2019 | 2020 | ||||||
Price: | 99.00 | EPS | 6.0 | 6.9 | |||
Shares Out. (in M): | 140 | P/E | 16.5 | 14.4 | |||
Market Cap (in $M): | 13,900 | P/FCF | 13 | 12 | |||
Net Debt (in $M): | 33 | EBIT | 968 | 1,040 | |||
TEV (in $M): | 13,933 | TEV/EBIT | 14.4 | 13.4 |
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We are long Citrix and believe it to be an intriguing and exciting opportunity to invest in a high-quality business at a significantly discounted valuation as the business is about to inflect positively. The opportunity exists also because the company is currently overlooked by investors. The fact that a software company with effectively 100% free float, publicly listed for almost a quarter of a century and with a market cap in excess of $10bn has never been written before on VIC is already telling. Buy side attitude towards Citrix is one of apathy, with similar attitude from the sell side with only 5 out of 20 Buy ratings. The company is going through a transition from on-prem license and maintenance model to a cloud based subscription model and such transition is negatively affecting near term results, causing investors to mistakenly believe the business is decelerating due to structural challenges. This narrative gives credence to the bearish view that virtualisation, Citrix core business, is in structural decline as obsolete in a world dominated by web-based applications. Such views create the opportunity to invest in a high-quality software business on low teens FCF multiple. We believe there is a clear opportunity to generate 20+% IRR in Citrix over the next 3 years.
Citrix operates 2 segments that offer vastly different sets of products: Workspace and Networking
The name Citrix in the software industry is directly associated with the concept of “virtualisation”. Virtualising an application or an operating system means detaching it from the physical machine and allowing different applications, operating systems or functions to be run on a single computer or server. Virtualisation can simplify the overall software and server architecture, thereby improving the overall performance thanks to a technology that can balance and maximise the resources available. Due to its first mover advantage, a superior product offering and a high reputation in the marketplace, Citrix became a synonym for virtualization. The company historically dominated the market and still holds as much as 50% market share, well ahead of peers Microsoft, VMware and smaller ones. Over ¾ of large enterprises worldwide use Citrix in some shape or form. Its installed base is vast and incredibly valuable. Citrix customers are remarkably loyal and sticky.
Historically, the virtualisation software represented the vast majority of Citrix business, especially after the sale of the GoTo SaaS business to LogMeIn in 2016. The virtualisation business is now included in its core Digital Workspace segment which includes core desktop and apps virtualisation businesses. Workspace now represents c. ¾ of Citrix sales.
Virtualisation takes different shapes:
Workspace covers the whole gamut of services, including:
a) Desktop and Application Virtualisation - the whole Windows desktop or an application is delivered remotely from an organization's datacentre. This allows businesses to reduce IT costs, improve redundancy and recovery time from hardware failures, and increase flexibility in scaling resources used with the changing needs of the business. Offering flexibility to employees to work remotely is also an important use case driving adoption
b) Mobile app delivery - mobile device management solutions (XenMobile) that allow administrators to provide users with secure access to applications (mobile apps or even Windows apps) and data (e.g., email) on mobile devices (e.g., smartphones, tablets)
c) Workspace Aggregator (Workspace Suite) is the third product category in this segment. The Citrix Workspace Suite is an integrated solution allowing enterprises to deliver secure access to apps, desktops, data and services from any device over any network. This product bundles the capabilities of XenApp, XenDesktop, XenMobile and other capabilities into a single platform
In very simple words, Citrix allows enterprises to maintain a hybrid model where people still work at their workstation or on their own devices but access to share data and shared applications. Citrix comes in handy when large enterprises want to manage the data flow of employees when they can access it from everywhere. Apps like Box and DropBox can’t do that effectively. The CIO of a large legal office can decide what kind of information associates have access to, what kind of data a partner can download on his device, how much data download becomes suspicious etc. Citrix also ensures that apps and data are secure. It also offers analytics solutions. Workspace has clearly changed and it’s no longer a simple VDI solution, it’s a “platform for work” that goes beyond virtualisation.
Citrix offers a unified consumer experience with continuity across web, mobile and desktop. In a secure and controlled environment, employees have access to all different sort of apps via 1 gateway / centralised app. It makes life easier for IT guys as well as for employees. As in our own office, we only need to sign-on to the system once, we don’t need a password for each app. It provides universal access across all apps and content.
Citrix commands a leading market share in the space. My understanding is that VMware has been aggressive as of late winning market share but Citrix close collaboration with Microsoft is providing them with a strong moat.
While this business hasn’t grown much in recent years (some of it was due to model transition headwinds, some of it due to bad commercial policy now rectified), the structural tailwinds are strong and recent quarterly performance suggest an acceleration in growth.
We believe there are numerous tailwinds to growth:
Citrix networking division is primarily constituted by 2 businesses: Citrix ADC (Application Delivery Controller), formerly known as NetScaler, and Citrix SD-WAN.
The ADC business consists of a combination of hardware and software designed to accelerate web services and removes workloads from web servers. They help large e-businesses deal with vast volumes of traffic. Revenues are under pressure as the model is shifting towards software only and the hardware business is consequently suffering. Furthermore, the business is very lumpy as a Cloud provider will purchase a large quantity of Citrix ADS as they expand their datacentres in one year with little revenue in the subsequent years.
Web-scale buyers now represent a very small (13% in Q1) proportion of Networking sales but its revenues were down 65% YoY in Q1, causing the whole segment to be down 18% YoY. Citrix reported growth rate would be much higher if not for the SSP part of the Networking business which has now become a tiny part of the mix.
Citrix SD-WAN, or software-defined wide-area network (SD-WAN) is a service that grants the enterprise with the ability to dynamically connect branch offices and data centres on a global scale. It’s effectively a traffic optimization product that bundled with Workspace deals has become again a growth driver for the company. As traffic grows because of growth in cloud-based applications, traditional WAN networks are unable to maintain adequate speed and therefore SD-WAN emerged as a cost-effective solution to optimize connectivity.
Our investment thesis rests on the conviction that the core workspace business is actually doing very well. The bearish narrative of Citrix exposed to a structurally declining virtualisation on-prem market is unfounded. Furthermore, the transition to a subscription model is impacting near term results which would be otherwise even stronger.
While on the surface Citrix is not growing much (reported Q1-19 top line growth was 3% and 5% in FY 2018), we can observe under the radar very strong growth from its Workspace segment, which is the core of the business. As per chart below, workspace sales growth accelerated to 6% in FY2018 and to as much as 13% in Q1-19.
These reported results are actually understated due to the mix shift from license + maintenance model to subscription. Consider that in Q1-18, 47% of all Workspace deals were rateable. This number moved to 62% in Q1-19. While management doesn’t quantify the implied headwind from the model transition in the way other software companies do (like PTC for example), it is estimated to be c. 200-300bps. This means that on an organic basis, Workspace grew as much as 15% in Q1-19 with its backlog growing more than 20% YoY. Such growth doesn’t seem compatible with the commonly accepted view that Citrix is an old established software company offering a legacy product in terminal decline.
Contrary to popular belief, we believe that the migration to the cloud model in fact increases the demand for desktop / app virtualisation. Cloud hosting has become an enabler for Citrix, not a threat. A common misconception is that there is no room for Citrix in a web-based powered application architecture. The actual reality is that the vast majority of enterprises are moving towards a hybrid model where cloud will co-exist with on-premises applications. Security and latency concerns are pushing CIOs to look at hybrid solutions. As long as there will be even a single app run on-prem, there will be need for VDI solutions. The outlook for Citrix is therefore bright. The feedback received from our conversations with clients and resellers is that Citrix product is a good fit for public cloud. Citrix is acting as an aggregator for all web-based apps, whether Microsoft, SAP, CRM, WDAY etc., significantly simplifying life for both users and system integrators.
As described above, Workspace allows customers to have a unified customer experience in 1 app. Whether the application is virtualised (e.g. Eze or Bloomberg), whether it’s on the company’s server (e.g. Outlook) or whether the application is web-based and SaaS-based (e.g. Workforce, Workday, Concur), Workspace allows the user to access them all from one secure application, without having to sign in and out every time and giving the IT department the flexibility and control to decide what data each employee has access to across all applications. It makes the job of the IT much easier and the consumers experience much better as the front-end looks the same:
The potential for growth is huge here because it’s platform agnostic. It’s obviously much easier to sell Workspace to Xen customers that want to integrate all applications in one. However, Workspace can also be used as a net new product to attract new customers that use the likes of Workday, Salesforce, Concur, Microsoft etc. and want to have a unified, simple, secure consumer experience that can be easily implemented and controlled by the IT department. Speaking to numerous industry contacts, it appears the product is doing well but it’s very new. There are 3 versions of Workspace:
· Workspace Standard
· Workspace Premium
· Workspace Premium plus
Not all versions are fully released, it’s really new. The potential impact on Citrix though is huge. The following chart produced at Q4-18 results illustrates the opportunity and shows how Virtualization, which represents today the vast majority of Citrix business, is actually a smaller percentage of the total revenue opportunity:
The key Citrix products, XenApp and XenDesk, which are the historical success stories in virtualization, represent a small percentage of the potential customer adoption. It’s very interesting to note that Citrix is very well penetrated amongst larger customers, especially in the enterprise:
Large customers know Citrix very well and ¾ of global enterprises use Citrix in one way or another. However, only 39% of Enterprise users are Citrix customers:
This means there is a huge opportunity for Citrix to grow adoption within the organisation. This is a lot easier than spending money trying to acquire new customers. Conversations with experts suggest that Workspace could be the tool to accelerate this process for Citrix.
Furthermore, having realised that the immediate growth opportunity for Citrix is to grow within the existing customer base, the whole salesforce has been restructured and refocused on this opportunity. Winning new customers is probably the least important of the 4 commercial strategies below:
We believe this strategy is fundamentally lower risk and less costly than a traditional commercial strategy focused on customer acquisition. Citrix always had a strong reputation and a huge installed base. Now it has the right product (Workspace) and the right commercial strategy to capitalize on the opportunity.
We believe Citrix is poised to re-rate in the next couple of years due to a business transformation that will take the business from a primarily perpetual license model to a subscription model. Over the next 3 years, we expect the business to change positively in the following way:
We believe these changes are not fully reflected in today’s share price and will lead to a significant re-rating of the stock. First and foremost, software businesses that move to a SaaS based subscription model naturally attract higher valuation multiples. The LTV of a customer increases in moving from perpetual to license as the implied price of the license paid increases and more products are being packaged together representing upselling opportunities. Citrix argues that the revenue uplift from a full transition, before factoring any potential incremental up-selling, could be as high as 30-35%. The revenue streams become then increasingly more predictable and not prone to large quarterly / annual swings. The business therefore becomes inherently more stable and less volatile. These positive attributes naturally garner higher valuations:
Secondly, while the transition to a subscription model leads to short term reduction in top line growths and margins, it leads to a reacceleration thereafter. This is a well know dynamic we have witnessed with the likes of Adobe, Autodesk and PTC. As a result, SaaS based subscription businesses exit their transition phase with an acceleration in revenues and an expansion in margins:
Such an acceleration in margins, but especially in revenue growth, leads to a re-rating of the company. This is very intuitive for any company in the world but especially for software stocks, where P/E valuations are very much tied to their expected top line growth. Sales growth is a much more important valuation driver than EPS growth. Citrix’s history demonstrated this. As per 2 charts below, Citrix’s P/E was much more closely correlated to its top line growth (left hand chart) than its EPS growth (right hand chart):
In 2015 and 2016, Citrix margins inflected positively, primarily following an activist campaign led by Elliott. While the large EPS acceleration boosted the stock price, it didn’t help the rating of the stock – in 2015 and 2016 Citrix P/E multiples fell from 20x+ to as low as 13-14x. It’s our belief that as the shift to subscription model normalises in 2020-21, top line will re-accelerate and the stock will significantly re-rate. There is a very close correlation in the software space between top line growth and P/E valuations as per chart below. Citrix will move upwards in the valuation matrix as illustrated below:
There is a reason the valuation discount exists today. Management has not been at all transparent as to how the transition to subscription sales will affect the company and as to what is the true underlying growth of the business. To date, management released very little information to help analysts properly model the transition. Some of the basic KPIs that companies such as Adobe, PTC, Tableau etc. provide to the market to help them model a business transition include ARR (Annualised Recurring Revenue), New Bookings, rateable license bookings as % of total bookings and churn. Without these KPIs it’s virtually impossible to accurately predict the transition of the business and Citrix doesn’t disclose these, yet. We believe this to be the single biggest factor depressing the stock valuation – Citrix currently trades on this year (2019) estimated free cash flow yield of nearly 8%. The stock is unduly cheap. A couple of brokers’ commentary / comments made support this view:
Morgan Stanley (SELL rated) – “In short, management is asking investors to focus more directly on the shift in business towards subscription sources versus the revenues and earnings showing up on the income statement, in the near-term. While this leap of faith is common in most Cloud transition stories, we think Citrix currently lacks two of the key elements needed to give investors’ confidence in the transaction: 1) a clear leading indicator of success… 2) a clear Cloud value proposition… we'd need to garner more conviction in the momentum and uplift available from the Citrix Cloud transition before shifting our focus away from the income statement and getting more constructive on the shares”
ML (NEUTRAL rated) – “There is still uncertainty as to the pace of the cloud transition...The cloud transition creates some uncertainty on the EPS/FCF profile, which has been a tenet of valuation support”
Jefferies (SELL rated) – “My question has to do with this transition to subscription. And I guess I'm just a little confused… depending upon the duration of the contracts and if that were to change, things like that, it's – and without a lot of historical information, it's really hard to just place our faith in that number right now”
We believe many of the above points will be addressed at the next Investor Day in scheduled for September 9th.
We believe another important overhang for Citrix is the competitive threat from Microsoft. Microsoft is expanding its desktop virtualization offering and the move is perceived to be antagonistic to Citrix. This would be a big risk as Microsoft is an important strategic partner, as per 10K disclosure: “In partnership with Microsoft, Citrix Virtual Apps is designed to embrace and extend Microsoft Remote Desktop technology by providing advanced provisioning, performance, monitoring and management functionality. Our joint solution with Microsoft lowers the cost of delivering and maintaining Windows applications for all users in the enterprise”.
Microsoft and Citrix maintained a strategic relationship for nearly 30 years and together offer solutions to facilitate the move to hybrid-cloud or multi-cloud delivery models. In 2018, Citrix announced a new collaboration agreement to provide customers a simplified experience by enabling them to purchase and deploy Citrix-powered digital workspaces and networking solutions directly within Microsoft Azure. Microsoft is clearly Citrix’s most important partner.
Following conversations with industry participants, our understanding is that Citrix is becoming increasingly important to Microsoft from a strategic perspective as virtualisation apps run in the cloud on Azure create highly profitable revenue streams for Microsoft. The move to the cloud seems to bring MSFT and Citrix closer than ever before and the Windows 10 upgrade cycle represents a strong tailwind for Citrix and Workspace. The launch in 2018 of Windows Virtual Desktop was initially seen as a dangerous, potentially competing alternative to Citrix. In reality, it appears the two solutions are perfectly complementary to each other, not competing. Citrix is in fact going to give Microsoft sales reps the possibility to sell Workspace along with Azure, demonstrating the strong partnership between the two.
Citrix seems comfortable with long term growth targets of 5-9% for Workspace due to the numerous tailwinds described above. This is in line with our 2021-22 growth rate of c. 7%. However, these growth targets are still somewhat affected by c. 200bps of annual headwind from model transition to subscription. From 2023, the headwinds will dissipate and we believe Citrix could accelerate top line growth to as much as 9%. As the short-term headwinds from the model transition abate, margins will also expand. We therefore estimate non-GAAP operating margins to expand from 31% in 2019 to 34% in 2022 and to continue expanding thereafter into the high 30s in the long term. Our returns assumptions are based on 2022 earning power in excess of $9 per share and FCF per share in excess of $10 per share. We believe that an acceleration of the top line growth and a shift to subscription will lift the valuation multiple from low-to-mid-teens P/E to high-teens, for nearly a doubling of the shares over the next 3 years.
We also believe the prospective returns are highly asymmetric as we see very little downside in a bear case scenario where growth continues to stagnate and margins don’t expand, as this is the scenario the market is currently implicitly assuming in valuing the shares today.
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15 | |
Anyone still looking at this now that it's back to $100ish? | |
14 | |
Hi Novana - CTXS's cloud transition appears to be playing out very nicely, accentuated by the acceleration in nearly all of the KPI's today. CTXS has $1.2bn of subscription ARR growing at 62% YoY despite only having transitioned a low-teens % of their customer base over! It's kind of astonishing in my opinon. I'm curious what you think of the Wrike deal. It clearly fits into their "intelligent workspace" vision that they outlined at their analyst day, but my impression was that they intended to build that mostly organically. What worries me is that, within 1 year of a prominent activist leaving the board and selling their shares (an activist whose platform was to divest past M&A failures and return your mountains of cash to shareholders!), they are spending nearly 2 years of FCF on this! It still seems like they're soundly on track to generate $10 of FCF per share in 2022 (probably more than that given mgmt's history of beating targets), so we're talking about 13-14x that. I used to take solace in the fact that that FCF was being returned to very consistently creating real downside protection but now we've gotta bet that CTXS is going to get this vision right. The upside still feels like it's there, but I worry the downside is also now much larger. | |
13 | |
Thanks so much. | |
12 | |
Hey Tyler, I don't have a strong view in terms of the competitiveness of the "pure"mobile device management solution of Citrix Vs VMware but I'd make 2 points:
I therefore look at Workspace as entirely incremental to the core VDI business which is super sticky and, yes - surprisingly, still growing | |
11 | |
On 8/20/19, Bismarck asked about the competitiveness of their MDM product, and raised the possibility that "Citrix's core install base would be at risk because VMware can go to Citrix's clients as they're contemplating the switch to cloud and say "hey, since you're considering cloud for VDI already, why don't you take our cloud-first VDI solution which also offers top notch MDM?". Novana, would you please give your thoughts on this (and Bismarck, if you have subsequently reached a conclusion on the concern you raise, would you mind sharing? Thanks. | |
10 | |
Novana, I have several follow up devil's advocate questions. What are your thoughts wrt how MSFT's multiuser windows impacts Citrix's license count? Doesn't the latency issue get resolved over time as cloud providers build more data centers? Thus, virtualization's latency advantage gets slowly eroded over time. The number of desktop and application virtualization use cases/users is probably flat, maybe very gradual growth (LSD). Would you agree with that? If the "market" opportunity is not growing that much and more companies are considering moving more workload to the cloud and potentially adopting cloud native virtualization tech (which could be improving every year), wouldn't Citrix's share slowly get eroded? In a flat to maybe gradual market, doesn't share erosion mean a decrease in revenue? Where I'm getting to: desktop/application virtualization is a stable flat or gradually declining segment (losing more share in a flat market to cloud native virtualization technologies). Changing license to subscription just changes the timing of the cash flows. To make the $10 and high teens multiple work, intelligent workspace has to significantly increase that 30% penetration because that's the only growth driver. One challenge they'll have is the ecosystem of partners. They're still early stages in building more integrations with partners and getting a developer community to build microapps. This is a fairly new skillset for Citrix so it'll be interesting to see how they execute. On this, I'm positive and thus bullish on the stock. Appreciate your thoughts. | |
9 | |
Near and mid-term guidance was very much in line with what I expected:
The big overhang of uncertainty of model transition is now behind us. The stock should re-rate over time as the company delivers on these targets. The street remains very skeptical on the company's ability to execute. Just to give you an example, take Morgan Stanley (UW rated). After Q2, they complained about lack of targets: "As the transition accelerates in the qtrs ahead, visibility into growth becomes more challenging while lack of margin & FCF targets makes the attractiveness of the transition difficult to assess”. Now that margin and FCF targets were clearly communicated to the market, they stick to their UW rating because targets were too aggressive: "While targets look attractive, underlying assumptions may prove aggressive keeping us UW for now". We remain bullish.
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7 | |
thanks for your comprehensive reply! | |
6 | |
SpocksBrainX,
You are asking a very good and most important question - is there something we are missing here? Or otherwise, what is the Street missing? After all, so many companies went through model transitions, why is it that the Sell Side doesn’t seem to give Citrix the benefit of the doubt in this case?
I think it’s very useful to look at a past successful model transition to try to understand some sell-side psychology that could shed some light on what is going on here. Let’s look at Adobe for example. In the case of Adobe, the company decided to proactively shift the business towards subscription in 2011. In 2011, only 11% of product sales was in subscription form. This number is over 90% today. It’s interesting to look at “peak headwind” from model transition for Adobe:
As per chart above, while subscription really started in 2011, the “peak headwind” year was 2014 as the annual mix change was as high as 22%, moving from 28% in 2013 to 50% of 2014. Unsurprisingly then, trough margins occurred in 2014:
We think trough margins for Citrix will occur in 2020, possibly 2021. Adobe’s 2014 is equivalent to Citrix 2020-21. What is interesting here is that while margins troughed in 2014, Adobe started to guide the market for a full model transition already in 2011. In November 2011, Adobe held an Investor Day describing the model transition. Over the subsequent couple of weeks, EBITDA expectations for 2014 fell from over $2bn to c. $1.2bn. In the subsequent weeks after the Investor Day, ADBE share price fell c. 15% from over $30 to $26 due to above described downgrades. However, by December 2014, when trough EBITDA was finally reported, the stock tripled to c. $75. What I am trying to say here is that the Street doesn’t need to see margins inflecting to re-rate the stock. The just need to understand the model transition to allow for multiple expansion. In the short term, nobody likes to see earning downgrades; however, it’s certainty about margin inflection that is needed in order to reward a business with higher multiples for changing its model for the best.
Let’s take Jefferies (SELL rated) for example. After Q1, as CITRIX explained on the call the headwinds from the model transition, the analyst asked on the call the following: “My question has to do with this transition to subscription. And I guess I'm just a little confused… depending upon the duration of the contracts and if that were to change, things like that, it's – and without a lot of historical information, it's really hard to just place our faith in that number right now”. The analyst may understand the transition, but doesn’t really believe in it because lack of historical information. On this, I’d like to point out that at Q2, Citrix did report average duration of the contracts as the analyst asked, but he failed to include it in his model. Similarly, Morgan Stanley (SELL rated), after Q1 wrote: “In short, management is asking investors to focus more directly on the shift in business towards subscription sources versus the revenues and earnings showing up on the income statement, in the near-term. While this leap of faith is common in most Cloud transition stories, we think Citrix currently lacks two of the key elements needed to give investors’ confidence in the transaction: 1) a clear leading indicator of success… 2) a clear Cloud value proposition… we'd need to garner more conviction in the momentum and uplift available from the Citrix Cloud transition before shifting our focus away from the income statement and getting more constructive on the shares”. After Q2, the commentary was very similar. Morgan Stanley yesterday wrote: “As the transition accelerates in the qtrs ahead, visibility into growth becomes more challenging while lack of margin & FCF targets makes the attractiveness of the transition difficult to assess”. Once again, it’s the lack of visibility here, not the earning downgrades that is bothering the Street. If margin and FCF targets are finally given (and they are in the range of what I expect them to be), the biggest bear argument falls away.
Not to pick on Jefferies, but looking at Adobe, in the midst of its model transition in 2012, the analyst downgraded the stock because “too much change to navigate comfortably…. Our downgrade is based on higher near-term revenue risk due to potentially stronger Creative Cloud subscription adoption”. Exactly 1 year later, in June 2013, with FY’13 estimates significantly lowered from a year earlier and the stock up over 40%, the same analyst upgraded the stock: “While we have missed the stock move so far, we have increased conviction on the multi-year shift and highlight new user growth, point-product transition and churn as areas of upside”.
In summary, while short term downgrades (which will come) are never taken very positively, what is holding back the street is some transparency on the business transition, some targets that illustrate the positive trajectory and long term goals where we can build scenarios around. This is what, I hope, will be provided at the forthcoming investor day. Absent those longer term targets, analysts will focus on the only thing they have at their disposal, i.e. short term expectations, which are being currently lowered. Sorry for the long answer but I thought you asked a good question that deserved some consideration.
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5 | |
BenHillGriffin, thanks for your comments and questions. I don't think 2020-21 numbers will be upgraded at the Investor Day. In fact, I think 2020 will be peak headwind in terms of transition. I'm assuming that in 2020, 70-75% of product bookings will come in subscription form, which is c. 1,000bps higher than in 2019. That will mean c. $120-150m in reported revenue headwind, or c. 400-500bps growth headwind. Assuming organic growth of 7-8% for the whole business, that would imply 2020 revenue growth of c. 2-4%, say 3%, or c. $3.07bn expected sales in 2020. Consensus is $3.13bn, I am therefore 2/3% below. As costs will continue to grow MSD, I am assuming further margin compression in 2020 while consensus seems to assume flat margins. If you are looking for 2020-21 upgrades to consensus from the Investor Day, you will be disappointed. The importance of the Investor day is not guidance 2020-21. It's rather about the full model transition transparency needed to understand the true underlying growth drivers of this business. I hope the company will give enough details for us to model this business properly until the headwinds from the model transition dissipate in 2022-23. At that point in time, I believe we will have a business generating in excess of $10/share in FCF, growing such FCF/share organically in the mid-teens. Similar businesses like ADBE, ADSK, PTC trade on 20-25x FCF. Including the effect of buybacks, which will reduce the share count, I believe this stock will be worth $200-300 once the model transition is completed. Discount this back 3-4 years, you have significant upside from current level. The Investor Day will, in my opinion, help the investment community thinking about Citrix in these terms rather than focusing on which quarter will margin trough. Regarding your second question about CEO commentary saying that vast majority of their customer base (c. 90%) hasn't transitioned yet, I think it's a bit of a red herring and can be explained with a combination of the following:
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4 | |
as per my usual MO, I have a very dumb question if you care to respond - why are at least three analysts downgrading today? I read the WF analysis on this which suggested that, short of the growth in subscriptions, top line growth and other metrics would be in line with the company forecast, which obviously seems in line with what the company said too in both the narrative and call. So if this is 'common knowledge' (esp with subscription transitions now widely understood), why the downgrades from the other folks - assuming these other analysts are reading the same things we do and can come to the same conclusions? Is it simply, ala BHG's comment previous to this note, that the transition will accelerate and thus near-term numbers will look worse before they transition so the downgrades are entirely short-term oriented? Or is there some other thought out there, some other expectation that the company did not meet? I realize that focusing on downgrades/upgrades from analysts can be perilous and often a poor way of making money but I'm new to this name and would like to better understand what makes it move. Even speculations are helpful... thx for any help | |
3 | |
Hi Novana,
Appreciate your write-up and I agree with your point that it’s very interesting that despite being a rare classically cheap on FCF software stock with an interesting growth/transition story, it has never been written up on VIC. In fact, your write-up didn’t even draw a comment until earnings! Very interesting in terms of sentiment.
But anyways, I’ve been digging in and get pretty positive feedback on hyperconverged infra and hybrid cloud implementations as well as lower hardware costs driving a resurgence in VDI implementations.
Do you have any thoughts on this commentary they gave on the call ahead of their analyst day – perhaps indicating that the P&L pressures will step up in in 2020 as the transition accelerates? Could the analyst day not quite be the positive event we’re hoping for, at least in terms of 2020-2021 expectations?
“And so, we're two years into this transition. I think we made really good progress, all in. But, unlike other model transitions that, we've seen across the industry. We've never really seen any material impact on the P&L, and I up to this point.
I think that's been for two reasons. First is that, we've just had better internal execution and a really good product story. So, we've sold more. We've sold more and we've just been trying to balance the impact up to that point. And so, phase one has been focused really on net net new. Largely due to capacity and focus. And so, last year we moved about 42% of the moved -- net new mix the subscription. This year as I said, we're looking at 60% to 65%. So that's a big increase, the law -- in the numbers are now large enough, that it's creating this headwind. That you're seeing over the course of Q2 in the balance of this year, really into the reported P&L Again, like I mentioned a minute ago, the offsets going to show up and deferred and unbilled, plus these new metric. So everybody has completed this ability. The way I'm thinking about the next couple of years though, is Phase 2 is going to bring much more focus on transitioning or really big installed.
So we've started that this year, we've seen a nice uplift and kind of the annualized dollars, those customers are paying for those we've transitioned so far. So this is a big incremental opportunity. In fact, hundreds of millions of dollars annually. That's going to start to become a priority in 2020.
And that's why to help everybody understand this, we've delivered these new metrics, on build revenue, ARR in particular. So that everybody can really just see how that -- it impacts beyond reported in P&L So we'll talk about all that in at our next analyst meeting to make sure that you have complete perspective. And again, that we're providing the metrics you can measure us along the way. Look much more like a traditional subscription transition, and looking forward to having that in-depth conversation.”
The other part of this I’m struggling with is that they say 62% of bookings are subscription…..but that the vast majority of their existing customer base (~90%) have not transitioned – how does that foot?
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Not bad at all in my opinion. Subscription mix came in at 62% Vs. c.52% expected, so 1,000bps higher (which is a nice thing in the long term). Company said that every 1% of mix shift from license to subscription represent a $10-12m headwind to annual sales. The order of magnitude makes sense. Assuming current bookings run-rate of c. $1.6bn (not disclosed), a 1% shift means a $16m hit to license sales, partially offset by the subscription revenue recognized in the year. Assuming the contract is signed on the 1st day of the year and assuming it's priced at c. 30-35% of license prices incl. maintenance (so if license is 100, maintenance is 20, the annual revenue is 120 and subscription is priced at 35-42), the annual subscription revenue recognized would be c. $4.8-5.6m. The net impact would therefore be c. $10.4-11.2m, exactly in line with the $10-12m guided by management. For the sake of argument, let's take $11m as mid-point for the year or $2.75m per quarter. In Q2-19, mix shift was c. 1,000bps higher than the original forecast in favor of subscription . This means that faster than expected transition led to c. $27.5m of revenue headwind, which explains over 100% of the miss. For the rest, business is doing well, committed revenue up 15% YoY, useful disclosure of ARR finally revealed, Workspace is growing 7% notwithstanding headwinds. Lots of things to like here. I remember earlier model transition days for the likes of PTC, Adobe, Autodesk had similar results. Investors and sell side are slowly learning how to think about the business transition and nobody gives management the benefit of the doubt. Investor Day in September could go a long way in rectifying this. | |
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Novana - what do you think? Optically, bad. But the transition to subscription/SaaS is happening faster than anticipated. What's your take? |
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