Nutanix (NTNX) Taken to the Woodshed as JPMorgan Downgrades to Lowest Rating

Shares of Nutanix (NASDAQ: NTNX) are down over 6% in early trading on a downgrade from JP Morgan to Underweight (from Neutral) and a price target of $30.

The negative rating action on NTNX, from analyst Mark Murphy, is part of a larger call on software names likely to experience "decelerating business with limited recurring revenue" in 2018. The analyst also downgrades, both BlackLIne (NYSE: BL) and Talend (NASDAQ: TLND), to Underweight (from Neutral), driving the shares lower this morning, down 4.8% and 3.66%, respectively, citing similar declaration business concerns.

Murphy notes caution across the three names to clients, suggesting the "transition to software-only model appear priced in" with the Software Index ETF (IGV) up 42% in 2017, outperforming the broad market S&P 500 ETF (SPY), up 19% in 2017. However, the JP Morgan analyst is clear to indicate the downgrading of NTNX, BL and TLND, does not represent a call to "Sell" shares, but rather acknowledges the increased potential for underperformance in 2018, "relative to our coverage list."

On NTNX specifically, the analyst said the transition to a software-only model appears priced in for a "decelerating business with limited recurring revenue."

They lists four reasons for the cut, all centered around the transition.

1) Period of Transition Could Create Near-Term Business Disruption. While they support the shift to software, the analyst think the various moving parts carry the potential to create some disruption in the business

2) Different Type of Transition. While investors are quick to pile in to transition stories along the lines of Adobe and Autodesk those transitions are starkly different. "... they transition from perpetual License to Recurring; they transition from on-premise to Cloud; and customer lifetime value (CLTV) tends to increase noticeably. For Nutanix, the main change is to eliminate pass-through hardware revenue from its P&L, while remaining an on-premise offering with very limited subscription revenue (for now) and no clear-cut change in CLTV."

3) New Sales Leadership Could Lead to Further Changes in the Sales Organization ".... we think it is reasonable to consider ramifications of the Sales Leadership changes coming in conjunction with material business model changes."

4) Reporting Changes Associated with Transition to Software Induce Dampening of Reported Growth. The decision to move away from the pass-through hardware piece over the next few quarters will have a dampening effect on total revenue and billings growth, unless software only sales pick up the slack. "We are forecasting revenue growth to slow from 34% in FY18 (July) to 16% in FY19 (July)."

The $30 valuation on NTNX is based on a roughly four times enterprise value to calendar year 2018 revenue estimates ratio, a discount to NTNX's high growth peers.

The current price target represents 17.6% downside from Wednesday's closing price.

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