Credit: Shutterstock photoBy Suhail Capital :
We recently picked up some Nimble Storage (NYSE: NMBL ) shares. The position is to a degree on the more speculative side of things for us as we have generally hated the flash storage vendor space and broader enterprise storage space for years, but as is always the case in markets at some point things change.
The starting point for this thesis has been our desire to look outside of semiconductors/platform tech giants/and enterprise software for some appealing longs in the broader technology industry. Storage has been that spot for us of late. We have dabbled since late last fall with outright investments in the likes of Network Appliance (NASDAQ: NTAP ) or even related names with industry exposure like VMware (NYSE: VMW ) on the software defined storage side or Nutanix (NASDAQ: NTNX ) as far as hyper converged vendors pure plays go. But the operative word here is dabbled, as we have been reluctant to commit to a bullish view on the sector.
Why have we been so reluctant?
A Brief Trip Down Storage Memory Lane
Well, in short the enterprise storage space has been a notoriously bad place to be long anything for a very long time. In fact there hasn't been a true public success story in the space since NTAP. And we define success by a public billion + sales company that is profitable and actually generates returns for shareholders. What the space has instead offered up is a very long list of fantastically hyped up short opportunities.
Our experience here goes all the way back to STEC, a leader in the SSD market with what was supposed to be game changing flash controller technology, which in retrospect ended up providing the script for all enterprise flash storage related investing for years to come. Now we could probably write a short story about our experiences with STEC as we initially bought into the hyped disruptor pitch, before quickly changing directions once we got to know the management and space. Whether it was dodgy CEOs, mind-boggling related party transactions, insider trading, blue-chip customer name dropping, or crazy one-time orders that never ever rematerialized; STEC had it all. But as far as this note is concerned all that mattered here is the stock and business quickly collapsed as the industry quickly shifted. Ultimately STEC's technology was acquired for a fraction of its previous value by [[WDC]].
Naturally, the STEC experience made us very wary of the next hot name in the space: Fusion-IO. This server side flash caching PCIe card company which Facebook ( FB ) and Apple ( AAPL ) couldn't live without and with genius Apple co-founder Steve Wozniak as CTO was an instant market darling. Fusion was also a tough short because their business didn't implode overnight. The demand for their technology was initially there, but over time the growth and margins didn't pan out as expected as the broader demand for flash caching never really took off as expected. Why? Well, in our view the technology became more complimentary versus necessary as the affordable all-flash array market took off. That being said, selling out to Sandisk at half its IPO price from a couple years earlier ended up being a far better final outcome than the next hot name in the space would face.
Violin Memory burst on the scene as the all-flash array game changer that was going to rock the storage market, but that unraveled fairly quickly after HP dumped them to focus on their own in house 3par strategy. After problems with HP torpedoed a $2bl plus dream IPO, Violin was forced to float at all costs just to sustain the business. The story was spun some, but really you didn't need to be a genius to figure out this was a name to avoid. The subsequent IPO was a flop, and the Violin model never got any better. The consensus view on what went wrong here was that Violin's custom memory-based approach to its all-flash array solution vs. commodity SSD was what killed them, as the likes of Pure Storage ( PSTG ) arrived in their space and larger storage providers like EMC got more aggressive. Either way, Violin went from IPO to Chapter 11 in 3 years. That's called a disaster, and yet here we are about to make a case for going long Nimble Storage.
A Little Nimble IPO History
Nimble's IPO was around the same time as Violin's disaster, but ended up being an instant success. Shares closed up over 60% on the first day of trading, and within two months traded to a market value of just under $5 billion and valuation of 50x ttm revenue. Naturally, we read the prospectus and sat back waiting for a short opportunity, but at the time we were pretty busy with Veeva so couldn't do the detailed work. Anyway, it didn't really matter as a good chunk of the Nimble bubble burst in the Spring of 2014 with the rest of the tech IPO bubble crowd. When we finally got around to looking closely at the stock we had our fair share of doubts. The story around Nimble was that Hybrid Arrays are simpler and cheaper than AFAs and easier to manage software wise, and thus that its addressable market and growth opportunity outside of large enterprise were extremely appealing. The bull case was that the Enterprise AFA market would be left to the likes of Pure and EMC XtremIO to battle over, while Nimble actually got profitable pretty quick with its commercial hybrid focus. That obviously hasn't panned out as the stock trades at roughly a quarter of its post-bubble collapse level, has a market cap of roughly 2x its ttm revenue.
So why do we like it now?
The Case For Nimble
The case for Nimble obviously starts with the valuation. At a current enterprise value of roughly 1x expected 2017 revenue the stock is cheap, and trading at a discount to Pure Storage's multiple of 1.7x. Of course, in this space valuations can be misleading as technology can become obsolete awfully quick. So we are not really value hunting here in the traditional sense. In fact, we took a small position in Nimble calls in front of its last earnings as we wanted to express the view that its push into the AFA space was working. Although the trade didn't work due to a seemingly sour market mood at the time, we were pleased with the conference call and quarterly results. Anyway, we have been keeping a close eye on the name ever since. All we needed to get a little more comfortable initiating a position in the stock was evidence that the sector in itself has stabilized enough, and that broader tech hardware valuations could support a long case in the name. Well, we feel we hit that point recently. Specifically, the market headline tick the box type of bottom event that the Violin Memory bankruptcy provided in December gave us confidence that the cycle of shareholder value destruction in this space has probably come to an end. Thus, we got more comfortable with testing out our long thesis in the stock.
Anyway, let's get a little more detailed here about what we were thinking thesis wise when we first started looking at Nimble. The bear case on the name has been pretty clear-cut. The short argument had been that Nimble didn't play at all in the enterprise all flash array market, and that Pure Storage's launch of the M10 would start to eat away at their share in the commercial space. This take coupled with typical investor skepticism around customer rocking software differentiation for such a vendor, plus the fact that hyper converged players like Nutanix tend to be viewed as more of an initial threat to use cases in Nimble's core market, made being bearish on the name not very difficult. The argument essentially was that Nimble would gradually burn through its cash and never succeed as a stand-alone vendor.
And to be clear on the surface it was pretty hard to argue with this thesis, but then Nimble complicated things even further by announcing its entry into the all-flash array market. Thus, you now had to worry about its new product strategy failing, leading to an accelerating cash burn and becoming an unnecessary distraction for management in an already extremely cut-throat competitive environment. Basically, get ready for Violin Memory part deux. But here is the thing……
Its Strategy Worked.
Nimble has quickly and brilliantly succeeded with its move into the AFA space. It got to the $100 million annualized booking run rate in two quarters, and all the checks with customers that we have done have been overwhelmingly positive. Consequently, Nimble's odds of surviving as a stand-alone vendor in the space have drastically improved. In fact, our main concern now is that the company has become a glaring takeover target at these levels to just about half a dozen tech names with the resources and justification to pay 50%+ premium to the current share price to acquire them. And yet the stock is trading like viability going forward is still in question?
How to Play This
Nimble reports its Q4 results next week and will guide on Q1. Consensus growth for next year is 22% while Pure's expectations are for 39%. We think Nimble is positioned to outgrow consensus and Pure is more likely to disappoint. So there is a nice pair trade here which looks even nicer because of the significant valuation gap between the two, and the fact that Nimble's gains are likely to come more and more at the expense of Pure. That being said, we think the current bull market in tech and glaring takeover appeal for an opportunistic suitor here make Nimble an easy outright long position for those who don't like to short/hedge with pairs.
See also CenterPoint Energy, Inc. 2016 Q4 - Results - Earnings Call Slides on seekingalpha.com
The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.
The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.
