Introduction:
New Relic provides APM and Observability tools to Software Developers so they can better operate their applications and infrastructure and improve their digital customer experience.
DevOps and APM market is expanding fast. We all know that Software is eating the world. So we need Software to manage and monitor those Softwares. This Software is generally referred to as Application Performance Management (APM) Software. There are lots of companies in this space, like AppDynamics, Dynatrace, Splunk, Elastic NV which provide such solutions. New Relic is one of them.
Let me list out a few example problems these Softwares solve:
- What is the response time and transaction time of loading a web page?
- What is the error rate of loading a web page?
- How is the user satisfaction?
- How much time does it take to respond when I click “Order Now” button on my Android / iOS App? If it is taking a lot of time to respond, which part of the response is delaying it?
- How do I monitor a user’s session and reproduce a user’s session? Can I use that reproducible data to test my PreProduction code?
- How is the health of my servers at XYZ data center?
So New Relic was founded in 2008 by Lew Cirne and it went public in 2014 at 2+ Billion USD valuation. It has risen upto 8 billion USD in 2018, but since then the stock has corrected by 50% over the past three as growth has been tapering off, without any signs of near-term profitability.
What changed recently?
After the company’s growth started fading off, they have shifted their revenue model from Subscription to Consumption. In Subscription model, the company was depending on up-front payments. Customers have to pay up-front to use the product and as they keep ingesting more and more data and keep using more and more features, they have to keep upgrading their subscription tiers.
Now they have moved to Consumption model where the customers can pay very minimal amounts up-front, but can use the platform as much as they want. Customers’ billing will increase with the amount of data they ingest into the platform.
The company also used to have multiple products before (each product for each use case) and customers have to pay up-front and subscribe to each of those separately. But all of these products are now combined into a single product called “New Relic One” with a single small subscription fee and from thereon, customers are charged based on how much they consume on the “New Relic One” platform.
Consumption model has a lot of advantages as it shifts the focus of sales from negotiating with customers before they use the product to actually ensuring that the customer makes the best use of the product after he signs up. Simply put, the energy of the company shifts from “Sales” to “Customer Success”. Consumption model also avoids the mental barrier of committing money up-front before actually using the product. Customers will explore the product more enthusiastically and pay as they use more and more features.
New Relic has also introduced a perpetual free tier subscription (not to be confused with free trial). In this subscription, developers can ingest 100 GB data and has access to full stack observability for one user. With this initiative, the number of developers have gone up by 10x who were previously using New Relic products at sub-100 GB level. All of these developers could be potential customers in the future as they realize the value New Relic Platform could bring.
Financials:
| 2021 | 2020 | 2019 | 2018 | 2017 | ||
|---|---|---|---|---|---|---|
| Revenue (m$) | 668 | 600 | 479 | 355 | 263 | |
| Gross Profit | 486 | 496 | 402 | 292 | 213 | |
| Gross Margins | 0.73 | 0.83 | 0.84 | 0.82 | 0.81 | |
| Operating Profit | -171 | -85 | -33 | -47 | -61 | |
| Operating Margins | -0.26 | -0.14 | -0.07 | -0.13 | -0.23 |
A quick look at those numbers suggest that the growth has been tapering off. Their guidance for FY22 is Revenue of 700 m$ at Gross Margins of 70%.
The customers are still being transitioned from the old subscription model to the new consumption model. Company expects most of this to be done by end of FY22. There is a bit of revenue lost as pricing model is being switched i.e. the new model charges lesser assuming same usage of the system. Also introduction of the perpetual free tier adds to this loss in revenue. However, due to aligned interests and incentives, company expects that the amount of data being ingested into the system to grow faster and hence revenues would start growing at faster rates from FY23. To give a perspective, amount of data ingested into New Relic’s systems increased by 70-80% in FY22 as customers switched to the new model.
Another important observation in above financials is the dip in Gross margins. The company is investing aggressively to transition out of their data centers and into the cloud, as well as, investing to drive data ingest (as they are seeing solid uptick here with the new model) and hence expects gross margins to stay at 70% range in near future. However when the transition to the cloud is complete in about two years, the company expects gross margins to be back in the 80% range.
Management:
The company was founded by Lew Cirne, who is a serial entrepreneur. His previous company was Wily Technology and was acquired by CA Inc. In my opinion, Lew led the company very well until it hit 500m$ in revenue. However growth tapered off post that nor did they focus on achieving profitability with growth slowing down.
However, Lew has brought in Bill Staples two years ago as Chief Product Officer, who was the driver of the company’s transition to the consumption model, unifying multiple products into a single “New Relic One” and also the introduction of the free tier. Bill Staples is now made CEO in May, which implies that the company internally believes that this transition model is a success. We will have to see how this translates into financials.
Valuation:
P/E ratio doesn’t make sense as the company is loss-making.
P/S ratio is 6.5.
Looking at current valuation multiples in US Software companies, this looks normal.
Competitor’s valuation multiples: Dynatrace is valued at 20 P/S, Splunk at 12 P/S, DataDog at 50 P/S.
The company has raised 488 m$ through Convertible Senior Notes in FY19. So one needs to be informed about dilution risk here.
Risks:
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Liabilities on convertible senior notes is a stress on the balance sheet. The company is loss-making and with no profits in sight, de-leveraging these notes will be a tough task to the management
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Data ingestion growth is at 70-80% as the company changed its revenue model. We need to understand when this would slow down to value the longevity of the company
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Due to the free tier introduction, lots of small paying customers have become free users of the product, but this also increased the number of free users by 10x. It may be possible that none of these users become paid customers
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Software industry is highly disruptive. One should always be on the lookout for various innovations going on in the APM space and be highly informed
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Equity dilution risk as the company is not profitable yet
Disclosures:
Please consider me a novice in investing and also the APM Software Industry. This company is listed in the US. This is not a buy / sell recommendation. Please do your own research before investing / trading.