My history with New Relic
At the end of June a year ago (2017) a post by Bear got me interested. Here’s what Bear said (Note that whenever I quote someone here I’ve edited and greatly abreviated what they said for my own notes):
New Relic monitors web and mobile applications in real time, detecting issues before they become problems, and helping companies figure out where the pain points may be before it costs them sales, or even customers. Along with CSCO’s recent acquisition, AppDynamics, and Dynatrace, New Relic is one of the main leaders in the APM space (Application Performance Monitoring). They recently partnered with Splunk, which I think solidifies their position even more.
Then I found that Bert had done a deep dive nine months previously, in Sept of 2016. Here’s what Bert said:
New Relic is a fast-growing company with a cloud offering in the APM space. It is still a long way from profitability, but it says it will reach it by the end of its fiscal 2018. It has many competitive advantages and it is gaining market share very rapidly. It has developed a dashboard product to extend its footprint beyond APM, a wise move given the revenue limitations of the space. Its mobile product, which is a very unique offering, should provide for further differentiation down the road.
Application performance measurement apps aren’t usually any more sexy or exciting than a thermometer or a barometer. Screens full of all kinds of numbers and graphs with different colors explaining capacity utilization or latency. Not exciting.
The problem with the APM category is that it has never gotten very large. It is around $3 billion/year of total revenues for APM. Adding Network Performance Monitoring (NPM) software brings the TAM to $8 billion as of 2015. But the TAM of the NPM space is growing more slowly. There are signs though that the growth of the APM space as well as the NPM space are accelerating noticeably. In 2015, NPM grew by more than 21% and APM grew by 11%.
Historically, the growth in APM was limited by competition from homegrown systems and because of some ingrained reluctance on the part of larger enterprises to monitor the performance of their applications. It has become less feasible to deploy homegrown technology, and given the payback from getting performance of web based applications right, the long-term ceiling in this field seems to be lifting.
Should you buy New Relic? Probably not at this point or with this valuation. There is a mismatch between expected growth, lack of profits and EV/S that needs to be rectified. But this is a company whose prospects are excellent, and it should come to dominate its space. The shares are worth putting on a watch list and trying to pick them off. It is how I intend to proceed.
New Relic is in the fourth position overall and has more than doubled its market share in two years. Based on its current performance in terms of revenues and its forecast, it is likely to move up to second in terms of the APM market by the end of this year. So while it is relatively small and is estimated to reach only $254 million in total revenues this year, it forecasts that it will reach both sustained positive free cash flow and non-GAAP breakeven by the end of fiscal year 2018 (ends 3/31/18).
The other major question will indeed relate to market share and the company’s growth. Forecasted growth this year is 40%, forecasted growth next year is 27%. From my perspective, I would expect it to outperform its rivals in this space very noticeably and I feel that these estimates are unreasonably low. At the moment though, I feel there is no significant potential for positive alpha. (Saul: Boy, was he wrong about that! That was the old Bert, focussed on EV/S. It was $37 when he wrote and is now $109, almost up 200%)
New Relic is a cloud-based company and has always been so. All of the other companies in the space, with the exception of AppDynamics, started with an on-premise model and have migrated. That has given New Relic an advantage in the ease of use of its products. It has thousands of small customers who use the tool to monitor the performance of their digital “store-fronts” either at peak retail season or around the year.
It also has a growing stable of enterprise customers who are acquiring the software to ensure that they get value from the applications they buy or internally develop. The enterprise business has much longer average contract terms coupled with far larger transaction sizes. Average annualized revenue per customer was only $17,000 a quarter, although that is up 36% year on year and 8% sequentially.
New Relic has prudently begun to develop what might be described as a real-time dashboard of surrounding metrics and telemetry to help users have a complete view of their business. This is a very nascent undertaking but it offers the company the ability to escape from the ceilings that have plagued other APM vendors. I think that a key to its retaining its revenue growth at levels well above the consensus forecast is going to be the Insight product that encapsulates this dashboard functionality.
If I were forecasting revenue prospects based on the size of the market, the competition, the company’s current momentum in competitive engagements, and the traction of its new products, I would say that it will significantly exceed estimates. Its strategy should work, in my view.
What’s this worth? I think recommending the shares is a close call. They are simply too expensive for me without better visibility with regard to revenue growth significantly above the current forecast. I would certainly be looking to buy these shares if there is a significant market pullback. And I would also look to buy these shares if investors are not pleased with some sub-headline metric as described above.
I am intrigued, but not quite ready to pull the trigger. (Saul’s Note: As I said above, Bert was perhaps over cautious.)
In July 2017 when Bear got my attention, I also found a current article on SA. Here’s a brief summary
New Relic, A Relatively Unknown Gem - It’s a relatively small market cap company in a fast growing segment. It is on a solid track to profitability by the end of FY18. It is relatively unknown, not a battleground stock, and is worth a speculative buy at current prices.
I don’t normally invest in stocks that are not profitable. But in New Relic’s case, I made a rare exception. I’ll try to explain its business model.
We are defining a new category of enterprise software we call digital intelligence, designed to help companies see their business more clearly.
Did that clear it up? No? Let’s try this version.
Not exclusively, its software is made for the “backroom” guys who are monitoring and designing a business’ applications. For example, they can show a real-time change in customer retention rates based on a price change. Or, where the mobile app they are designing is requesting too much data from the host. They can show the actual customer experience in real time.
It’s a big data world, and the faster you can maximize your performance metrics, sales programs, and user interaction, well, that’s big money. New Relic helps companies do just that. It went public in 2014. After some ups and downs, it has now moved to new highs. It has best-in-class margins. One key metric is its number of customers with an annual revenue of at least $100,000. This is a nice base of recurring revenue, and it is steadily rising.
I don’t like to buy stocks without earnings and almost never stocks with losses into the great unknown. New Relic, however, recently guided that it will be adjusted profitable by the end of Mar 2018. That is impressive for such an early and fast-growing enterprise. This is due to its scalability of growth and its large gross margins. It is also capturing larger customers.
Summary - These types of stocks are always difficult to judge. What appeals to me is their rapid growth rate, the attractive market they are in, and the fact they are relatively unknown. This is not a stock with hundreds of articles on it. It has a lot of time to get more attention and appreciate in price. As a testament to its model, Cisco purchased one of its competitors, AppDynamics, for $3.7 billion just before it was to go public in Jan 2017.
With a relatively low market cap of $2.4 billion, if NEWR can hit or exceed its estimated numbers, the stock could go much higher. Still risky, but a risk that is well worth taking. I may initiate a long position in the next 72 hours.
Saul here: I looked at the results of their Mar 2017 quarter
Revenue up 40% to $73.3 million in the quarter
Dollar-Based Net Expansion Rate of 133%
GAAP operating margin up 16%
We had an incredible finish to our fiscal year, with more than $263 million in revenue and revenue growth of 45%. This growth is driven by our success in the enterprise market, as nearly every forward-thinking company today is making a strategic investment in cloud and digital transformation initiatives. We showed significant efficiencies, improving our operating margins by over 13% despite investments in our enterprise business. We expect these initiatives to drive strong results including positive free cash flow for fiscal 2018 and adjusted operating income breakeven by the end of the fiscal year.
Quarter:
• Revenue of $73 million, up 40%, and up 8% sequentially.
• Adj loss from operations was $5.8 million, down from a loss of $12.0 million.
• Adj net loss per share was 11 cents, down from a loss of 24 cents.
Fiscal Year 2017:
• Revenue of $264 million, up 45%.
• Adj loss from operations was $25 million down from $41 million .
• Adj net loss per share was 49 cents, down from with a loss of 85 cents.
Business Highlights:
• Announced a strategic alliance with Splunk, unifying performance monitoring and machine data that helps enterprises transform customer experiences and drive revenues.
Saul here: Here was my take in July 2017 - Great results. I decided I really liked the company which is helping to disrupt a previously stagnant field. I took a half position and will probably keep it at that low level for two reasons:
First, the TAM seems somewhat limited, but obviously growing faster than expected, and
Second, I think that AppDynamics being acquired by Cisco will make AppDynamics more of a competitior with Cisco’s clout behind it.
I’ll keep a close eye on New Relic’s continued growth for signs of problems with competition.
Saul here: Then in August, after they announced June earnings, I decided to exit. Why? Here’s Chris’ summary which says it all:
Last night, NEWR reported their results. I see some things that I don’t like and that point to the validation of the hypothesis that their ability to scale is limited. What did I see?
The first warning sign is that revenue growth continues to decelerate. The q/q growth rate for the past 6 quarters was the following:
Q/Q Revenue Growth
Q1 17 54%
Q2 17 48%
Q3 17 44%
Q4 17 40%
Q1 17 37%
Q2 17 30% (E)
Don’t like that deceleration.
Next, let’s look at customer acquisition for the past 5 quarters. It has nose-dived!
Customers Cust Added Seq Growth Y/Y Growth
Q4 2016 13518
Q1 2017 14048 530 3.9%
Q2 2017 14538 490 3.5%
Q3 2017 14915 377 2.6%
Q4 2017 15216 301 2.0% 12.6%
Q1 2018 15400 184 1.2% 9.6%
They should be adding more and more customers each quarter. That would be evidence that scaling is working. If you compare the sequential growth in customers to other companies in the peer group, it looks pretty terrible. For me this is the nail in the coffin.
Six months later, in Feb 2018, a re-evaluation by Bear (He apparently sold out last August, the same time Chris and I did.)
Some of you may remember a little company I brought to the board last year, New Relic. Saul briefly owned it as well. It just reported what I consider a fantastic quarter. I decided to buy back in, and I wanted to give a little info explaining why.
One of the main reasons I sold several months ago was because the new customer acquisition seemed to be slowing. Well, they really have kicked it back up these last couple quarters!
Total accounts
Mar16: 13,500
Jun16: 14,000
Sep16: 14,500
Dec16: 14,900
Mar17: 15,200 (less growth)
Jun17: 15,400 (a lot less growth...I sold)
Sep17: 15,900 (big uptick)
Dec17: 16,600 (woah)
Enterprise Accounts - As with Shopify Plus for Shopify, the large accounts are what matters for New Relic as well. They had 629 Enterprise Accounts this quarter (accounts spending over $100,000). These accounts make up a full 52% of annual recurring revenue. Let me say that again, 629 out of 16,600 accounts, make up more than half the revenue! We know what to look at now.
Now, they’re not growing the enterprise group exponentially. They add on average 39 members each quarter. This quarter it was 43. But slow and steady growth is just fine, because its Dollar-Based Net Expansion Rate this quarter was 125%. If the trend continues, these enterprise accounts will eventually make up 55%, 60%, and maybe much more of the total revenue. These are entrenched partnerships with switching costs galore, and as such, this is great for NEWR.
Revenue Growth Ticked Back Up
Revenue (in millions)
Mar Jun Sep Dec
2016: 52 59 63 68
2017: 73 80 85 92
Revenue Growth
Mar Jun Sep Dec
2016: 57% 54% 48% 42%
2017: 40% 37% 33% 35%
That’s not blistering compared to some, but the uptick makes me believe it will be steady around this level. That’s also a reasonable assumption due to the predominance of their enterprise accounts. But even more relevant than revenue growth is the leverage situation, so let’s talk about that.
Gross Profit grew nicely, from $69 million last quarter to $76 million this quarter. That’s sequential growth!
OpEx barely grew, from 83.8M to 84.1M! Basically flat!
So Operating Loss narrowed from $15 million in Sept, to only $8 million in Dec. Pretty obviously scaling.
Conviction - My conviction rating on New Relic is 8.5. I believe they have a solid niche carved out. They partner with Splunk, which lends some credibility to that assertion. Almost all revenue is recurring, gross margin is fantastic, they’ve shown they can grow without increasing spending, and seem to be well on the way to profitability.
Conclusion - As I said, I’m back into New Relic with a 4% position for now. I plan to keep it this time. I don’t expect it to take over the world, but I think what they do is really cool. Their PS is currently 10.8. I consider them fairly valued here based on the likelihood that they continue growing. (Saul: I should have paid more attention)
From Another post by Bear
They help customers to figure out:
If something breaks or is about to
Where customer pain points are
Areas where they could improve functionality
Areas they could engage with customers better and upsell
Ways to enhance customer experience on their products
New data points to consider in evaluating their solutions
Ideas for future products and upgrades
How to better troubleshoot for developers
How to better troubleshoot for customers
Where customers spend time
How customers spend money
What captivates customers attention
…and this list could probably go on forever. Because they monitor billions of things. Literally. So that is kind of exciting when you think about it.
Then in May, there was a recommendation by the company that sponsors our board. I can mention it now as it’s well more than 30 days since that recommendation. Here’s a little excerpt:
New Relic makes software that ensures everything behaves the way it should — whether applications are in the cloud, on premises, or part of a hybrid system. As a pioneer of Application Performance Management (APM), it allows companies to see what’s working, what isn’t, and why. That’s important for making sure your back-office systems function the way they should, and it’s critical for understanding your customers’ experience.
Excitement over New Relic’s smart use of artificial intelligence has helped the stock roughly double over the past year. But I think there’s much more to come as a strengthening business serves a pressing need for an ever-growing range of customers. I think this could be a great time to buy.
Saul here: There’s a lot more, and if you are not a subscriber to the Motley Fool, you should be. It’s a nominal charge for the kind of information you get. (It got me Shopify in 2016, for instance, which paid for 100 years of subscriptions.)
Finally, two weeks ago, I looked aback at all these notes, and more, and decided to take a small position back myself? Why? It was much higher prices than those I sold at, after all. Here’s why I did it:
__**Operating cash flow margin percent** went from a loss of 33% of revenue to positive 10% of revenue in one year! Here are the quarterly results. Pretty impressive!__
**2017: -33% -12% +02% +07%**
**2018: +10%**
__**Adj operating margin percent** went from a loss of 44% of revenue to breakeven in one year! Even more impressive!__
**2017: -44% -33% -23% -10%**
**2018: 00%**
__**Adj FCF margin percent** went from a loss of 56% of revenue to positive in one year! That’s positively wild!__
**2017: -56% -33% -08% -02%**
**2018: 03%**
And dollar-based net retention of 141%, up from 133% the year before, and up from 125% sequentially?
And TTM adjusted earnings went from a loss of 49 cents to a loss of 1 cent in the same year. The last two quarters were positive 5 cents and 9 cents.
Pretty good, wouldn’t you say. I’m in for a 3.8% position.
Best,
Saul
