Pivotal Software ($PVTL) went public on Friday at $15/share. The offering didn’t get a resounding vote from the markets. Unlike other recent enterprise software deals, this one ended quietly at $15.75.
We think PVTL is likely to do well from these levels. Partly because investors focused on “slowing growth” in revenues. That misses the most valuable aspect of the growth story - services revenues are actually declining YoY while software subscription revenue growth remains robust.
The table below illustrates the underlying dynamics. Note not only the growth in SaaS revenue but also the overall increase in gross margin. With 90% margins on the SaaS business, this is the one we want to grow.
Our IV estimate (below) suggests the shares may see $34 in the next year.
Industry Context and Background
When we say “big and ugly” we mean that in a good way. Enterprise IT is a very complex beast. Enterprises have legacy applications, individual and global architectures, multiple databases and transactional systems and need a high level of security, monitoring, and compliance.
Being productive in such an environment is an ever-present challenge. Over the years there have been waves of technology in this space. In the very early days, we had “Computer-Aided Software Engineering” or CASE which spawned an array of tools and techniques that saw some adoption.
In the 1990’s this shifted to “model-based development” led by companies like Rational Software which ultimately was acquired by IBM. During the same period, large companies started to shift away from mainframes thanks to distributed software infrastructure from companies like BEA Systems which was acquired by Oracle.
For the past decade, most new trends in development have been toward lighter frameworks, speed and “agile” development methods. At the same time, the infrastructure has shifted yet again to the cloud led by providers like Amazon (AWS) and now Microsoft (Azure).
A whole crop of “cool” infrastructure technology providers have come public including Twilio (TWLO), MuleSoft (MULE), MongoDB (MDB), Nutanix (NTNX), ServiceNow (NOW), Zendesk (ZEN), Okta (OKTA), Atlassian (TEAM), Coupa (COUP), Tableau (DATA), ZScaler (ZS) and New Relic (NEWR) to name a few! These stocks have mostly done VERY well.
Today enterprises are looking for ways to exploit the advantages of these new development technologies to increase productivity and be able to leverage the cloud for their own business needs.
At a very high-level PVTL provides 1) a development framework and approach, 2) a set of development tools and 3) a deployment platform that works on top of mainstream services like AWS and Azure.
If you want a more complete “feel” for the PVTL platform you can learn more by just skimming the portal to the documentation: https://docs.pivotal.io/
Stock Conclusion
As long as Pivotal continues to grow their subscription revenue the investment case is strong. It's recurring and much higher margin than the services business which is more appropriately performed by large partners like Anderson Consulting, PWC, or IBM.
Investors worry about what Dell may do with the rest of the shares they own. This "overhang" may be part of the reason for the lack of post-IPO performance. The Dell stake also might make it harder for a natural acquirer like IBM or Oracle to make a move on PVTL.
At these levels, PVTL offers attractive risk/reward - especially versus some of the other infrastructure software names that have moved up sharply and trade much closer or even above our IV estimates.
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