PSTG is highly volatile with a nonsensical short-term valuation, but buying dips may offer a payoff due to its durable business model.

You probably know if you're invested in Everpure or watching this company, it is a very volatile stock. Why is the market so touch and go with this one?

Or is it touch and go at all? Is this just normal volatility for a scaling business? Over there on the left side, this is where Everpure fits in tech equipment and devices, and now they're also in that enterprise software portion of the semiconductor industry.

We have Gartner that lists Everpure as a leader in the enterprise storage platform, partnered next to Red Lobster? NASA and ServiceNow.

They started as a storage server company where data was stored. They eventually evolved from just the hardware to storage as a service.

And so Everpure kind of evolved from providing just the hardware to also providing storage as a service. They had that as part of their business model, and now they're becoming even more of a data everything company.

They provide the hardware, they provide it as a subscription service, and they also are becoming more of a software and engineering style company.

Memory, of course, is the big topic this year, not just because Everpure buys NAND flash chips, but because memory prices have gone up a lot because of the memory and NAND flash shortage driven by AI data centers.

Everpure has said they're not going to try to pass those costs off and turn a profit on that on their customers.

Last year, Everpure announced that they were partnering with Meta. And now they have a second hyperscaler that they've inked a deal with which is also in the top five. Which revenue will start kicking in in fiscal year 2028, which reminder, that mostly corresponds with calendar year 2027.

All of a sudden, they went from pretty robustly free cash flow positive in the last 12 months to negative 20% free cash flow margin in Q2.

This probably sums up the stock price running well over $100 per share headed into the quarter, and then post-earnings the sell-off back into the low 90s. So zoom in again to that free cash flow for Everpure.

Negative nearly $240 million for the quarter, negative free cash flow margin of 20%. And the reason this is, is because Everpure still has to spend money on product components.

Even though they have started to shift to a more subscription-based model software business, they still have very much their hands on hardware. And memory prices, as we've talked about, are astronomical, and so they're spending a lot of cash on those components.

Management said there was, about a $500 million prepaid expense for components. Basically, they're just getting their hands on inventory that they need to fulfill orders.

The product revenue has been a bit more flat the last few years as they've prioritized subscriptions. We can go back up here and toggle quarterly. There has been a bump up the last two quarters in quarterly product sales as well. Subscription revenue has slowed just a bit.

If subscriptions are the driving force now for Everpure, that more of a platform business, a software business, I would say it begs the question then, why are they needing to drop $500 million in prepaid expenses to buy storage, NAND flash, and other components to build the storage arrays?

At some point, Everpure may rectify this situation and shuffle around their key performance indicators and the revenue breakdown, because what's happening is you still have the business from a few years ago where you could purchase those storage arrays as a subscription, bundled with the software.

Everpure handles everything remotely in the cloud, upgrades to the hardware and whatnot. All of that is both also hardware and software, so in products and subscription.

And now on top of that, the newer business that's really supercharging growth this year and next is the relationship with Meta, where Everpure actually isn't providing any hardware at all.

Meta is buying the NAND flash and the hardware directly from Kioxia, leaving Everpure to do engineering and software licensing and probably also software subscriptions. But that is a newer revenue line item, and so that's why you're still getting these big lumpy free cash flows with prepaid expenses for hardware, because that is still the majority of the business.

Is Everpure going to be that? We have no idea, but all the signs are there that they are piecing that together little by little. It's just gonna be a really, really bumpy road.

In addition to there being execution risk, you know, they don't pull it off.

You can see that in the guidance, this year they are going to get these little patches of elevated growth pushing towards high 30% thanks in large part to the Meta deal. And the second hyperscaler.

And then adjusted operating margin operating income is increasing faster than revenue you can see this possibly working out.

Another thing that went wrong in the quarter is, of course, adjusted operating income backs out stock-based compensation. SBC keeps going up for Everpure. They did offset it a bit, about sixty million in stock repurchases, they basically dipped into the net cash they have on balance to partially offset the stock-based comp.

That is part of what went wrong after the quarter, and it remains something to monitor closely with this company. That is one of the things that could derail this compounding story.

But metrics like this on an adjusted basis at least demonstrate that things are headed in the right direction, and it indicates what could be possible. Everpure surpassing its closest incumbent peer and NetApp in terms of revenue, very quickly homing in on six billion-plus in revenue. That's where NetApp is at today.

As we've already disclosed, Everpure has been in our portfolio. It has been a very volatile stock in our portfolio, but let's take a look at where it is, where it sits today, and run a reverse DCF on this.

At the time of this recording, share price is between 92 and $93 per share. We used earnings per share and free cash flow blend. The reason being is because both of these should, over time, converge to a 20% margin.

If you do too short of a horizon, the valuation makes zero sense whatsoever, even after really large pullbacks in stock price. Maybe that's why the stock price is down. That about sums it up. The valuation makes no sense.

Seeing free cash flow head deeply into the red in this most recent quarter, the market has to discount that in the future price. But even then, because this company is not prioritizing profit yet, You could look at this and say, "This should be a $20 business, $20 per share stock."

Because the market does realize this is hardware and software, it's pretty sticky. I don't wanna say a defensible business, but there is something durable starting to be built here.

Yeah, so that puts the growth rate then at 32%, which is a pretty high bar to clear. With Everpure, there is going to continue to be volatility. So if you're willing to have that kind of volatility in your portfolio, maybe buy on the dips when there's a significant pullback and wait this out, there is a possibility that this could be a good payoff.

And just realize that, the volatility will be even more extreme than it has been just in the last couple of weeks. This is what happens with businesses that are scaling with the potential to actually compound. They're just gonna be all over the board.

What this scenario, 32% per share profit growth for the next 10 years implies, though, is probably something around a low to mid-teens average revenue growth rate, and then profitability, both on a GAAP and an adjusted basis, like free cash flow would be an adjusted basis, both going from, zero or low single digits to 20%.

Both of those things will need to happen. So you don't even need this to be the craziest revenue growth story in the world, as long as they gradually make progress on profitability, manage the dilution in the share count- and just continue to execute on their strategy of building out a full-blown data storage platform But strap in.