Company Summary

Pivotal Software, the creator of the Pivotal Cloud Foundry platform, filed for a $100M IPO with Morgan Stanley leading the offering. Pivotal did not yet release a ticker symbol or the stock exchange the company plans to trade on. Unlike some other IPOs thus far this year including Dropbox, Zscaler, and Zuora, Pivotal is not venture-backed but is majority-owned by DellEMC, which came about after its merger with EMC in 2016. Pivotal was spun off from DellEMC and VMware in April 2013. Pivotal’s mission is to “transform how the world builds software” through their cloud-native solution, Pivotal Cloud Foundry. Pivotal also offers complimentary services alongside their PCF (Pivotal Cloud Foundry) solution, called Pivotal Labs. Pivotal got their start providing mostly services to their customers alongside their software/subscription offerings, but have shifted their focus over the past few years towards subscription, and Pivotal as of last quarter was a 56% subscription revenue business. The company was actually founded in 1989 as a consultancy by Robert Mee (current CEO), was acquired by EMC in 2012 and then spun off as a new business, Pivotal Software.

Market Backdrop

Pivotal is definitely a company in the middle of the cloud infrastructure transition. Adopting the cloud is no longer the question for large enterprises, but a matter of how and when. Digital transformation, cloud-first, cloud, cloud-native, microservices, etc. have taken hold and will only accelerate. The move to the cloud is powering a fundamental change in IT and this move also brings changes to an organization’s internal operating model in important ways towards DevOps and Agile, and away from the traditional waterfall software delivery model. The waterfall delivery model prioritizes minimizing risk instead of maximizing agility, restricts individual autonomy, slows feedback loops, and requires many checkpoints for each small change to an application. While software applications are changing, so is the infrastructure underpinning it all. We’re moving away from large, expensive, slow-changing and monolithic environments and moving towards loosely coupled services (microservices) that are rapidly updated. Enterprises need to adapt to this new, application-centric approach.

The whole of digital transformation is underpinned by software. To avoid disruption by new entrants or faster-moving competitors, companies making the transition to software-defined businesses will need to adapt to a new reality of approaches to building, deploying, and supporting in-house applications as well as packaged software. Since out-of-the-box approaches rarely work for everyone, customization and integration are key to taking apps beyond innovation silos to the point where they’re useful at scale. Software is driving the economy, and to be competitive in today’s world, companies need to rapidly deploy software products that create business value. To rapidly produce software, companies need to invest in infrastructure, like Pivotal. Below is a graphic that shows the legacy vs cloud-native approach.

Product and Metrics

Pivotal’s core offering, Pivotal Cloud Foundry, which key components include a multi-cloud orchestration foundation, an embedded operating system, a central security and credential framework, a built-in container networking and security engine, an application middleware environment and application and data microservices technologies. PCF also fosters an ecosystem of first and third-party cloud services that can be accessed on their platform through Pivotal Services Marketplace, which has over 75 independent software vendors. PCF is enabled by Pivotal’s service offering, Pivotal Labs, where they help customers create new applications and transform existing applications. Pivotal says some of their larger customers have increased productivity by 50% or more by using their solution.

Pivotal did $509M of total revenue in FY’18 (ending January 31), up 22% YoY. Given the revenue mix has been shifting toward subscription, their implied ARR (annual recurring revenue) was $300M ending FY’18, up 58% YoY. They are still losing a lot of money on a GAAP and non-GAAP basis, and their GAAP operating margin was (33)% in FY’18, an improvement from (54)% from the prior year in FY’17. On a non-GAAP operating margin basis, they had a (25)% and (44)% margin during the same time period. Pivotal charges subscriptions with pricing based on the number of workloads, such as applications, containers, or other microservices. Subscriptions are offered typically for one to three year terms and they generally bill customers annually in advance. As of FY’17 and FY’18, the company had a backlog of approximately $475M and $820M, respectively. They expect to recognize approximately 50% of those amounts as subscription or services revenue over the next 12 months and the remainder thereafter. For comparison, you can see how Pivotal stacks up to other IPOs for ARR, net dollar retention, contract sizes and cash consumption. Pivotal has $73M in cash. The company is based in San Francisco, California, and has 2,518 FTEs (full-time employees).

Below are a few other interesting stats pulled from their S-1.

• Transactions processed through our strategic partners under our agency agreements with DellEMC and VMware generated 46% of our total revenue in fiscal 2016, 44% of our total revenue in fiscal 2017 and 37% of our total revenue in fiscal 2018.
• A Forrester study found that 72% of developers spend less than three hours a day productively writing code. This inefficiency is often replicated across each application and infrastructure silo.
• An IDC survey showed that IT personnel devote over 70% of their time to routine service request approval, monitoring, troubleshooting, provisioning, security patching and configuration management.
• Enterprises want to optimize for performance and cost in choosing among private, public and multi-cloud environments. IDC expects more than 90% of enterprise IT organizations will commit to multi-cloud architectures by 2020.
• Gartner predicts that through 2021, 99% of vulnerabilities exploited will continue to be ones known by security and IT professionals for at least one year.
• As of February 2, 2018, we had been granted or had acquired 118 U.S. patents and had 73 U.S. patent applications pending.

Market Opportunity

Pivotal operates in the very large cloud infrastructure market. They believe their market for infrastructure, which spans application infrastructure, middleware, and other development software (PaaS) is a $50B+ revenue opportunity.

The cloud infrastructure services or PaaS market is expected to be $16B in 2018, growing to $29B by 2021, representing a 22% CAGR (Gartner). The application infrastructure, middleware, and development solutions spend is expected to be $43.2B in 2018, growing to $51.4B by 2021, representing a 6% CAGR (Gartner).

Moreover, PCF gives customers the flexibility to run software across private, public, and multi-cloud environments through a consistent developer operations interface. Given the move towards multi and hybrid-cloud environments, it’s likely that every F-500 company will utilize services from each cloud provider (i.e. AWS and Azure) to avoid vendor lock-in, increase product differentiation, reduce competitive pressure and cost, increase performance and resiliency, among many other factors. If Pivotal is able to help catalyze this shift to multi-cloud environments as well as offering a product that cannot be subsumed by the large cloud vendors like AWS and Azure, they could be in a unique spot. AWS and Azure are not likely to build products that would bridge services to each other. Pivotal could position itself as a common developer layer among the major cloud providers.

Competition

Given the massive market opportunity, there are many vendors trying to capture this spend and Pivotal is in a highly competitive market. They believe their main competitors to be legacy products and services from IBM and Oracle, Red Hat, other Cloud Foundry platforms in IBM Cloud and SAP Cloud Platform, and internally built solutions. Even though they partner with the cloud vendors, they state they do also compete with Amazon’s AWS, Google’s GCP, and Microsoft’s Azure.

Investors and Ownership

Pivotal was spun out of DellEMC and VMware in 2013 and has raised $1.7B in total from General Electric, Ford, and Microsoft. Dell (and it’s affiliates) own a majority of the company.

Financials and Metrics

Given Pivotal is rapidly moving towards subscription revenue, it’s helpful to look at the business on a quarterly-basis. They ended FY’18 at $299.9M of ARR, and grew ARR 58% YoY, while total revenue grew only 18% YoY from Q4. The mix has rapidly shifted though, with subscription revenue representing 56% of total revenue last quarter, up from 33% in the quarter ended April 2016. The gross margin on subscription has also reached 90%, while services gross margin is at 15%, both as of last quarter. Given the large customers and rapidly shifting revenue mix between subscription and services, their sales efficiency is less relevant, but they averaged a 73-month payback over the past 7 quarters (gross-margin burdened). Their net dollar expansion is very high and has averaged 164% over the past 4 quarters. Their average customer is large — $940K last quarter on average (implied ARR / # of customers) and added 5 net new customers last quarter. Pivotal targets the Global 2000. Pitoval had some legacy perpetual revenue, which was less than 2% of revenue in FY’18. Outputs of other financials and metrics are below:

Annual Historical P&L & Metrics (000's)

Quarterly Subscription Revenue ($M)

Implied Ending ARR ($M)

Given Pivotal’s large contract sizes, their net new ARR quarter-over-quarter has been lumpier. The company has added $110M of net new ARR in the last 12 months.

Subscription vs Professional Services Revenue Mix

Subscription Customers and Net New Customers

Dollar-based Net Expansion

Customers start smaller and expand over time with Pivotal’s product and the company exhibits very attractive net dollar expansion characteristics.

% Gross Margin Mix

GAAP and Non-GAAP Operating Margins

Implied Subscription Annual Contract Value (ACV)

Customer Cohorts S-1 Output

‍Annual Cash Flows (000's)

Quarterly P&L / Metrics (000's)

Valuation

I think valuation for Pivotal will be a bit different than other high-growth software businesses due to their significant services revenue, which is almost half of their revenue today (although declining quickly as a percentage of total revenue). Given that, the table below looks at Pivotal’s valuation on an NTM (next-twelve-months) subscription revenue basis using a high-growth software multiple range for subscription revenue (6x-12x) and a 2.5x NTM revenue multiple for the services business (roughly Accenture’s multiple).

Adding both up, we can see an illustrative enterprise value and multiple range on a whole company-basis, which in the middle of the range comes out similar to a Cloudera multiple of ~6.5x NTM revenue. This is a *very simple* back-of-the-envelope analysis but could make sense given the higher (but declining) percentage of services revenue.

Pivotal is an important business in the cloud infrastructure market and is operating in one of the largest software markets globally. Companies that can find the white space in between the cloud providers (AWS and Azure) are uniquely positioned, like Pivotal. With that said, the company is still losing a lot of money and public markets will hone on their path to profitability, unit economics and leverage in the business model. Pivotal also just recently became a majority subscription revenue business. While services are strategic to the company and their customers, it’s not a pure-play SaaS company and could get a lower total multiple, but the growth and scale is impressive. Overall, given they grew subscription revenue 73% YoY at their large scale, Pivotal is likely on the path to success in the public markets — congrats to the company and team.

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