New Relic (NEWR)

Investment Analysis Clubs Saul’s Investing Discussions
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Some of you may remember a little company I brought to the board last year, New Relic. Saul briefly owned it as well: http://discussion.fool.com/my-review-of-new-relic-newr-32786219…

On Tuesday (2/6), NEWR reported what I consider a fantastic quarter. I decided to buy back in, and I wanted to give a little info explaining why.

Company Summary

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 Cisco’s recent acquisition, AppDynamics, and a private company called Dynatrace, New Relic is one of the main leaders in the APM space (Application Performance Monitoring).

Paid Business Accounts Growth Accelerating

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 SHOP, the large accounts are where the rubber meets the road for NEWR 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 NEWR’s Dollar-Based Net Expansion Rate this quarter was 125%. Who do you think is spending more with them all the time? That’s right, the enterprise accounts.

If the trend continues, these 629 accounts (and those that reach enterprise level in the future) will eventually make up 55%, 60%, and maybe much more of the total revenue for NEWR. These are entrenched partnerships with switching costs galore, and as such, this is great for NEWR.

Revenue Growth Ticked Back Up

Here’s the history:


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, OpEx Barely Grew, therefore Operating Loss Narrowed

Extremely nice uptick in gross profit: from 69M last quarter to 76.2M this quarter. That’s sequential growth!

OpEx? Sequentially it only grew from 83.8M to 84.1M! Almost no growth at all.

So obviously, this had a impressive effect on Operating Loss. Where they lost 15M in September, that loss was only 8M in December. Pretty obviously scaling.

Outlook for Next Quarter

Revenue between $95.0 million and $96.5 million, representing year-over-year growth of between 30% and 32%, respectively.
Non-GAAP income from operations of between $2.0 million and $3.0 million.
Non-GAAP net income per diluted share of between $0.04 and $0.05. This assumes 58.6 million weighted average diluted shares outstanding.

Conviction
(http://discussion.fool.com/what-makes-a-company-good-32969538.as…)

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 do think what they do is really cool: http://discussion.fool.com/thanks-ant-while-i-actually-think-new…

Their PS is currently 10.8 and their HPE30 (a metric I made up meaning hypothetical PE at a 30% margin) is 36. I consider them fairly valued here based on the likelihood that they continue growing.

Bear

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Paul - I agree. I kept an eye on this one even when dropped from the board or at least Saul’s portfolio. I thought their numbers and emerging profitability looked really good.
I never took a stake but have always consider doing so.
Ant

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Hi Bear, I liked your re-evaluation and agree it looks interesting. Have no free cash though at the moment, but will keep New Relic in mind.
Saul

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This is a great post that I’m afraid got a little lost with the flurry of recent posts with all the volatility going on. I’ve been meaning to look more into NEWR since last July when I saw it mentioned a few times on this board, and reading your post makes it sound like the have done exactly what they proposed to do 3 quarters ago.

Thanks for bringing this to the board. I wonder if anyone else has any thoughts on NEWR as I am seriously looking into them now and like what I see at first glance.

Anything to be concerned about with competition, moat, etc?

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I gotta say, I just don’t get the current infatuation with “non-profits” that seem to exhibit only one compelling characteristic: revenue growth.

What happened to all the tried-and-true standard metrics formerly used to evaluate the financials of business enterprises? What I’m observing today seems very much like “late stage bull market thinking”

And I’m thinking we may very well return someday to a more conservative/value-oriented approach to evaluating companies.

I took a quick glance at NEWR and came away scratching my head as to why anyone would want to invest hard-earned dollars in an enterprise with the following characteristics:

Market Cap 3.54B
Revenue 329.95M
Price/Sales 10.74
Forward P/E 257.52
Profit Margin (-16.17%)
Operating Margin (-16.47%)
Return on Assets (-9.83%)
Return on Equity (-27.47%)
Net Income Avi to Common (-53.35M)
Diluted EPS (-0.99)

Given all the above, I’ll pass.

May we all live long and prosper

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Anything to be concerned about with competition, moat, etc?

Good question, for sure. And it’s always tough to evaluate, but I think they’re clearly one of the two or three companies in a leadership position with APM (Gartner agrees). I don’t follow AppDynamics or Dynatrace (New Relic’s two main competitors), but I don’t see why all three can’t do well in this growing space if all keep innovating. If both New Relic’s customers and Splunk see NEWR as their preferred choice, that’s encouraging to me.

I’ll of course keep a watchful eye that the numbers continue to tell the same story. So far I believe they are doing so.

Bear

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I gotta say, I just don’t get the current infatuation with “non-profits” that seem to exhibit only one compelling characteristic: revenue growth. What happened to all the tried-and-true standard metrics formerly used to evaluate the financials of business enterprises? What I’m observing today seems very much like “late stage bull market thinking”…I took a quick glance at NEWR and came away scratching my head as to why anyone would want to invest hard-earned dollars in an enterprise with the following characteristics:

Market Cap 3.54B
Revenue 329.95M
Price/Sales 10.74
Forward P/E 257.52
Profit Margin (-16.17%)
Operating Margin (-16.47%)
Return on Assets (-9.83%)
Return on Equity (-27.47%)
Net Income Avi to Common (-53.35M)
Diluted EPS (-0.99)

Given all the above, I’ll pass…

Hi putnid,
That sounds very logical and sensible. The only problem with your analysis that I see is that your logical reasoning would have said the exact same thing about Shopify, exactly the same thing, a year and eight months ago or so, when I bought it at $27.00. Shopify is now at $119.50 (443% of my entry price in less than two years). That doesn’t mean I’m rushing out to buy New Relic, but investments in a lot of these subscription-based companies with losses but rapid growth, lots of recurring revenue, and lots of deferred revenue, have turned out to be very successful.
Saul

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The only problem with your analysis that I see is that your logical reasoning would have said the exact same thing about Shopify, exactly the same thing, a year and eight months ago or so, when I bought it at $27.00. Shopify is now at $119.50 (443% of my entry price in less than two years). That doesn’t mean I’m rushing out to buy New Relic, but investments in a lot of these subscription-based companies with losses but rapid growth, lots of recurring revenue, and lots of deferred revenue, have turned out to be very successful.

Saul:

You forgot to mention that NEWR is growing revenue YoY at 35% as compared to gargantuan revenue growth for SHOP…that would certainly be a rather eye opening difference in comparison between SHOP and NEWR.

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You’re right, Duma, I didn’t think of that. But on the other hand, the speed of growth wasn’t one of the objections presented.

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You’re right, Duma, I didn’t think of that. But on the other hand, the speed of growth wasn’t one of the objections presented.

True and I know you have stressed the near unprecedented revenue growth rate for SHOP on several occasions so it wasn’t really a fair fight when you used that example for NEWR :slight_smile:

Really interested in the upcoming SHOP earnings as regards the MRR…I think this is the best proxy for the highest paying merchant types…two categories that likely will tell us if the “near unprecedented” will still stand.

Best:
Duma

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That sounds very logical and sensible. The only problem with your analysis that I see is that your logical reasoning would have said the exact same thing about Shopify, exactly the same thing, a year and eight months ago or so, when I bought it at $27.00. Shopify is now at $119.50 (443% of my entry price in less than two years). That doesn’t mean I’m rushing out to buy New Relic, but investments in a lot of these subscription-based companies with losses but rapid growth, lots of recurring revenue, and lots of deferred revenue, have turned out to be very successful. - Saul

Hello Saul,

“The only problem with your analysis…is that your logical reasoning would have said the exact same thing about Shopify…”

Excuse me, where, exactly, is the problem with my analysis? Are you saying that good price action in a specific stock in a late stage bull market constitutes some sort of proof? There’s an old, old Wall Street saying that “Bull markets make geniuses of us all”. I’m delighted you did well with SHOP. Perhaps it will surprise you that my experience with Micron (MU) was just as positive. I’ve posted about Micron on several occasions. Some might recall that I recommended Micron to the board when it began recovering from a down cycle in the first half of 2016. The financials were already compelling. I bought a great many shares at prices in the $9.50 to $10.00 range. Even after harvesting a good deal of profit, my Micron position today is 20+ percent of my portfolio. And, hey, guess what? Micron reached a high of $49+ in late November 2017. Golly gee, a 450+% gain in less than two years! Yeppers bull markets make geniuses of us all. So, has Micron maxed out? Not by a long shot. Let’s go over the financial metrics, shall we?

Market Cap 46.73B
Revenue 23.15B
Price/Sales 2.02
Forward P/E 4.64
Profit Margin 32.77%
Operating Margin 37.67%
Return on Assets 16.77%
Return on Equity 41.51%
Net Income Avi to Common 7.59B
Diluted EPS 6.40

Why not seriously compare and contrast these financial metrics with those of NEWR, WIX and even SHOP? By my logic, even after a four-fold increase in share price, a very profitable Micron may move significantly higher in light of its current undervalued position. I can’t say the same for the “non-profits” you favor so much. So, I’ll ask again: where is the problem in my analysis?

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So, I’ll ask again: where is the problem in my analysis?

You are not Saul!! Sorry, couldn’t resist…

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Hi putnid,
I was really being very serious when I said that the way you analyzed it seemed very logical and sensible. You were saying that companies that were losing money, had negative earnings and high price to sales ratios seemed like poor investments. I was saying that the only problem with that kind of analysis was that you would rule out some marvelous companies that were growing very fast. The very words I used were but investments in a lot of these subscription-based companies with losses but rapid growth, lots of recurring revenue, and lots of deferred revenue, have turned out to be very successful. I wasn’t trying to attack your way of investing. Many people won’t touch these SaaS companies with a 10-foot pole, and I’m very aware of it. I was simply saying that you’ll miss some very successful companies. Some of them are growing so fast that it’s hard to believe, even for management. More than once I’ve heard a CEO say something on the order of “Once we sign a company we have recurring growing revenue basically forever. We have a green field in front of us and we’d be insane not to spend every penny we make in profits on Sales and Marketing to sign up more customers and grow our customer base as fast as we can. It increases our expenses this quarter, but the revenue from the sale that we are paying for this quarter doesn’t just come in in this quarter, it comes in the next, and the next, and the next, and… with very little further S&M expense.” I can certainly live with that kind of thinking, and it’s no put-down to you if that’s just not your thing.
Best,
Saul

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Why not seriously compare and contrast these financial metrics with those of NEWR, WIX and even SHOP? By my logic, even after a four-fold increase in share price, a very profitable Micron may move significantly higher in light of its current undervalued position. I can’t say the same for the “non-profits” you favor so much. So, I’ll ask again: where is the problem in my analysis?

Putnid,

First, let me say that I join you in owning Micron, and I agree with you that it has great potential and seems very undervalued based on that potential.

Second, let me say that I feel almost immeasurably more convinced that the “non-profits” you mention will continue to grow reliably for years into the future. That’s because revenue is based on subscriptions, which these companies tend to retain at a near-100% clip. Next year, they’ll make just about what they make this year, plus any more that their current customers decide to spend with them, plus any revenue from new customers. I fail to see how anybody could not like this business model.

Sure, you have to make sure these companies have the ability to leverage, which starts with a good or great gross margin. Think about it:

-Let’s say you are all but certain you can grow revenue 30% or 40% next year, even if you have to spend 100% of revenue this year to do it
-Now, if you simply don’t increase spending next year, that 30% - 40% could potentially all be profit.
-Even if you’re losing money (spending more than 100% of revenue) this year, it’s not hard to see that you can catch up very quickly whenever you want: Because gross margin is so high, spending is easy to throttle when it becomes harder to land new business.

Micron is simply nothing like this at all. Revenue is not based on subscriptions, so you just cannot say that “Next year, they’ll make just about what they make this year, plus any more that their current customers decide to spend with them, plus any revenue from new customers.” No, with Micron, next year they will eat what they kill. Just like this year. I happen to believe the ground is fertile and the demand will be good…but the winds could change and demand could be lower. Even if demand stays high or increases, one of Micron’s competitors might be able to up their production, driving down prices, and with them, Micron’s revenue…but more importantly its margins. It’s a huge difference from the “non-profits” which have the security of revenue from subscription contracts, and gross margins.

So there is really nothing wrong with your analysis. I even agree that Micron may have more room to run than the “non-profits,” because it is a comparatively less expensive stock. There’s less certainty, so more opportunity if things work out. But I hope I have also explained here:

  1. Why I believe the market values these SaaS companies so highly, and
  2. Why I believe they deserve it.

Bear

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First, let me say that I join you in owning Micron, and I agree with you that it has great potential and seems very undervalued based on that potential.

Micron Technology is a cyclical boom and bust business:

https://invest.kleinnet.com/bmw1/stats30/MU.html

Denny Schlesinger

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Second, let me say that I feel almost immeasurably more convinced that the “non-profits” you mention will continue to grow reliably for years into the future. That’s because revenue is based on subscriptions, which these companies tend to retain at a near-100% clip. Next year, they’ll make just about what they make this year, plus any more that their current customers decide to spend with them, plus any revenue from new customers. I fail to see how anybody could not like this business model.

Micron Technology is a cyclical boom and bust business

Thanks Bear and Denny, You said it even better than I did.

Saul

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Hi Fion, Welcome to the board! Have you read the Knowledgebase yet? It’s at the top of the right panel on every board post. It’s in three parts.
Best,
Saul

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I’m a customer of New Relic, and I like their service, but I’m a bit reluctant to invest in them.

Now they are very well integrated into cloud services, and are probably the first company that any startup would choose. AppDynamics is bigger in the big enterprise market though, as far as I can see.

More importantly, the service they provide - application monitoring, metrics and analysis is almost a commodity service these days. They have many competitors, plus the cloud titans provide these services for free. I’m not saying they don’t provide added value by letting you look into your servers across all your hosting areas (local, private cloud, public cloud), but it is hard to charge a lot for this.

This is also the type of thing that hosting and consulting companies always implement for themselves, then try and sell to others - so there is always going to be new competitors coming up that will be self-funded because someone wants their own version of it.

I guess my basic question here is based around their moat - do we believe they really have one, or is it just based on brand and support? Without a moat, even a company that is executing great is going to find it hard to grow revenue and margin.

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I guess my basic question here is based around their moat - do we believe they really have one, or is it just based on brand and support? Without a moat, even a company that is executing great is going to find it hard to grow revenue and margin.

Great point, and it is borne out in the numbers. The last several quarters NEWR’s revenue growth has averaged 35%. Nothing to sneeze at, of course, but not the 40%+ or even 50%+ of the companies that are really lighting the world on fire.

Alteryx (AYX), for example, grew revenue 50% in the March quarter. We don’t focus on valuation too much here, but a quick comp shows that NEWR’s PS ratio is 14.5 and AYX’s is 13.0. So AYX is growing much faster and the price is lower. NEWR is expensive.

I still really like NEWR, but I ended up selling my shares to buy other things (like AYX). If you’re not as concentrated, you may have room for NEWR, but I don’t think I’d pick now to load up.

Bear

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Thanks for that Bear, will definitely keep en eye out for discounts.