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Storage issues – We do not doubt the existence of ‘unicorns’, only their investment case

06/11/2015

Andrew Evans

Andrew Evans

Fund Manager, Equity Value

Exciting times here at The Value Perspective because, having recently highlighted the existence of modern-day unicorns in Hit and myth, we have now been blessed with the chance to study one up close and find out just what the fuss is all about. Just to remind you, the word is now being used to refer to unlisted start-up businesses that have reached the magic paper valuation of at least $1billion (£660 billion). 

Last month, Pure Storage floated on the New York Stock Exchange at $17 (£11) a share – the consequent $3.5 billion (£2.3 billion) valuation easily qualifying it for unicorn status. Wondering just what $3.5 billion (£2.3 billion) can buy you these days, we learned from the company’s prospectus that, for one thing, it can buy you the $174 (£114) of revenues and the $180 million (£118 million) of losses it made over the preceding 12 months. 

Not terribly exciting then – but of course these sorts of companies are all about the future and, as we also learned from the prospectus, Pure Storage’s future would seem strikingly rosy. The business is apparently growing at more than 100% a year and is well-paced to take a meaningful share of the currently $24 billion (£15 billion) data storage marketplace. 

It is generally about this point that, here at The Value Perspective, we like to play a little game called “What would we have to assume to make that happen?” Well, to gain a 10% share of the storage market, which is itself growing at around 3% a year, we would probably have to assume that Pure Storage will grow its top line by about 35% a year over the next decade. 

Let’s then assume Pure Storage has the same margins as NetApp, one of the current crop of data storage players it clearly hopes to be challenging. That being so, Pure Storage would see its revenues grow from $175,000 (£115,000)  in 2015 to some $3.5 billion (£2.3 billion) in 2025 while, over the same period, it would turn that annual loss of $180,000(£118,000)  into an operating profit of $350,000 (£231,000). 

If that were to come to pass, Pure Storage would be trading on a price/earnings ratio of around 14x and an enterprise value to earnings before interest and tax ratio of 10x, which as it happens is not very far from where NetApp stands at present. So, yes, the future as envisaged in Pure Storage’s prospectus is theoretically possible. But here is a more important question – is it likely? 

Well, work by Credit Suisse on the growth rates of S&P companies over the 10 years to 2014 found that some businesses with Pure Storage’s level of revenues were indeed able to grow at 35% or more for 10 years – but only 46 out of a sample size of 808. So, while the market now reckons with 100% certainty that Pure Storage will be able to grow at this rate, history sees it more as a 15-to-1 shot. 

And, if forced to pick a side ourselves, we would, as it were, be on the side of history – if only because of all the hurdles Pure Storage will have to clear along the way. First up, there are all the standard problems any growing company has to negotiate – finding employees with the right skills, which is especially hard in the tech world, expanding supply chains, building distribution channels and so on. 

Obviously that all costs money, which is hard enough for a company to come by even when it is not, as Pure Storage currently is, burning about 113% of its revenues each year. Then there is the fact Pure Storage finds itself up against some real heavyweights in the storage space – Dell, HP, IBM, to name but three – even the smallest of whom (NetApp) spends $900 million (£594 million) a year on research and development. 

And even if you were still of a mind to buy into Pure Storage’s future, one other detail that leapt out at us from the prospectus is that you would become the owner of ‘A’ shares, which carry one-tenth of the weight of the ‘B’ shares that are owned by the company’s founders. As long as your thinking always matches theirs, of course, you should be fine. But if not … 

One last concern – for now – would be that, its $3.5 billion (£2.3 billion) valuation notwithstanding, Pure Storage is currently still classified as an ‘emerging growth’ company under the rules of the US regulator, the Securities and Exchange Commission. This means its disclosure requirements – what the company has to tell the market – are less onerous than they would otherwise be. 

As you will probably have worked out by now, we have not really changed our view of modern-day unicorns. It is not that we doubt their existence, only their validity as long-term investments. Not so much Pure Storage, then, as pure speculation.

Author

Andrew Evans

Andrew Evans

Fund Manager, Equity Value

I joined Schroders in 2015 as a member of the Value Investment team. Prior to joining Schroders I was responsible for the UK research process at Threadneedle. I began my investment career in 2001 at Dresdner Kleinwort as a Pan-European transport analyst. 

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