The cloud computing industry has been growing at a nice clip for the past few years, and it isn't expected to slow down anytime soon. IDC estimates that public cloud spending will hit $500 billion by 2023 from $229 billion last year. That translates into a compound annual growth rate of 22.3%, which would be driven by increasing demand for Software-as-a-Service (SaaS) by corporations and enterprises.

Gartner, for instance, forecasts that SaaS revenue could jump over 50% by 2022. Nutanix (NASDAQ:NTNX) is one cloud stock investors can buy to take advantage of the growth in public cloud spending, as it stands to win big from the SaaS vertical. Let's see how.

Abstract representation of computers connected to the cloud.

Image source: Getty Images.

Nutanix's transition to software makes it an attractive bet

Nutanix has quickly transformed itself from selling hardware appliances to a software-centric business model in the space of just five quarters. The company was getting a quarter of its revenue from selling hardware for hyper-converged cloud infrastructure before the pivot happened. But that business had weak margins and the prospects looked bleak thanks to ballooning memory costs.

In fact, Nutanix's gross profit margin was 61.9% when Nutanix announced the software pivot. The metric was moving in the wrong direction as hardware costs pressured the company's margin profile. The story is much different now, as Nutanix has started getting a big chunk of its revenue from software sales.

NTNX Gross Profit Margin Chart

NTNX Gross Profit Margin data by YCharts

In the first quarter of fiscal 2020, Nutanix's software and support revenue came in at $305 million, an increase of 9% over the prior-year period. The company's total revenue stood at $314.8 million, which means that hardware sales have been reduced to a tiny portion of the company's overall business. More specifically, Nutanix got just $9.7 million in revenue from hardware sales last quarter as compared to $32.5 million in the year-ago period.

Subscription-only sales clocked impressive annual growth of around 71% to almost $218 million. However, one-time software sales plunged to $77.5 million from $146.5 million a year ago as Nutanix's transition to a software-centric model continued. This means that Nutanix now gets just over 69% of its total revenue from selling software subscriptions.

So, the company still has some way to go before it completely eliminates its legacy hardware and software businesses. Nutanix has set itself a target of generating 75% of total billings from the subscription business by the end of the current fiscal year. It is close to attaining that target, as now 72.5% of billings in the first quarter came from subscriptions.

More growth in the cards

It won't be surprising to see Nutanix's subscription business supply a greater proportion of the overall revenue in the future, considering the pace of growth in its deferred revenue. The company's deferred revenue shot up 39% annually to $975 million during the first quarter of fiscal 2020, while its overall revenue was flat on a year-over-year basis at $314.8 million.

Deferred revenue is the amount of money collected by a company in advance for services that will be rendered at a future date. The deferred revenue is recognized on the income statement when services are actually delivered.

For Nutanix, this means that the company's subscription business is succeeding. In fact, the average contract term of Nutanix's subscription customers stood at 3.9 years in the last reported quarter. This points toward long-term growth at Nutanix, as the company is able to lock customers in long-term contracts.

What's more, Nutanix's existing customers are spending more money on its services. That's evident from the company's 132% dollar-based net expansion rate last quarter. This is considered to be a solid number for a SaaS company as per Crunchbase estimates, which puts the industry average at 106%. Additionally, Nutanix was able to retain 97% of its customers last quarter.

In all, Nutanix looks like a solid cloud computing bet, as it is operating in a fast-growing market and is pulling the right strings to increase both margins and revenue. Mordor Intelligence estimates that the hyper-converged cloud infrastructure market will clock 13% annual growth from 2020 to 2025. The growth in Nutanix's software business suggests that it is growing at a faster pace than the industry it operates in.

This makes Nutanix an attractive bet for anyone looking to buy a top stock for the long run.

 
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