Nutanix Is A Cloud IT Provider Worth Watching

Whether you are familiar with the world of enterprise IT or not, it is likely you have heard of the decades-long transition to "cloud computing".

20 years ago, the IT infrastructure (computers, storage, networking) of most major enterprises was built internally in "on-premises" data centers. That means the company itself purchased the buildings and hardware needed, and either hired its own employees to setup and manage it, or hired contractors to do it.

Today, a more common way to build up a data center is to simply use a "cloud provider" like Amazon Web Services (AWS) or Microsoft's Azure. Here, there is no need to worry about buying equipment and managing it. You simply pay those companies for the resources you need, then package your applications in containers and deploy them to the platform.

A third option is what is known as a "private cloud". This is kind of a mash up of the two above extremes. In this scenario, your company owns the data center and related equipment, but operates it as a cloud hosting infrastructure, allowing easy management and deployments.

Obviously, there are advantages and disadvantages to each. Internally owned infrastructure gives a company some piece of mind as far as data security and dedicated resources, although it has the downsides of cost and scalability. Using an external cloud provider makes management and scalability almost non-concerns, but in many cases you are giving a competitor control over key parts of your business.

What has tended to happen is that large enterprises use a mix of these deployment models. For example, a firm may use internal IT infrastructure for deploying its most sensitive data and apps, while using cloud providers for client-facing apps that may need to scale or be updated quickly.

The problem becomes one of managing this complexity. That is where the focus of today's review enters the stage. Let's take a look at Green Screen stock Nutanix (NTNX).

What Nutanix Does

Nutanix makes what is known as "hyper-converged infrastructure", or HCI, software, called the Nutanix Cloud Platform (NCP). An HCI acts as a "command-and-control" software package for managing computing, storage, and networking resources across many different deployment models and data center locations. It allows much easier management of disparate IT resources, allowing you to deploy applications, manage storage needs, scale compute resources, and monitor uptime and performance all using one software tool (instead of dozens).

Customers purchase software subscription licenses for the NCP that renew on regular terms (1 to 5 years). The platform can be deployed wherever the customer wants - in their own data centers, in a third-party cloud (like AWS), or even via Nutanix-hosted services.

This is a high-level understanding of the product offering, but those that lean into technical details can learn a lot more about the intricacies of NCP from the company's "Nutanix in 3 Minutes" presentation.

The value to customers is many. In addition to greatly simplifying deployment and management of multi-cloud environments, NCP also helps to avoid unplanned downtime, eliminates costly over-provisioning, enables maximum flexibility for use of IT resources, and helps to reduce IT risk and waste.

Is Revenue Growing and Recurring?

Like many software companies, Nutanix underwent a transition from the traditional "perpetual license" sales model to a subscription model in the 2018-2021 period. Today, over 93% of revenues are from either subscription or support contracts. This highly recurring sales model is just what we are looking for.

Hyper-converged Infrastructure is a large and growing market. Today it is worth about $9 billion globally, but expected to grow at a fantastic 24% annual rate, reaching $49 billion by 2031. Many of the world's largest companies in telecommunications, healthcare, financial services, IT, and government utilize multi-cloud infrastructures, but don't yet deploy HCI management. This is a large opportunity.

Nutanix has been growing sales about 16% annually for the past 5 years. Given the market dynamics, I see no reason the firm cannot continue to grow at this rate - or even faster - over the next 5-10 years.

What Kind Of Moat Does Nutanix Have?

The HCI market is dominated by two firms at present, with Nutanix and VMWare each sporting 35% market share. Dell, HPE, Cisco, Microsoft, IBM/Red Hat, and Oracle all have competing products. However, many of these larger IT firms have also entered into partnerships with Nutanix, pre-installing NCP on both hardware and cloud platforms.

This market leadership makes Nutanix a brand name for companies looking for an HCI solution, giving it a leg up on smaller competing offerings. IT managers are quite risk-averse - the old saying "you can't go wrong buying IBM" still applies, even though IBM isn't the choice much nowadays.

Like many IT platforms, Nutanix's offerings have high switching costs. Integrating it into a complex infrastructure takes time, effort, and money, and once it is up and running, changing to a different provider would be a painful undertaking. Average contract duration is over 3 years, and net revenue retention rate has exceeded 120%. Customers are quite "sticky" and tend to expand their use of NCP over time.

In short, Nutanix has very solid economic moat characteristics.

Management and Finances

Rajiv Ramaswami took over as President and CEO in December 2020. He has quite a background in the industry, with senior positions at VMWare, Broadcom, and Cisco on his resume.

With such a short tenure, his ownership stake is not particularly large (about 0.3%). However, Ramaswami's previous experience in converting VMWare to a subscription model has paid off handsomely for Nutanix. The firm's lackluster results have turned sharply since he took over, and the company is now delivering impressive free cash margins exceeding 27%, while maintaining a 3-to-1 cash-to-debt ratio on the balance sheet, and continuing to grow revenue at a healthy pace.

No concerns here, leadership looks strong and the financials are in good shape.

Risks

Nutanix faces most of the same risks as your usual IT software provider.

Competition is strong, particularly from VMWare and Microsoft, and there's always the risk that the firm's key partners (Dell and HPE) may decide to cut ties and enter the market on their own. Nutanix will have to spend to keep their technology competitive, to keep clients renewing and expanding deals, and to bring new customers into the fold.

There are also key event risks like a data security breach, or a cyberattack.

Overall, though, I would rate Nutanix as a "medium-to-low" risk company as far as business risk goes. The real risk for investors is getting into the shares at a valuation that doesn't make sense.

Conclusion

Nutanix covers all the bases to earn a "green dot stock" nod. The firm provides key pieces of software in the modern IT infrastructure stack, it is growing sales at good rates with strong growth in the underlying market, sales are nearly fully recurring, and switching costs give it a captive moat against competition. Management looks plenty capable, and there are no concerns financially.

Now we get to the key question - what's the stock worth? I've modeled for somewhat modest 14% annual growth over the next 5 years, with a 27.5% free cash margin (about what they are doing now), and a modestly high 11% discount rate to account for a checkered history. I get a fair value of $54 per share. With the stock currently at just over $64, we will add Nutanix to the Watch List and wait for a better entry point.