Pure Storage Stock: Software Eats Hardware

AI algorithms are solely nearly as good as the large information you feed them. ARK Make investments’s fearless chief, Cathie Wooden, advised Bloomberg immediately that software program firms would be the true beneficiaries of the AI explosion. UiPath (PATH) is studying about how information staff work, and this permits them to carry out extra superior automations, maybe even with trade specializations. Teladoc (TDOC) makes use of their telehealth providing to generate plenty of healthcare information which may probably be used to construct new merchandise. Each corporations might make the most of AI {hardware} to coach algorithms on, however the true worth is of their information.

ARK’s level is that software program is the place the true worth is realized for disruptive tech themes, a perception mimicked within the adage, “software program eats the world.” It’s why we’re notably suspicious of hardware-only enterprise fashions. Recurring income streams ought to be developed concurrently with development so buyers can see the potential unfolding. It’s like firms that promote consumables. When you’re promoting {hardware}, and consumables aren’t turning into an more and more necessary part of revenues over time, then one thing is improper along with your razor-blade mannequin. And in the event you’re promoting a high-margin {hardware} product, you higher be growing a software program/providers part to fill the margin hole when pricing pressures drive down your gross margins.

Pure Storage-as-a-Service

Our earlier piece on Investing in Information Storage {Hardware} Shares mentioned the thrill behind “flash native” storage know-how and Pure Storage (PSTG), an organization that constructed their {hardware} and software program from scratch to create an environment friendly economically aggressive resolution to flash drives. Bear in mind exhausting disks vs. random access memory (RAM)? Now, laptops just like the one this text is being typed on use RAM exhausting drives (additionally referred to as solid-state drives or SSDs) which improve efficiency. Everybody prefers RAM as a result of it’s faster, nevertheless it’s not value efficient. Pure Storage modifications that.

Oftentimes, extremely aggressive {hardware} merchandise include dismal gross margins. This implies you’re unable to compete with the Teslas of the world who will bait you right into a value conflict as a result of they will (cough, Xpeng, cough). So, when Pure Storage presents buyers gross margins of (checks notes) 70%, it appears nothing wanting outstanding. This begs the query as to how software program vs {hardware} gross margins examine, and the reply may shock you – each are floating round 70%. Take into consideration how a lot pricing flexibility that gives Pure Storage on the {hardware} aspect.

One other factor to think about right here is likely to be the uplift clients can get from simply shopping for {hardware} (on premise) to using the storage-as-a-service resolution from PSTG (additionally referred to as Pure Fusion). Shoppers could possibly minimize prices by switching whereas PSTG’s income streams turn into extra steady and predictable. Over time, software program is slowly rising extra vital, clocking in at 35% of complete revenues final yr. In final yr’s piece on Pure Storage Inventory: A Massive Information Pure Play, we talked about how we like the corporate, however wanted to think about alternative prices. Are there higher methods to spend money on the expansion of huge information? It’s a superb segue into some issues we have now across the firm.

Pure Storage Issues

We like Pure Storage, however we’re not right here to force-feed you the bull thesis. At present, we wish to deal with some issues we have now previous to going lengthy this inventory (if ever).

• Competitors – the place there are juicy gross margins, sharks will finally come
• Low forecasted development – “mid to excessive single digit development” this yr
• Survivability – money available, burn charge, debt

Let’s begin on the high.

Pure Storage Competitors

Pure Storage isn’t promoting right into a blue ocean, they’re displacing legacy {hardware} suppliers resembling IBM and Dell. They’re rising on the expense of others, however they’re hardly a pacesetter. Whereas the corporate claims to be constantly rising market share greater than all different opponents, they’re nonetheless a small fish in an enormous information storage ocean.

The above chart displays most the gamers Gartner lists of their leaders quadrant (solely lacking Infinidat and Huawei). An evaluation by Blocks & Information reveals that Pure Storage solely commanded a 4% market share for enterprise storage programs. Whereas the information is a number of years previous, it isn’t more likely to have modified that a lot.

This can be a “skate to the place the puck shall be” state of affairs, one which Pure Storage believes they will win as a result of they’re in a position to seize market share extra successfully than legacy distributors who could also be merely cannibalizing their very own {hardware} when promoting new information storage applied sciences. From a know-how standpoint, Pure Storage is the chief – or so they are saying. In comparison with the competitors, they declare to be 10x extra dependable, 2X to 5X extra energy and house environment friendly, and “require 5 to 10x much less handbook labor to function, ensuing total in no less than 50% decrease total cost of ownership (TCO).” It’s that decrease TCO that may assist insulate Pure Storage towards having to compete on value. Then, there’s this little gem Gartner drops which factors to the expansion potential for Pure’s SaaS providing:

By 2025, greater than 75% of company, enterprise-grade storage capability shall be deployed as consumption-based choices, which is a rise from lower than 40% in 2022.

Credit score: Gartner

Sounds nice for Pure Storage’s storage-as-a-service providing, so why are they solely anticipating “mid to excessive single digit development” this yr?

Pure Storage Development

Says the corporate, “annual income steering assumes that macro circumstances will proceed to be difficult and shall be in keeping with what we have now seen over the past couple of quarters.” Subsequent quarter’s steering – flat year-over-year development – implies “continued robust subscription income development and a slight year-over-year decline in product income.” Strengthening subscription income alongside weakening product income is smart if we assume that firms wish to scale back complete value of possession by shifting to storage-as-service as an alternative of on-premise. Subscription additionally appears to be constantly rising over time, although the development is slowly being eroded.

In Pure’s most up-to-date earnings name, there was a standard theme all through the accompanying Q&A session. No, it wasn’t that analysts stored citing AI for no matter motive, simply displaying how hype is permeating Wall Road in any respect ranges. It was that analysts gave the impression to be pushing Pure’s administration exhausting on their steering suggesting doable upsides which hinted at impatience across the 5-9% development they count on to see this yr. Pure’s response caught to the speaking factors and spoke about their gross sales group having a greater understanding of the gross sales cycle (confidence of their steering) and that there might be a return to raised development finish of this yr or starting of subsequent.

Stability Sheet Bits and Bobs

With $1.2 billion in money and constructive working money circulate of $173 million final quarter, Pure Storage ought to be capable of not simply survive however thrive. That’s the money stability after they paid off $575 million of convertible senior notes which largely retired their debt obligations. Different makes use of of money embody shopping for again shares, although shares excellent have been progressively growing over time – from 264 million in 2020 to 304 million in 2023, a rise of 15% over three years. That’s significant, however nothing to be overly involved about. Total, Pure Storage has a strong stability sheet that appears a lot better for the reason that final time we checked in.

Valuing Pure Storage

Our simple valuation ratio (SVR) makes use of annualized revenues for a motive, primarily in order that it may be conscious of firms which might be rising in a short time (or cease rising shortly). Within the case of corporations with cyclical revenues – like Pure Storage – it is going to be deceptively low for bigger quarters and better for smaller quarters. So, a present SVR of 4 for Pure Storage is larger than what we’ll see within the fourth quarter of this fiscal yr, all issues being equal. Evaluate this to our catalog common of 6 and PSTG seems to be undervalued, although one may argue solely double-digit development must accompany wealthy valuations. Finally, we nonetheless haven’t answered the query. If Pure Storage decreases complete value of possession by 50%, and firms look to chop prices within the face of macroeconomic headwinds, then why aren’t these options promoting like hotcakes? Are revenues dropping due to pricing pressures or one thing else? Or are these the traditional “it takes longer to get signatures” macroeconomic headwinds that each one SaaS distributors are experiencing?

Conclusion

Would we go lengthy Pure Storage? Including some publicity to the expansion of huge information is interesting, which is why we went lengthy Snowflake (SNOW). There are different shares we’re eyeballing, so possibly it’s a matter of taking one of the best alternative that comes alongside. Discount searching this yr has been slim pickings although, with the Nasdaq up +30% year-to-date, and AI hype driving many tech names upwards. PSTG jumped that a lot up to now 5 days alone, main us to assume it’s a bit overheated.

Whereas Pure Storage might not seem like a pacesetter in the case of market share, their superior product providing makes up for that. We simply can’t work out why their development seems stunted this yr. Is administration enjoying a conservative hand and making ready for a year-end shock, or are the TCO numbers simply not compelling sufficient when it comes time to signal on the dotted line?

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