Click to enlargeShares of Solarwinds Inc. (SWI) are off sharply today after the company announced first quarter earnings. While the headlines beat the published consensus expectations, the devil was in the details. As I write, the stock is off close to 15% as growth assumptions are being challenged, and speculative investors are getting punished.
Despite the “alternative energy” name, Solarwinds is actually a network company which seeks to identify and solve network performance issues. The company has a broad client base – boasting 93,000 customers at the end of the first quarter and offers a wide assortment of solutions:
- Network Monitoring
- Configuration Management
- Network Traffic Monitoring
- App & Server Monitoring
- IP Address Management
- IP SLA Monitoring
- Virtualization Monitoring
- Wireless Monitoring
- Network Mapping
I’m not a tech guy by any means, but I can tell you that investors were excited about this relatively new stock because of the broad number of services the company offers, and the potential to cross- sell these services to existing clients. The idea is for the company to get their foot in the door by selling one service, and then quickly explain why the customer needs a full bundle of services to operate efficiently.
Up to this point, it looks like the company has been very effective in growing its revenue base. The first quarter showed a revenue increase of 43% over the same quarter last year. The business was nearly evenly split between license revenue and maintenance revenue. The maintenance business is a bit more valuable to investors because this is largely recurring revenue with stability quarter after quarter.
But looking at management’s projections, it appears the growth rate is likely to contract considerably – which is a major concern for investors. For the second quarter, management is guiding revenue of $36 to $37.8 million which is at best a 40% increase over the second quarter of 2009. For the full year, revenue is expected to be $159-165 million. This indicates that management is expecting a significant pickup in revenue for the third and fourth quarters in what is known as a “back end weighted” year.
Essentially, management is asking investors to take a “leap of faith” stating that revenues will be in the mid 30 million level for the first two quarters – and then the high 40 million range for the third and fourth quarter. Unless there is a particular contract that management expects to land – and the timing is very specific, it would seem that the back-end weighted guidance is sketchy at best.
Despite the 15% drop in Tuesday trading, the stock still appears to be over-valued based on earnings expectations. Management is guiding analysts to expect 72 to 75 cents per share this year which only represents an increase of 15%. But at $20.50, the stock is trading at 27 times the high end of guidance. This multiple might be reasonable for a stock in the middle of a strong growth period, but with heavy competition, disappointing growth projections, an extended and vulnerable market, and a technically broken stock chart; the risks seem to far outweigh the potential benefits of owning the stock.
Shorting SWI today may be a bit premature. With the market likely to at least stage a rebound attempt from the sharply negative trade today, I wouldn’t be surprised to see SWI consolidate or even trade back to the $22-23 range. But with the technical breakdown we have seen today and the potential for more selling as managers become less confident in the recovery, the stock will remain on my short list and could potentially trade back down to the IPO price of $13.
Full Disclosure: Author does not have a position in SWI