December 10, 2018 - 5:28pm EST by
2018 2019
Price: 18.03 EPS 0 0
Shares Out. (in M): 275 P/E 0 0
Market Cap (in $M): 4,958 P/FCF 0 0
Net Debt (in $M): -800 EBIT -20 75
TEV ($): 4,158 TEV/EBIT N/A 55

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At the current price, PVTL is an asymmetric investment opportunity with I believe to be limited downside and could easily be a 1.5-2x MOIC over the next 2 -3 years.  


At a high level, every company is going through some form of a digital transformation.   


According to Dell: a digital transformation  "involves making fast and profound change in business activities, processes, competencies, and models to strategically leverage digital technologies and their wide-reaching impacts. Where before enterprises were unsure if IT or technology mattered (hence the outsourcing trend of a decade ago), today’s companies are focused on how to solve complex technical problems in software."  



A digital transformation is a large and encompassing term, but the purpose is for a firm to get value from its data through business applications.  


This requires firms to re-architect their existing IT infrastructure and processes.  


Cloud native is a culture of software development that takes advantage of the benefits of cloud computing. As the name implies it leverages public IaaS, but it’s primarily about adopting a process of integrating your developers of the software with the operators of the infrastructure that the software runs on, continuously deploying software, and utilizing a micro services architecture where applications are decomposed into their functional parts.   


All companies have software, but very few are cloud native. Most enterprises have historically built software in a waterfall process around massive monolithic applications. A waterfall process means that the entire scope of the software application is designed up-front and all the IT procurement required to support the application is acquired before the application is developed or tested. A monolithic application involves all the components of the application being integrated as opposed to a set of individual services that can communicate with each other forming the entire application. (A website broken down into its components such as a recommendation engine, engine to serve video, and a catalog etc.)  Monolithic applications can cause numerous issues, at times a part of the application may need to scale while other parts may not, it usually involves one type of data model as opposed to tying the data model to the specific service, and failures in one part of the application can bring down the entire application.   


Pivotal Labs, Pivotal Software's consulting business, teaches firms how to properly develop software which is in an agile manner and teaches them how to intelligently architect applications which is through microservices. Agile is an iterative process of planning, designing, testing, building, accepting and then deploying software, while microservices break an application into each of its parts (as in the example before) which further increases agility by allowing small teams to iterate on specific services, use the right tool for the right service, scale services independent of other services, and isolate issues at the service level.    


Pivotal Cloud Foundry, Pivotal's application development platform, helps developers and operations build better software, faster: the value proposition is that it drives developer productivity, operator efficiency, and increases security.  


In a simple sense, PCF automates a multitude of tasks that a developer needs to do build, test, and release software,  as well as tasks for operations such as provisioning and managing the underlying infrastructure that the software runs on.  


These tasks include: host management, infrastructure automation, container registries, key management, container run-time, networking, scheduling & orchestration, service management, integrating and managing data stores, among others. 


It has hard $ ROI from lowering the number of operations people that are required to support developers, and moves valuable developer time from managing software to building software.   


Why this is interesting:  


Today a low single digit % of workloads are managed via PaaS / Containers (the vast majority are deployed directly to virtual machines). Over the next 3-5 years this is forecast to be multiples higher (around 10% per Dell Technologies Forum).    


Customers that  I spoke to seemed to indicate that they are also in the earlier innings of their deployments. Workloads grow on the platform via three-ways: 


 1. Net new workloads are created by companies building new applications 

 2. Existing applications are re-architected to become cloud native 

 3. Growth in the application  


The business model is tied to the number of workloads run on the platform: 


PCF is sticky (very low churn) and strategic to their existing customers. The business has very strong net expansion rates, and can one can model a multitude of different scenarios going forward --- and while I don’t know with precision what they will be, it seems more than reasonable that PCF will be significantly larger over the next few years.   


Historical net expansion rate has been the following:   


163% at the end of fiscal 17 and 158% at the end of fiscal 18 and about 150% in fiscal 19. 


Customer growth has been the following: 


75 at end of 15, 180 at the end of 16, 275 at the end of 17, and 319 at the end of 18. 


Ultimately we are in the very early innings of platform use, and PCF is massively underpenetrated from a customer perspective.   


Pivotal is forecasting to end the year with $390m of subscription revenue from and net expansion rate of 150%   


We can breakdown business into two parts: 


  1. 1.  Net expansion rate of current customers  


This is imprecise and is more qualitative then knowing a specific # --- but broadly have spoken to a number of customers and I believe most companies are still in the earlier innings of their PCF deployment.   


Dropping from a 150% CAGR over the last three years to a 128% net expansion rate CAGR over next 3 years --- would double the current base of business 


I think this is reasonably conservative. 


2. New customer bookings and new customer expansion rate    


70 customers per year at $430k average land and averaging out the booking throughout the year would be  $20m per year. These customers will likely have a higher net expansion rate which we can model at 150%, 140%, and 130% over three years.   


I think 7x gross profit is a reasonable terminal multiple (RedHat was acquired at 10x gross profit). At 7x 2021 gross profit - while gross profit would be CAGRing in the high 20s – the Pivotal would be worth $26.8 which is a 1.45x MOIC. At 10x it would be a 2x MOIC. 



  FY 2019 2020 2021 2022
Subscription Revenue 390,000 546,500 734,450 947,563
Services Revenue 250,000 275,000 300,000 325,000
Existing Customer Net ARR 150% 135% 130% 125%
2018 Base Subscription Revenue   526,500 684,450 855,563
2020 New Customer Revenue   20,000 30,000 42,000
      150% 140%
2021 New Customer Revenue     20,000 30,000
2022 New Customer Revenue       20,000
Subscription Gross Profit   91% 92% 93%
Services Gross Profit   20% 20% 20%
Total Gross Profit   552,315 735,694 941,495
YoY Gross Profit Growth     33% 28%



EV Calculation Red Hat Base
Red Hat Gross Profit Multiple 10.00x 7.00x
CY 2021 / FY 2022 EV           9,414,953           6,590,467
Net Cash              800,000              800,000
EV        10,214,953           7,440,467
Fully Diluted Shares              278,000              278,000
Price per Share  $               36.74  $               26.76
Price Today  $               18.03  $               18.03
MOIC 2.04x 1.47x



Why does this opportunity exists?  

Pivotal had earnings on 9/12/18 and after a blow-out first quarter bookings appeared light to the street. The company's preferred target metric of RPO has no YoY comparison #. The business is a little hard to model because it is lumpy, the customers are large, and there can be some multi-year pre-payments.   


The company also only announces customers that are $50k minimum and only once they have started recognizing revenue not on bookings. 


What matters is the go forward net expansion rate, new customer growth, new customer size, and new customer net expansion rate. 


I think when one weights qualitative factors of where they are positioned in the market, the scope of the opportunity, and current success with customers positions them to hit the above targets.     



PCF is Pivotal's commercial product of Cloud Foundry which is an open source project.  

There are other commercial versions of Cloud Foundry. 

OpenShift is their largest competitor but the market is so massive it's hard to say they compete. OpenShift is part of RedHat, and RedHat and was recently acquired by IBM. 

Customer growth completely stalls out 

Customers stop adding workloads to the platform 

Significant changes in pricing as customers scale that mutes net expansion rates 


Descriptions provided herein are summary in nature and are not complete. Any statements constitute only subjective views, beliefs, opinions or intentions, as of the date shown, which are subject to change due to a variety of factors, including fluctuating market conditions. No representation is made that such statements or examples are now, or will continue to be, complete or accurate. Statements regarding possible future events, opportunities or growth should not be relied on and involve inherent risks and uncertainties, both general and specific, many of which cannot be predicted or quantified. No statement, example, graph or similar information should be construed as an investment recommendation or advice. These statements are not intended to be and do not constitute investment, tax or legal advice.


I do not hold a position with the issuer such as employment, directorship, or consultancy.
I and/or others I advise hold a material investment in the issuer's securities.


Sustained revenue growth

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