Pure Storage finally breaks out of its stockmarket lethargy

The flash-memory data storage specialist had stayed on the sidelines of the AI rally.

Forgetfulness has now been corrected. After eighteen months of hesitation, the company's valuation has literally exploded since August, while yesterday's quarterly results once again sent the stock up 7%.

Why? Not so easy to answer this question, although Pure Storage has a convincing investment thesis: well embedded in the data-center ecosystem with differentiated technology and a key solution in hand, its equipment is built to last - and still supported by strong demand.

Proof is again evident in the current fiscal year, as revenue rose 14% in the first nine months of the year: a rebound seems to be starting after a trough. Pure Storage had sevenfold its revenue over the last ten years, but that theoretical growth rate abruptly stopped at the end of the pandemic.

Meanwhile, a new form of competition emerged, determined to capitalize on AI as well, in addition to the historical challenge from larger players like Dell, HPE, or IBM. The group also operates in an environment of prices it itself describes as 'dynamic', with cyclical demand and a strong dependence on equipment makers such as Micron, Samsung, or SK Hynix.

In reality, the issue at Pure, already highlighted it is the cost-structure problem, and particularly stock-based compensation. With this question in the background: is the company run in the interest of its shareholders or its executives?

Because this year again, the entirety of operating profit is vampirized by stock options, which is frankly exorbitant: $348m over nine months, or 13% of revenue.

To compensate for the dilution caused, Pure redirects its cash flows toward massive share buybacks. But these only serve to ease the pain rather than genuinely reward shareholders: on a diluted basis, the number of shares outstanding has not moved for three years.

Everything would be different if this hemorrhage stopped. In theory, Pure Storage could then produce $550m of free cash flow per year. But relative to its current market capitalization, this still equates to a multiple of 54x free cash flow. Put simply, no misstep is permitted at such levels.

With many caveats, Pure Storage's situation is therefore identical to that of the database specialist MongoDB, also discussed yesterday in these same pages.