As most of you know, I have a very outspoken opinion on how a software company should be run. When you’re a giant like Salesforce, and you’re operating on a 2.26% margin (July ’19), you’re doing something very fucking wrong. The company I am recommending today is running at 85.24% gross profit margin.
The risk of an upcoming recession is growing day by day. In fact, many believe we have already entered a recession. Considering the near-zero growth over the past 20 months and the central bank dilemma that is going on around the world, it doesn’t sound that unfounded. Given this recessionary risk, I tend to include tech stocks in my portfolio that are more resistant to the markets turning negative. Most of the growth stocks just pose too much risk right now.
Now we all know the cloud story, and it’s incredible importance in the forthcoming years. Tech companies have aggressively pursued cloud dominance throughout the past decade. The recommendation today is a bit of an exception; their cloud strategy started just two years ago.
The company I am talking about is Citrix, most famous for their workspace, virtualization, and the recent sale of GoTo products.
Citrix offers enterprise-level virtualization software and virtual desktop infrastructure (VDI) solutions to give employees the freedom to work anytime and anywhere. About 75% of global enterprises use Citrix in some way, and thereby amassed tens of millions of active users. The stickiness is very high, as Citrix is deeply integrated into the IT infrastructure of its clients. As a result, the cost of potentially switching is often too expensive as well.
Although Citrix has a suite of products, we only need to focus on one segment. The segment that is currently generating 75% of the sales and is expected to become a larger share of the total sales for Citrix. This segment is the workspace. The workspace covers desktop/application virtualization, mobile app delivery, and workspace suite (workspace aggregator).
What the workspace does is very simple. It unifies all of the applications, data, devices, and desktops into one workspace. As an example, a person in the Tokyo office can work on a multimedia project requiring many files and software applications. All of this will be accessible within one platform. His colleague in the USA has direct access to this as well. This way, the two colleagues, or any others, can collaborate on a project. Everything runs within the Citrix platform. Whether it’s the project data files, the software that the multimedia project is edited on, and whatever else, all on one platform. Simply said: you can work anytime from anywhere, and within one platform have access to everything, for an entire corporation.
The average customer (corporations) is delivering 500 applications across all different app types. Do you want the entire team to remember the password for every single application, and endlessly email all the files back and forth? That’s an organizational nightmare. This is why Citrix is so essential. You only sign in once. It unifies everything and keeps it extremely simple to use. And best of all, they now offer the workspace on the cloud, so customers don’t have an expensive upfront cost for an on-prem license and installation. Right now, customers can sign up for an annual subscription, thereby making Citrix a subscription-based-SaaS, the type of company that yields a higher stock valuation…
Citrix’s main competitor is VMware, which has aggressively pursued a cloud strategy for many years but still have less market share than Citrix. The one moat that Citrix has against them is their partnership with Microsoft, which has been ongoing and strengthening for 30 years. Recently Microsoft has identified virtualization as a significant profit center. As a result, their partnership is closer than ever before. The Windows Virtual Desktop is now integrated with Citrix cloud. The Microsoft sales reps can also sell Citrix along with their Azure product.
The big opportunity
The most beautiful thing about all of this is: the stock is trading at a discount to its peers, and still hasn’t priced in the transition. Management has not been transparent in the past two years about giving information that allows analysts to make estimates. Analysts are looking at a low single-digit growth rate but are not taking into consideration that Citrix is switching from expensive upfront perpetual license deals to annual subscription plans. That means there is less cash now but will be more cash in the future.
Adobe was the first company to really transition towards a cloud-based model, and the stock quickly doubled with 90% of its revenue being recurring. Autodesk, during their transition, showed negative YoY growth, and the stock still flourished afterward. Citrix still has positive YoY growth, though minimal, but I see it as irrelevant as the model is changing. Now it will have a stable and predictable revenue.
Citrix is actually exceeding the internal expectations for their transition towards the cloud. Only 10% of their existing customers have transitioned so far, and Citrix has done that on purpose. Because up until now, the focus has been on net-new customers for their cloud product, to first build a base of users.
Citrix holds an excellent reputation amongst its extensive existing installed base. As mentioned, only 10% of them have transitioned thus far, and the new strategy focuses on selling to these internal customers. These sales are relatively more accessible, as they are familiar with the service and a fair share of them have requested this transition. Once they are adopted on the cloud-based subscription platform, Citrix’s revenue will be far more stable and predictable.
It’s just the perfect match of having the right product at the right time with the right customers. The more complex companies become, with individuals working remotely and on different devices, the service that Citrix provides becomes more necessary.
The simple rule for a good investment is: find a great company that is near guaranteed to grow in the next decade. Citrix is near guaranteed to grow. Virtualization will only increase amongst corporations. Meanwhile, they are operating at a near 85% gross profit margin and revenues are becoming more stable due to the cloud-based subscription method. These type of SaaS firms yield higher valuations, and given the current discounted price of Citrix, we believe that at the current price of $90/share up until $105/share it remains a very strong buy, with a price target of $130 within 3 years.