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VMware: Stay Long

VMware (NYSE:VMW), the company best known for its invention of so-called “virtual machines,” or the ability to use software to allocate operating system resources from a remote server to a third-party client, deserves a lot more love than it’s getting, in my opinion. The company posted a solid Q3 underlined by fantastic billings, a top-line beat, and a deluge of free cash flows. Still, despite the good news, VMware’s stock practically stayed flat after the earnings announcement.

It’s been a tough week for the technology sector. The NASDAQ suffered a sharp reversal on the second-to-last trading day of November as tech stocks sold off and investors piled into beaten-down value names in the retail sector. The beginnings of a trend are clear: as we head into 2018 and the S&P 500 continues to shatter records daily (the most recent rally being fueled by supportive Fed commentary), value stocks (and stock selection itself) are top-of-mind topics.

VMware has proven itself as a unique value play – not words commonly used to describe a stock trading at ~24x P/E (though as I mention in a prior article, VMware generates much more free cash flow than GAAP earnings, and its free cash flow valuation is more in line with a cheap 18x multiple – a bargain, especially after this quarter’s cash flow results). Like industrial value names, VMware is a company that’s had to reinvent itself. Back when cloud computing was just a research project, VMware reigned king as client-server computing was the bedrock of enterprise IT, with each company maintaining its own servers and using VMware’s vSphere hypervisor to partition computing resources to “thin clients” – a fancy name for the desktop terminals that fill office desks, but with no computing guts themselves. These days, however, more and more workloads are being shifted to the public cloud, primarily into Amazon’s AWS (NASDAQ:AMZN), and out of corporate-owned “on-premise” data centers.

But to keep itself from becoming irrelevant, VMware has initiated a partnership with AWS to offer VMware Cloud on AWS, which eases the burden on CIOs who want to retain their existing VMware infrastructure while migrating into a public cloud environment. Having rebranded itself as a cloud-friendly vendor that can support “hybrid cloud” environments, VMware is experiencing a renaissance, with revenues growing at double digits for the second sequential quarter – which is fairly uncommon for a large-cap legacy IT company with ~$8 billion in revenues that is dealing with revenue declines in its out-of-vogue products. While Oracle (NYSE:ORCL) isn’t a perfect comp because it’s 4x the size of VMware, Oracle is also a company that is trying to shift from its on-prem legacy to a cloud environment – and Oracle grew only 3% y/y in its last quarter. VMware, by contrast, has really gotten into the swing of things with 21% growth in billings.

The key point to note: VMware is a value name with tremendous valuation support in its free cash flow; but unlike a traditional industrial value play, its new found strength in cloud is supporting double-digit revenue growth and massive (50%-plus) cash flow growth. Tech investors are starting to pay more and more attention to value-oriented growth names, and VMware fits the bill perfectly. The fact that the stock reacted so calmly to a great quarter is indicative of an opportunity to buy. I’ve been long on this name for years, sticking with it through the Dell-EMC tracking stock drama and am retaining a price target of $147 (20x EV/FCF) on the company. Even if (really, when) the company hits that mark sometime in the next year, I’m still holding my shares for the long haul, as VMware’s dominance in the enterprise datacenter (and now its newfound prominence in cloud-based datacenters) merit it a market capitalization in excess of $100 billion (more akin to Oracle and Cisco (NASDAQ:CSCO), other datacenter juggernauts), whereas its valuation now only sits at a polite $49 billion.

Q3 download: remarkable performance across all metrics, especially free cash flow

VMware posted $1.98 billion in revenue (+11% y/y) in Q3, beating out analyst expectations of $1.96 billion. License revenues grew 14% y/y to $785 million, while the remaining bulk of the revenue was derived from maintenance and support services. It’s important to note that this is VMware’s second consecutive quarter of double-digit revenue growth – in Q2, VMware posted 12% growth, while Q1’s growth rate was only 9%. It’s clear that beginning in Q2, VMware began picking up additional steam on the back of its new product offerings.

Figure 1. VMware revenue results
Source: VMware earnings release

As highlighted by the title of this article, however, it’s billings that stole the show (at least in terms of top-line metrics; cash flow growth is VMware’s true prize jewel). As a refresher, like most software companies, VMware’s long-term and subscription deals are booked into deferred revenues and recognized as revenue ratably over time. The sum of revenue plus the change in deferred revenue is referred to as “billings” in the quarter. Billings, rather than revenue, is a clearer picture of the volume of deals closed in a quarter – and in Q3, VMware had a fantastic billings quarter, with total billings of $2.1 billion growing 21% y/, as shown in the chart below:

Figure 2. VMware billings results

Analysts had only called for $2.0 billion in billings (+14% y/y). Given the fact that billings is the longer term yardstick for revenue health and that VMware smashed billings expectations by seven points, I’m surprised that the stock reacted so casually to the billings beat, choosing instead to focus on the thinner beat on revenues.

VMware’s deferred revenue balance grew to $5.6 billion in the quarter ($3.5 billion in short-term and will be recognized as revenue within the year; $2.1 billion is longer term), up 11% y/y. Software maintenance continues to form the bulk of deferred revenues, consisting of the agreements that customers sign with VMware to receive support and software upgrades over a predetermined term.

One more product-related note: VMware also announced that Gartner (NYSE:IT) has proclaimed it the largest software vendor of hyperconverged infrastructure (HCI), based on sales of VMware’s vSAN. Though VMware doesn’t break out sales by product, I must confess that, at least where it concerns HCI, I’m partial to Nutanix (NASDAQ:NTNX) and consider Nutanix the leader of that space. Nutanix, coincidentally, reported earnings on the same day as VMware and blew away analyst expectations, showing at least that there’s room in the field for two. HPE’s SimpliVity (NYSE:HPE), which the crisis-ridden company purchased earlier this year for $650 million, seems to be a very distant third.

Cash flow in focus, supporting VMware’s valuation

Now that we’ve established VMware’s top line metrics are trending strongly, we can turn to the major reason most investors buy VMware: its cash flow.

Cash flow expansion was driven by top-line growth as well as improvements in opex spending; more specifically:

Sales and marketing expenses dropped to 30.7% of revenues, down from 31.7% in 3Q17 General and administrative expenses dropped to 8.9% of revenues, down from 10.0% in 3Q17

VMware improved its operating margin by 2.1% to 23.5% (up from 21.4% in 3Q17). That might sound like a small amount, but at VMware’s revenue scale, two points is more than $40 million – a good chunk to improve earnings by.

Cash flow expanded in tandem. Operating cash flows in the quarter grew 56% y/y to $970 million, and after netting out $59 million of capex, VMware was left with free cash flow of $911 million, up 54% y/y.

Figure 3. VMware free cash flow bridge
This represents a 46% free cash flow margin, among the highest in software and among large-cap companies in general – which proves a salient point about software companies: in the startup phase (or even in a more mature growth phase), software companies might spend a lot on sales and drive massive losses to spur growth, but once they reach VMware’s size, these businesses become cash cows.

In the nine months year to date, VMware has generated $2.2 billion in FCF, representing a 39% margin to YTD revenues of $5.6 billion. Given that in the prior year’s YTD period, VMware generated only $1.8 billion of FCF on revenue of $5.1 billion (a 36% margin), VMware is driving cash flow margins in the right direction.

It’s no secret that VMware is headed in the direction of $10 billion in annual revenues, as its new product initiatives give it access to cloud-based deals that weren’t open to it before. At this scale (which the company should reach in 2-3 years, given its current growth trajectory), VMware would be generating $4 billion in free cash flow annually (assuming its 40% FCF margin holds; in all likelihood, this margin would expand steadily over time).

Compared to VMware’s current $49 billion market cap and $42 billion enterprise value (the company has ~$7 billion in net cash), VMware only trades at a ~10.5x EV/FCF multiple on its hypothetical future cash flow. For the forward-looking investor who believes in VMware’s growth, this cash flow expansion potential makes the stock’s current ~17x FCF multiple (based on FY17 FCF of $2.4 billion) seem like a bargain.

To sense-check VMware’s current valuation against other value yardsticks, the company also trades at a 5.0x EV/FTM revenues multiple (based on a forward-twelve months revenue estimate of $8.2 billion, applying VMware’s growth linearity to its trailing revenues) and 24x P/E, based on analyst consensus FY18 EPS of $5.07 as reported on Yahoo Finance.

Not the cheapest of stocks, but VMware is a software play with the best elements of growth and value.

Stay long on VMware. Very few software stocks are “sleep at night stocks” because so few of them ever reach VMware’s scale (the only other such stock I can think of is Salesforce.com (NYSE:CR), another entrenched leader but in the frontend application software space, generating tons of cash flow). Based on the record-setting levels of the NASDAQ and investors’ general jitters on tech’s overvaluation, it’s these kinds of stocks that the market will turn to in 2018.

Disclosure: I am/we are long VMW, NTNX.

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.

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Nutanix Inc Stock, Up 25% Before Earnings. Can It Keep Popping Higher?

utanix Inc Stock, Up 25 percent Before Earnings. Can It Keep Popping Higher

Hyperconverged infrastructure providerNutanix Inc (NASDAQ: NTNX)stock is getting a lot of investor love ahead of its fiscal 2018 first-quarter earnings. Such has been the bullish sentiment, that Nutanix is stock is up25% alone in the month of November which has propelled the stock to a 52 week high. A string of analyst rating upgrades and price target hikes in this month have also helped the cause ofSan Jose, California-based hybrid cloud company shares. With NTNXstock at a 1 year high ahead of earnings, the question is, can the stock keep popping higher post earnings? Is plenty more upside left in Nutanix stock from here?


Nutanix Q1-2018 Earnings Wall Street Estimates.

Wall Street expects the Dheeraj Pandey led cloud computing specialist to report a non-GAAP loss per share of 26 cents a share, bettering theloss per share of 37 cents in Q1 2017 by a significant11 cents, near 30% year-over-year (YoY) growth. On the top line front, the analyst consensus is a revenue of $266.9 million, good for a 60%YoY growth. Interestingly, though, the managementrevenue guidance is very conservative, even the high-end revenue estimate also falls below Wall Street consensus. The top management gave a revenue guidance of $240-$250 million and earnings estimate of 37 cents loss per share. With the analyst estimates comparatively much higher, the expectations are very high ahead of earnings and any disappointment could result in the stock giving up some of its massive recent gains.

Nutanix will need more than an earningsbeat to sustain the high valuation.

Nutanix has a strong history of beating analyst estimates in its short public life. The hyperconverged infrastructure provider has delivered a beat on both the top line and bottom line numbers in all the quarters since its IPO. With NTNX stock trading at its highest sales multiple of 7x since going public, an earningsbeat is a must and perhaps would need much more than that to sustain the high valuation. Give the strong earnings history of NTNX stock, an earningsbeat is likely. TheNutanix Q1 earnings whispernumber makes case for much better earnings with aloss per share of just 21 cents, implying 5 cent beat and a massive 16 cents higher than management’s earnings estimates. The guidance again is very vital since the stock is prone to makemassive moves in either directiongoing by the stock price history. In the past post-earnings moves, the guidance played a major role in which direction the stock moved. Analysts expect the company to report a revenue of $282 million for the second quarter.

Key things to watch out for in the earnings release.

Given that the company is still at some distance on the road to profitability, it needs to maintain its strong revenue growth. Once again the company needs to show strong growth in deferred revenue to assure investors about its long-term growth story. The 77% YoY growth indeferred revenue to $526 million in last quarter earnings had outpaced its Q4 revenue growth of 62%. This has also been boosted by the impressive 87% YoY rise in the customer base. The company’s software segment gaining traction has got investors excited since pure software play means higher margins than its core hardware business. Thesoftware only bookings grew by 96% YoY in the fourth quarter forming 17% of the total bookings. The impact of the OEM agreements with IBM (NYSE:IBM) for software and Pure software agreement with Cisco (NASDAQ:CSCO) and Hewlett Packard Enterprises (NYSE:HPE) hardware is also likely to be closely watched. With DRAM prices expected to rise further, the increase in software moat could be very much welcomed by the investors.



The overall market sentiment towards NTNX stock has turned more bullish recently. The short interestdecline in the latest period by further 7.4%, a drop for the consecutive fourth quarter also suggests so. However, the short interest is still very high at 17.5% of the float with days to cover at 6. A strong showing post earnings could result in much higher gains as there is a possibility of a short squeeze. Having said this, investors need to be little cautious as the technical set up is not entirely favorable for Nutanix shares. The NTNX stock technical chart has some bearish signals which could mean the upside from here could be limited. The company shares are in overbought zone as both popular technical indicators Relative Strength Index (RSI) and Bollinger Bands suggest that the stock is heavily overbought. Given the recent run-up in Nutanix shares, and the unfavorable technical set up, the stock will certainly need something more than a beat to continue popping higher.

Nutanix Stock technical chart

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25 Stocks Moving In Friday's Mid-Day Session

American Woodmark Corporation (NASDAQ: AMWD) shares climbed 32 percent to $131.45. American Woodmark reported purchase of RSI Home Products for $1.075 billion in enterprise value and posted upbeat quarterly earnings.
Ambarella Inc (NASDAQ: AMBA) shares jumped 18 percent to $64.03 after the company reported stronger-than-expected results for its third quarter.
Foundation Medicine Inc (NASDAQ: FMI) shares climbed 16.4 percent to $61.92 after the FDA approved the company’s FoundationOne CDx Diagnostic test for solid tumors.
Nutanix Inc (NASDAQ: NTNX) shares jumped 15.3 percent to $37.83 after reporting a first quarter loss of 16 cents, 10 cents lower than analyst estimates. Sales came in $9 million higher than estimates at $275.6 million. The company issued better than expected second quarter earnings and sales guidance.
Marathon Patent Group Inc (NASDAQ: MARA) shares rose 10.26 percent to $4.60.
Titan Machinery Inc (NASDAQ: TITN) jumped 10.2 percent to $20.93.
Amira Nature Foods Ltd. (NYSE: ANFI) shares climbed 9.5 percent to $4.7601.
TapImmune, Inc. (NASDAQ: TPIV) shares rose 8.3 percent to $3.00.
Uniqure NV (NASDAQ: QURE) rose 6.3 percent to $16.09. Analysts at H.C. Wainwright initiated coverage on Uniqure with a Buy rating.
Global Blood Therapeutics Inc. (NASDAQ: GBT) jumped 5.5 percent to $41.60. H.C. Wainwright initiated coverage on Global Blood Therapeutics with a Buy rating.
Diana Containerships Inc. (NASDAQ: DCIX) shares gained 5.3 percent to $7.40.
UQM Technologies Inc (NYSE: UQM) gained 5.23 percent to $1.61 following news of a joint venture with China National Heavy Duty Truck Group late Thursday.
NoaBlue Apron Holdings Inc (NYSE: APRN) gained 5 percent to $3.14 after the company announced Co-Founder Matt Salzber has stepped down as President and CEO, naming Brad Dickerson as the new CEO.
Plug Power Inc (NASDAQ: PLUG) shares rose 4.01 percent to $2.46. Canaccord Genuity initiated coverage on Plug Power with a Buy rating and a $5.00 price target.

MER Telemanagement Solutions Ltd. (NASDAQ: MTSL) dropped 22.1 percent to $1.94 after the company posted Q3 results.
Genesco Inc. (NYSE: GCO) shares dipped 18.8 percent to $25.25 as the company reported downbeat quarterly earnings.
Zumiez Inc. (NASDAQ: ZUMZ) fell 13.8 percent to $18.80. Zumiez reported in-line earnings for its third quarter on Thursday.
Universal Technical Institute, Inc. (NYSE: UTI) shares dropped 13.6 percent to $3.18.
China Rapid Finance Ltd – ADR (NYSE: XRF) declined 10 percent to $6.70.
Pareteum Corp (NASDAQ: TEUM) shares fell 9.4 percent to $0.96.
Good Times Restaurants Inc. (NASDAQ: GTIM) shares dropped 8.2 percent to $2.25.
Ichor Holdings Ltd (NASDAQ: ICHR) fell 7.1 percent to $26.39.
Ulta Beauty Inc (NASDAQ: ULTA) fell 5.3 percent to $209.90. Ulta Beauty reported better-than-expected earnings for its third quarter. The company also saw comps up a whopping 10.3 percent in the quarter but issued weak fourth quarter earnings guidance.
Oxford Industries Inc (NYSE: OXM) dropped 4.7 percent to $65.73. Needham & Company downgraded Oxford Industries from Buy to Hold.
Cypress Semiconductor Corporation (NASDAQ: CY) fell 3.5 percent to $15.46. SunTrust Robinson Humphrey downgraded Cypress Semiconductor from Buy to Hold.