SolarWinds Guides To Low Revenue Growth In 2023

Summary

• SolarWinds recently reported its Q1 2023 financial results.
• The firm provides a broad range of IT systems monitoring and management software and services to organizations worldwide.
• SWI has improved its operating income results but revenue is expected to grow in 2023 by only 2% in a best-case scenario.
• I'm therefore Neutral [Hold] on SWI for the near term.
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greenbutterfly

A Quick Take On SolarWinds Corporation

SolarWinds Corporation (NYSE:SWI) provides an array of IT systems management tools for organizations worldwide.

Given management’s tepid growth forecast for all of 2023, I don’t see a significant organic upside catalyst to the stock.

I’m therefore Neutral [Hold] on SWI in the near term.

SolarWinds Overview

Austin, Texas-based SolarWinds was founded in 1999 to develop a portfolio of application monitoring, management and optimization solutions for a variety of IT environments.

The firm is headed by president and CEO Sudhakar Ramakrishna, who joined the company in 2021 in the wake of the firm’s widely publicized hack and was previously CEO of Pulse Secure.

The company’s primary offerings include the following:

• Monitoring

• Observability

• Service Management

• Systems Management

• Database Management

• IT Security

• Service Desk

• Remote Access

The firm acquires customers through its direct sales and marketing teams as well as through partner referrals and various reseller and integration provider relationships.

SolarWinds’ Market & Competition

According to a 2021 market research report by MarketsAndMarkets, the global market for cloud system management was estimated at $10.6 billion in 2020 and is forecast to reach $31.4 billion by 2025.

This represents a forecast CAGR of 24.1% from 2021 to 2025.

The main driver for this expected growth is the continued migration of IT infrastructure to cloud-based environments.

Also, companies are looking for vendors that can provide a variety of solutions, to reduce vendor bloat and a more integrated approach.

Major competitive or other industry participants include:

• Microsoft (MSFT)

• ManageEngine

• New Relic (NEWR)

• Splunk (SPLK)

• Cisco (CSCO)

• Amazon Web Services (AMZN)

• Dynatrace (DT)

• Datadog (DDOG)

SolarWinds’ Recent Financial Trends

• Total revenue by quarter has produced the following growth trajectory:

Total Revenue (Seeking Alpha)

• Gross profit margin by quarter has been largely flat, as shown below:

Gross Profit Margin (Seeking Alpha)

• Selling, G&A expenses as a percentage of total revenue by quarter have trended higher in recent quarters:

Selling, G&A % Of Revenue (Seeking Alpha)

• Operating income by quarter has grown recently:

Operating Income (Seeking Alpha)

• Operating leverage by quarter has increased markedly in recent quarters:

Operating Leverage (Seeking Alpha)

• Earnings per share (Diluted) have begun to approach breakeven:

Earnings Per Share (Seeking Alpha)

(All data in the above charts is GAAP)

In the past 12 months, SWI’s stock price has fallen 30.86% vs. that of New Relic’s rise of 12.7%, as the chart indicates below:

52-Week Stock Price (Seeking Alpha)

For the balance sheet, the firm ended the quarter with $140.7 million in cash, equivalents and short-term investments and $1.2 billion in total debt, of which $12.5 million was categorized as the current portion due within 12 months.

Over the trailing twelve months, free cash flow was $108.4 million, of which capital expenditures accounted for only $6.6 million. The company paid a hefty $68.0 million in stock-based compensation in the last four quarters, the second-highest amount in the past eleven quarters.

Valuation And Other Metrics For SolarWinds

Below is a table of relevant capitalization and valuation figures for the company:

Measure [TTM]	Amount
Enterprise Value / Sales	3.6
Enterprise Value / EBITDA	12.1
Price / Sales	2.0
Revenue Growth Rate	1.0%
Net Income Margin	-127.7%
EBITDA %	29.4%
Market Capitalization	$1,450,000,000
Enterprise Value	$2,590,000,000
Operating Cash Flow	$115,050,000
Earnings Per Share (Fully Diluted)	-$5.78

Click to enlarge

(Source - Seeking Alpha)

The Rule of 40 is a software industry rule of thumb that says that as long as the combined revenue growth rate and EBITDA percentage rate equal or exceed 40%, the firm is on an acceptable growth/EBITDA trajectory.

SolarWinds’ most recent Rule of 40 calculation was 30.4% as of Q1 2023’s results, so the firm needs some improvement in this regard, per the table below:

Rule of 40 Performance	Calculation
Recent Rev. Growth %	1.0%
EBITDA %	29.4%
Total	30.4%

Click to enlarge

(Source - Seeking Alpha)

Commentary On SolarWinds

In its last earnings call (Source - Seeking Alpha), covering Q1 2023’s results, management highlighted its focus on customer retention efforts but did not provide specific retention metrics other than changes versus prior periods.

The firm has seen improvement in its subscription-first approach, which has been a focus for a year or so, and subscription revenue produced a 40% growth rate year-over-year.

Total revenue for Q1 2023 rose by 5% year-over-year and gross profit was essentially unchanged.

SG&A as a percentage of revenue fell by one percentage point while operating income dropped sequentially but was still much improved year-over-year.

Operating leverage grew markedly while earnings per share was still negative, though closing in on breakeven.

Looking ahead, management guided 2023’s full year revenue growth of 2% at the midpoint of the range and adjusted EBITDA growth to be 7% year-over-year at the midpoint.

The company's financial position is moderate, with substantial debt but ample liquidity and strong positive free cash flow.

Regarding valuation, the market is valuing SWI at an EV/Sales multiple of around 3.6x.

The Meritech Capital Index of publicly held SaaS software companies showed an average forward EV/Revenue multiple of around 5.5x on April 27, 2023, as the chart shows here:

EV/Next 12 Months Revenue Multiple Index (Meritech Capital)

So, by comparison, SWI is currently valued by the market at a discount to the broader Meritech Capital SaaS Index, at least as of April 27, 2023.

Also by comparison, New Relic’s forward growth rate is expected to be 17%, far greater than SWI’s, although NEWR will be producing operating losses.

The primary risk to the company’s outlook is a highly anticipated macroeconomic slowdown or recession, which would serve to increase new customer discounting, lengthen sales cycles and slow its revenue growth trajectory.

For management’s current earnings call, I prepared a chart showing the frequency of key terms mentioned (or not) in the call, as shown below:

Q1 2023 Earnings Transcript Key Terms (Seeking Alpha)

I’m most interested in the frequency of potentially negative terms, so management cited ‘uncertain’ one time, ‘challeng[es][ing]’ six times, and ‘macro’ seven times in various contexts.

A potential upside catalyst to the stock could include an end to U.S. Federal Reserve interest rate hikes, reducing downward pressure on valuation multiples.

However, given management’s tepid growth forecast for all of 2023, I don’t see a significant organic upside catalyst to the stock.

I’m therefore Neutral [Hold] on SWI in the near term.

Analyst’s Disclosure: I/we have no stock, option or similar derivative position in any of the companies mentioned, and no plans to initiate any such positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.