There is nothing market old-timers enjoy more than saying “that was a sign of market top.” The use of past tense indicates the lack of pre-comprehension, which also implies there was no profitable transaction preceding such a proclamation, but it sounds good. As the market recovers some of May’s give-back this week, 2019 still offers many signs of toppy behavior among market participants. Those old-timers can pick one: is it the ridiculous post-IPO performance of vegan burger company Beyond Meat, the tripling of shares in Roku, or even what hindsight shows to have been inflated values for 2019 IPOs such as Lyft and Pinterest?
Today’s market action gives us a clear winner: Pivotal Software. Pivotal shares have plummeted more than 40% in this morning’s trading on the back of a disappointing earnings report. The sign of the top is not the plunge, though, it was Pivotal’s pre-plunge valuation of $5.6 billion, a ridiculous amount for a company that was not profitable and has very little public float. Dell owns 64.9% of the shares of Pivotal and controls 94.9% of the voting power through a dual-class structure.
So, why was Pivotal Software taken public in April, 2018? It’s top-of-the-market corporate finance at its best. Let’s float a small portion of an asset we control to try and monetize it while it bleeds cash. Such a transaction requires two parties, of course. Somebody has to buy this stuff. When it is the public, unfortunately, average joes tend up losing loads of money, while I am assuming Michael Dell is still quite wealthy.
The “financial presentation” on Pivotal’s investor relations site doesn’t include a single financial detail until page 22, which should have given investors pause. In terms of the actual results, though, Pivotal’s fiscal first quarter (which ended on May 3rd) actually came in slightly above analyst estimates for revenues and EPS, and slightly exceeded management’s guidance, which had been published in the company’s March 14th earnings release.
So, what is causing the cratering in Pivotal shares today? Management lowered guidance for Pivotal’s fiscal 2020 results. Combined with the slight outperformance in the first quarter, Pivotal management’s outlook implies a much-worse-than-expected balance for fiscal 2020. Management’s guidance is about 5% lower on the top-line–or $40 million in foregone annualized revenue–and the guidance on the bottom line is now $10 million lower at the midpoint, and implies a loss of about $46 million for the year.
Pivotal’s balance sheet showed a decline in deferred revenue for both the current (within one year) and non-current periods, and that is the key figure. Software companies live on future sales, and though there was no shortage of obfuscation on the company’s conference call, it is clear those sales just did not materialize in the quarter. Wedbush analyst Dan Ives, who is notable for his misplaced bullishness on Tesla until a recent downgrade, referred to Pivotal’s quarter as a “train wreck” and the lack of deferred revenues and billings as “disastrous.”
The bottom line when analyzing tech companies is to ignore the bottom line and look at operating cash flow. By focusing on EBITDA, and ignoring a very weird decline in receivables in Pivotal’s quarter, we see that Pivotal posted negative EBITDA of $30 million in its fiscal first quarter, a slight improvement from year-ago period’s negative EBITDA of $28 million.
Companies that constantly post negative EBITDA just should not be public.
Pivotal is basically a plaything for Michael Dell, with two other main shareholders, Fidelity and Ford, which is also one of Pivotal’s software customers. I didn’t know about the Ford relationship until I perused Pivotal’s proxy this morning, but as a long-time auto analyst, I have heaped enough scorn on Ford’s management team to last a lifetime. Ford has the reverse Midas touch as shown with failed investments in the otherwise red-hot ride-sharing (Chariot) and e-scooter (Spin) industries. The market should have guessed that Ford would pick the wrong cloud software company in which to invest, but that is really the point here.
The market just was not paying attention to Pivotal’s obvious shortcomings. It’s an expensive mistake, and one that I believe will be repeated with other high-flying stocks as we move throughout the summer.