INVESTMENT THESIS
New Relic Inc. NYSE: NEWR), which continues to pursue a turnaround in an unforgiving economic environment. Management sees the relaunch of its New Relic One platform in July as the basis for growth in coming years, but in the near term, the product revamp has slowed sales cycles and revenue growth as customers have been offered promotions in order to test the new product. We think the company’s turnaround efforts may take at least a few quarters to materialize.
We see New Relic as an early-stage tech company in the burgeoning market for big data analytics, and at the center of three secular technology trends: cloud computing, enterprise digital transformation, and DevOps. We expect the company to benefit over time as enterprise IT becomes increasingly application- and cloud-centric.
New Relic began by providing ‘break/fix’ IT services to small and medium-sized businesses, but now focuses on helping larger global enterprises to digitize their businesses through the rapid development of applications and the increased use of cloud-based services. It is also working to expand internationally.
RECENT DEVELOPMENTS
On July 30, in the middle of 2Q, the company launched a fundamental product overhaul and on August 15, it changed its pricing model. These changes negatively impacted 2Q results, slowing revenue and decimating margins as the company offered promotions to customers to try the new product without incurring financial risks. NEWR shares dropped 14% after the 2Q report, probably more on concerns about continued lackluster results in fiscal 2H21 than on the poor second-quarter results themselves.
Fiscal second-quarter revenue rose 15% from the prior year to $166 million. New Relic swung to a non-GAAP loss from operations of $5.3 million, down from operating income of $11.2 million in fiscal 2Q20. The non-GAAP operating margin also narrowed by eleven percentage points to negative 3%. The negative swing was due to a free entitlement period for a new product launch and costs related to the company’s transition to the public cloud. The GAAP operating loss of $43 million widened from $17 million in same period last year. The primary addback to non-GAAP operating income was $35 million in stock-based compensation, which grew a staggering 51% year-over-year, far outpacing revenue growth. The non-GAAP loss was $0.07 per share, down from EPS of $0.24 in 2Q20.
On July 30, founder Lew Cirne launched a major product overhaul in a blog post. The overhaul is intended to make it easier for customers to adopt New Relic across their software stack at a reasonable price. The overhaul involved simplifying the New Relic One application performance monitoring platform into three component products: a Telemetry Data Platform, Full-Stack Observability, and Applied Intelligence. The Telemetry Data Platform provides the base product that ingests and analyzes telemetry data and provides alerts in one central location. Full-Stack Observability analyzes and troubleshoots problems across a customer’s entire software stack. Applied Intelligences sits on top of the product and automatically detects data anomalies, correlates issues, and reduces alert noise. At the same time, New Relic has made its detection agents, integrations, and software developer kits available under an open-source license to third-party developers. The company is looking to accelerate innovation by leveraging the developer community. It has also revamped its pricing model to provide a more consumption-based service.
EARNINGS & GROWTH ANALYSIS
Management has put the New Relic One Observability Platform at the center of its marketing push. New Relic launched New Relic One in May 2019. CEO Lew Cirne has called it ‘a pan-enterprise, unified observability platform,’ though the July 30, 2020 overhaul essentially breaks the Platform into its three component parts. While we think the company would prefer its enterprise customers to standardize on its own platform, we also see the logic in allowing customers to mix and match with best-of-breed software DevOps vendors. New Relic One provides tools and dashboards for DevOps teams to manage data complexity across an enterprise’s systems, whether the systems are internal, web-facing, or cloud-based. New Relic One is also the platform for new service launches; Mr. Cirne sees it as the basis for company innovation over the next 10 years. Additional service solutions include log management and AIOps.
New Relic’s value proposition is based on its big data analytics platform, which offers business enterprise clients visibility into their IT systems. The company’s strategic vision is to become ‘the dominant DevOps platform for monitoring, managing and operating digital systems.’ Its target market is large and medium-sized enterprises. Management stresses that New Relic’s competitive advantages come from providing an application-centric platform, delivering curated experiences, and making simple, easy-to-use customer-native solutions. Like other enterprise software providers, New Relic seeks to help clients achieve rapid ‘digital transformation,’ whether through cloud adoption, software application development, or other efforts to enhance the digital customer experience. In our view, New Relic should benefit from strong positive secular trends in all three of these areas. New Relic systems collect 2 billion events and metrics per minute.
New Relic clients can collect, store and easily analyze the performance of applications and IT components across their IT infrastructures, including mobile, browser, and the cloud. The company believes that its subscription software-as-a-service (SaaS) products offer greater value and a lower total cost of ownership than legacy on-premise analytics software. The SaaS model enables frequent and rapid software updates. New Relic has developed an extensive selection of ‘purpose-built intelligent software agents’ that support a wide variety of software languages. Because it is cloud-based and includes both application programming interfaces (APIs) and software development kits (SDKs), collectively known as ‘plugins,’ the company’s software enables clients to build customized applications and to embed New Relic functionality into their own products.
New Relic’s core product is its Application Performance Management (APM) solution. Line-of-business users can also collect and analyze data on business transactions separately from data related to application performance. While APM remains its primary offering, New Relic has been diversifying into related businesses, including infrastructure management. Indeed, New Relic sees product diversification as an important growth driver over the next few years.
New Relic is wedded to the typical ‘land-and-expand’ software sales model. While the company began by catering to small and medium-sized businesses, New Relic has refocused on large, higher-value enterprise customers (i.e., firms with more than 1,000 employees) and is looking for even larger enterprise ‘strategic lands.’ Enterprise level is where the company can become a strategic IT partner rather than just another vendor. New Relic expects to double the size of its sales force to 600. The company wants to add 1,000 new $100,000 plus annual recurring revenue (ARR) customers over the next few years. Business accounts paying more than $100,000 per year increased 14% year-over-year, to 1,039, by the end of 2Q21. Seventy-seven percent of the company’s ARR came from customers over $100,000 in fiscal 2Q21, up from 71% in the same period last year.
New Relic has targeted $100,000-plus ARR customers because it sees these customers as having highly favorable characteristics for revenue expansion. Most of these high-quality enterprise customers tend to take multiple products from New Relic, with 43% taking more than four products. They also have both significantly lower churn and higher annualized dollar expansion.
Management believes that it has thus far penetrated only about 7% of 30,000 global enterprises – signifying a large growth-market opportunity. In addition to landing new customers, management expects to drive growth by increasing existing customers’ use of its Digital Intelligence Platform. Management assumes that 80% of FY22 revenue will come from increased sales to the installed base. Software subscription plans typically run for a one-year period.
FINANCIAL STRENGTH & DIVIDEND
The effective strike price on the convertible notes is $173.82.
MANAGEMENT & RISKS
While COVID-19 may have little direct impact on New Relic, the company may experience a secondary effect if an economic recession leads to tighter budgets and reduced IT spending. Board member Michael Christenson was appointed COO on October 1, 2019. Mr. Christenson’s appointment came after CTO Jim Gochee and chief revenue officer Erica Shultz resigned on September 16, 2019.
While operating losses are common for early stage tech companies as they scale up new technologies and reach for market share, management’s operating plans may not generate the expected results. This risk is exacerbated by the company’s limited operating history. Investors could lose faith in the company, and the share price could plummet if operating results are erratic or disappointing. Management will also need to skillfully manage the company’s growth as it enters new market segments and expands internationally.
New Relic’s Application Performance Monitoring (APM) software generates most of the company’s revenue and cash flow. While the company is broadening its product portfolio, which should lessen its reliance on APM, any near-term problems with this product could have a significant negative impact on New Relic’s financial outlook.
New Relic partners with Amazon Web Services and other hyperscale public cloud providers in order to deliver integrated solutions to clients, and could be hurt by any problems in its relationship with AWS. Given its large size and market presence, AWS could also expand its services to compete with New Relic on service offerings.
Competitors include firms that offer IT systems performance monitoring, such as AppDynamics (a division of Cisco Systems), Datadog Inc., Dynatrace LLC, and Splunk Inc.
New Relic is subject to the usual risks of a high-growth tech company.
New Relic operates in an industry with considerable intellectual property development, and faces a range of IP-related risks. The company is involved in patent litigation with CA, and a negative outcome for NEWR could have a material negative impact on its business. New Relic continues to fight the case vigorously.
In particular, it is likely to see stronger revenue in the second half of its fiscal year (the December and March quarters) than in the first half.
Lewis Cirne is the founder and CEO of New Relic. Before founding the company, he held senior technical positions at Apple and at venture capital firm Benchmark Capital.
COMPANY DESCRIPTION
New Relic is an enterprise software technology firm focused on the emerging technology of big data software analytics. New Relic’s Digital Intelligence Platform enables enterprise clients to ‘collect, store and analyze’ data generated by applications and IT infrastructure, and provides visibility into software and systems performance across desktop, mobile, browser, and cloud environments. The company uses a software-as-a-service (SaaS) delivery model. With a market cap of $3.4 billion, New Relic is considered a mid-cap company. New Relic was founded in September 2007 and completed its initial public offering on December 12, 2014 at $23 per share. New Relic derives about 32% of revenue from outside the U.S.
VALUATION
NEWR shares are down 14% year-to-date. This compares to a 6% capital gain for the Russell 2000 index and a 21% increase for the Russell 2000 Technology index.
On November 19, HOLD-rated NEWR closed at $56.71, up $1.18.
Source: Argus
