storage. HCI’s software-defined IT infrastructure converges the legacy hardware system into one single architecture. 92% of enterprises who run on-premises data centers have deployed or plan to deploy HCI.
Why initially go to market with hardware technology?
“Nutanix always wanted to be a software company but strategically went to market with hardware. The transition to software has been in the cards from the beginning.”–Seed-Stage Investor in Nutanix
#1 Market Timing: When Nutanix was founded, the world was moving fast to manage increasing amounts of data, and the demand for more data storage capacity was outpacing existing data storage technology. Existing hardware servers were not sufficient, nor cost-effective to scale. From his time at Google, Nutanix Co-Founder Mohit observed that the demand for digital storage was growing exponentially, but enterprise budgets couldn’t keep up with the exponential costs associated with scaling bulk storage solutions from vendors like Dell and HP. Instead, enterprises were in-market for technology with a lower price curve. Nutanix’s solution scratched that itch by providing cheaper, less clunky hardware technology, alongside software to make that hardware easier to manage and scale. Through their cutting-edge hardware, Nutanix was able to solve for enterprise’s most urgent pain paint at the time, data storage, and deliver a premium value proposition to its first customers.
#2 Software Distribution: Nutanix also used its appliance-strategy to get their software into the hands of customers. Nutanix has always sought to bifurcate their software from their hardware products. They built their software to be hardware-agnostic–usable on top of any hardware platform–to position it as a commodity of its own. However, while some early adopters may have been sophisticated enough to buy Nutanix’s software by itself and apply it to their own hardware systems, it was strategically easier for Nutanix to combine both their software and hardware products and sell smaller customers a simple, out-of-the-box solution. Nutanix has since pivoted to focus exclusively on software in order to take advantage of better margins and avoid competing with hardware channel partners like Dell and HP.
How Does Nutanix’s Software Platform Use HCI?
HCI is also one of the most popular architectures for enabling the hybrid cloud and multi-cloud. Virtualizing all elements of previously hardware-defined IT systems, HCI is the fundamental building block for transforming legacy data centers into distributed cloud-like infrastructure. Like public cloud infrastructure, HCI is API-driven and can be managed using the same techniques used to manage the public cloud.
Nutanix has expanded its ubiquitous platform to integrate services across public and private clouds, thereby enabling the hybrid cloud. Nutanix’s software platform allows IT teams to set up communication between and orchestrate multiple cloud environments and application deployments.
Nutanix’s foundational product suite is Nutanix Core, which includes AOS, AHV, and Prism. AOS is Nutanix’s HCI software, which can be bought by itself or with a turnkey appliance. AHV is Nutanix’s hypervisor that allows IT teams to virtualize their data centers without hypervisor specialists. Hardware- and platform-agnostic, these software solutions run servers and enterprise applications from any vendor. 40% of Global 2000 use Nutanix’s foundational products to modernize their data centers.
More companies are moving to the private cloud, particularly in segments like financial services. Nutanix Essentials enables its core infrastructure to run like a private cloud. Prism Pro creates an application dashboard, while Flow provides application visibility, and Calm automates workflow.
Nutanix Enterprise further enables the next generation of the hybrid cloud. Xi Frame provides Desktop-as-a-Service (DaaS) for remote IT teams to access apps on any device from any location without vendor lock-in. Xi Beam provides cost optimization tools for IT teams to manage their cloud investments. Nutanix is expanding into fast-growing verticals and adjacent TAM opportunities, like Edge Computing and DeVops with Xi IoT, as well as innovative technology, like Kubernetes with Karbon.
“IT doesn’t need to be experts in how the storage works. Nutanix is the storage expert, and if IT teams have any problems, they can just call them up. Nutanix has software that handles that layer, which makes it much easier for IT teams to focus on adding value to other parts of the organization.”–Charles Kruger, Senior Director at Princeton University Enterprise Infrastructure Services
Industry Trends & Tailwinds
Hybrid cloud has emerged as the leading enterprise IT strategy. Today, 87% of enterprises employ the hybrid cloud, meaning they utilize a combination of both the private and public cloud. IT decision-makers consider the hybrid cloud their ideal operating model because it is the most cost-effective, flexible, and secure option for most enterprises.
COVID has also accelerated enterprises’ digital transformation efforts and the need to upgrade IT infrastructure to support more distributed workforces. 46% of enterprises increased their investment in hybrid cloud solutions, like Nutanix, as a result of COVID.
Connectivity to and portability between the private and public cloud will only become a more important design consideration for IT teams. Given the long-term benefits of the hybrid cloud model, as well as its enabling hyper-converged software, we believe these trends are here to stay.
Market Size & Growth By Major Platform Segment
Key Growth Drivers
- Product — Nutanix is expanding its product offerings away from point-products towards a full-service platform solution, allowing Nutanix to up-sell customers on the platform’s unique, value-add capabilities.
- Market — Nutanix maintains a durable market share in its core HCI market growing at 28% CAGR through 2025. Nutanix is also building out their products suite in fast-growing markets, like edge computing, to expand into large adjacent TAM opportunities.
- New Executive Management — The experience of new management, including the new CEO (former COO of VMware) and the new largest shareholder Bain Capital, brings a strong a strong vision and ability to execute ongoing growth initiatives and channel partnerships.
- Business Model Transition — Transition to a SaaS business model demonstrates that Nutanix is on its way to strong ARR growth. The move from TCV to ACV contracts improves sales efficiency and deal economics, as it expands from middle market to enterprise customers.
- Partnerships — Creating more channel partnerships with leading public cloud vendors, like AWS and Azure, will reduce S&M cost of direct sales and help penetrate larger customer sets. Nutanix may also be an attractive acquisition target for public cloud companies and hyperscalers, like Google Cloud, eager to build out their technology as IT becomes the foundation of business going forward.
New Management Team
In December 2020, Nutanix announced Rajiv Ramaswami as its new CEO and President. Ramaswami succeeds Nutanix’s co-founder and now–retired CEO Dheeraj Pandey.
With 30 years experience scaling IT infrastructure at Broadcom, Cisco, Nortel, and IBM, Rajiv was most recently COO at VMware, one of Nutanix’s top competitors.
As a result of the move, VMware has actually filed a lawsuit against Rajiv for breach of contract, although they have a weak case since CA is notoriously pro-defendant in talent poaching/non-compete cases.
Ramaswami brings strategic knowledge on SaaS transitions. Joining VMware in 2016, he helped double their SaaS/subscription revenue, subsequently surpassing on-premise infrastructure sales. Rajiv also created the VMware/AWS partnership, which prepares him to deepen Nutanix’s partnerships with legacy vendors and hyperscalers alike.
In August 2020, Bain Capital invested $750M via convertible notes, becoming Nutanix’s largest shareholder and adding two investors to the Board. Bain Capital is therefore positioned to have an outsized and long-term influence on Nutanix’s capital return strategy. Previous investments such as Blue Coat (acquired by Symantec for $4.65B) highlight Bain Capital’s deep expertise in the on-premise to cloud software transition.
Key Competitive Advantages
Strong market leadership in HCI (~30% market share) positions Nutanix well as they up-sell existing customers and expand into the hybrid cloud. Dell’s VMware, their main competitor, has ~40% market share in HCI.
- Middle Market Concentration — Nutanix has its start in mid-sized enterprises with 94% of customers outside of the Global 2000. Models a trend similar to SaaS businesses ServiceNow and Salesforce, both of which expanded out from initial concentration in the middle market.
- High Customer Retention — Nutanix maintains 97% customer retention. Holds a 6-year average NPS score of 90, almost double that of VMware and Cisco and higher than Google, Microsoft, and Apple.
- Hardware Agnostic Software — As consolidation occurs more swiftly in the cloud market, Nutanix’s hardware-agnostic software stands out from VMware for customers frustrated with vendor lock-in.
New GTM Strategy
- Sales Model TCV to ACV Transition — Nutanix is moving its sales compensation strategy from Total Contract Value to Annual Contract Value based. The ACV-first focus incentives sales teams to sell contracts with shorter terms. Contract terms go down, so customers re-new more often. More efficient customer renewals leads to better deal economics for Nutanix, as well as provides customers with more optionality in software subscriptions.
- Partnerships with Hyperscalers — In August and September 2020, Nutanix announced new partnerships with AWS and Azure. These partnerships expand Nutanix’s ubiquitous reach.
- New Channel Partnership Program — Elevate, Nutanix’s new channel partnership program, equips partners with marketing and pricing support. The program has seen double-digit expansion and leverages partners’ strengths to help up-sell Nutanix’s entire product portfolio.
- “Land & Expand” Sales Strategy — Nutanix plans to launch an incipient renewal engine to drive follow on sales from current customers. This strategy allows Nutanix to up-sell existing customers and capture greater value from subscription-based contracts.
- Geographic Expansion — International customers are late adopters of the cloud. Nutanix is focusing on international expansion to penetrate the international market and address new customer segments.
Projected Returns
- Current Share Price: ~$30
- Target Share Price: $77
- 5-Year IRR: 27%
Valuation Methodology
We completed a rough revenue-based valuation considering customer and contract value growth as the main drivers of Nutanix’s future growth. We then applied an EV/Revenue LTM multiple to the FY26 revenue and estimated a share dilution schedule to arrive at our target prices.
We opted for this multiples-based approach instead of a DCF because we think that the management’s current guidance on their ACV to billings bridge and their steady state margins is incomplete. We expect them to update this at their upcoming Investor Day in June, which will also help the Street better recognize Nutanix’s hybrid cloud growth story.
Base Case Assumptions
- Nutanix is reasonably successful at enterprise penetration, which is reflected in 15–25% ACV contract growth for new logos through 2025.
- Renewals become 50%+ of revenue by end of 2024.
- Re-rates to CTXS and NEWR-type multiples (6.5X).
- Strong IT spending for cloud as evidenced by Microsoft’s record quarter makes 2021 a strong year for Nutanix subscription uptake.
Stock-based compensation also motivates high share price performance. Performance RSUs compose ~70% of CEO Ramaswam’s total equity grant. All of his performance RSUs vest if Nutanix’s share price hits ~$70 in 4 years. We are confident in management’s execution and capital return capabilities, so the Board approved 4-year vesting framework for Ramaswami demonstrates strong incentive alignment and an anchor point for our returns analysis.
See the pitch-deck for more detailed cases and assumptions.
Risks
- TCV to ACV Transition — Shift to a subscription-based business model compresses top line growth due to changes in timing of revenue recognition. Results in customer churn which increases customer acquisition and retention costs.
- Operating Losses Greater Than Revenue Growth — High cash burn with net losses every quarter since inception. FY21 operating expenses — particularly R&D, S&M expenses — are projected to remain high.
- Competition Threatens Unique Value Proposition — Larger competitors could build similar products and have a larger revenue base to scale.
- Recent Executive Sell of Shares — Insiders recently sold significant portions of their shareholdings despite record growth. Former CEO Dheeraj Pandey sold 93% of his stake in Nutanix. CCO, Tarkan Maner, sold 49% of his stake. CAO, Aaron Boynton, sold 17% of his stake.
- VMware Lawsuit Against Rajiv — VMware has sued Rajiv for leaving, which may impede the roll out of Nutanix’s strategy.
- COVID-19 Pandemic Economic Volatility & Uncertainty — Slowing IT spend in customer segments particularly impacted by the pandemic may detract from bottom line growth.
Mitigants
- TCV to ACV Transition — New management team brings a strong vision and execution ability to the transition. Continue to sustain strong ACV billings growth rate of 10%+ Y/Y, as well as maintain high customer satisfaction with current 97% customer retention.
- Operating Losses Greater Than Revenue Growth — Continue to drive revenue growth through “land and expand” business model, as well as enhanced focused on renewals. Stabilize projected contract term rates upon completion of ACV transition to provide leverage.
- Competition Threatens Unique Value Proposition — By offering complimentary products, like Nutanix Clusters, Nutanix is currently positioned as a partner, not a competitor, with vendors like AWS and Azure. AHV uptake at 49% of new nodes shows Nutanix leverages its complementary product suite to remain competitive.
- Recent Executive Sell of Shares — Former CEO Pandey sale of shares represents a clean break from the company. New CEO has strong incentive alignment with share price performance. Maner and Boynton both have significant unvested equity compensation since joining the company. This may have been for liquidity needs.
- VMware Lawsuit Against Rajiv — VMware has a weak case since CA is notoriously pro-defendant in talent poaching/non-compete cases.
- COVID-19 Pandemic Economic Volatility & Uncertainty — Enterprises have actually accelerated digital transformation efforts, which has been a tailwind for Nutanix’s subscription offerings. To meet the drastic increase in customer demand for remote infrastructure, Nutanix has launched remote IT solutions, like Foundation Central.
Thank you to David Blumberg and Charles Kruger for your contributions to our research and feedback on our stock pitch.
