Shares 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.
FD: Author does not have a position in SWI
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April 29th, 2010 at 11:41 am
Excellent post. Good points made. Thanks for this.
April 29th, 2010 at 11:54 am
I find your conclusion that TNDM’s 2010 revenue guidance will be revised downward due to the recent court decision a huge leap and arguably indefensible so would love to hear your supporting evidence. We know a few things about this dispute:
1) This dispute dates back to around 2004
2) Neutral Tandem has filed suit against Peerless for patent infringement and that case is not scheduled to be heard until later this fall.
3) The ruling you refer to does not in fact overturn the patent issued to TNDM but rather rules against their effort for injunctive relief which would stopped a reexamination of the existing patent. I’m not aware of an expected timetable for said reexamination.
So for your conclusion to pan out it would mean:
1) The US Patent office would have to finish it’s rexamination of the existing patent;
2) The finding in the reexamination would have to go against TNDM;
3) There would have to be no appeal process with this decision being immediately effective;
4) The lawsuit between the parties would have to be dismissed;
5) All of the above would result in either:
a) A change in Peerless product/service offering to customers that would allow them to gain market share at TNDM’s expense, or
b) Customers perception of TNDM turned negative because they felt Peerless gave them a better price or service and/or were better capitalized to provide comfort for the future.
I find not evidence for the majority of the above occuring much less in the timeframe you would need to cause TNDM to reduce their 2010 revenue guidance.
Please let us know how you came to that conclusion.
thanks