Here's Why New Relic Is Sinking Fast

What first appeared as a ho-hum report for New Relic has turned into a disaster Wednesday morning. Analysts across the board have sliced price targets, and Wedbush removed the stock from its Best Ideas list only months after adding it. First, a quick recap of the results, before I take a stab at why the stock is trading down more than 30% at the time of my writing. After the bell on Tuesday, New Relic reported first-quarter earnings per share of 19 cents on revenue of $141 million. Earnings per share land a dime ahead of expectations, while revenue came in a little more than a half-million shy of estimates. There was nothing in those numbers to justify a 30% haircut. Guidance is being call mixed. Management sees a midpoint of 15 cents on earnings per share and $144 million vs. the current 12 cent estimate on revenue of $148.60. While those are midpoints, the ranges are only 1 unit above and below, so using the midpoint keeps it simple. For the full year, earnings per share will be in the range of 55 cents to 63 cents on revenue of $600 million to $607 million. Consensus of 60 cents on earnings per share and revenue of $606.14 basically puts full year guidance in line. The issue here is the read through on the third and fourth quarters. If the company made 19 cents in the first quarter and 15 cents in the second quarter, then the second half of the year will net 29 cents max per share with the possibility of NEWR only making 21 cents per share. That's concerning because it potentially projects the third and fourth quarters to show sequential declines. With first and second quarter revenues basically in line with projections, we don't have the same issue of sequential declines, but we see a different issue: slowing growth. Many of the analysts have focused on the more-than 30% year-over-year revenue growth rate of the company. We saw it this quarter as well, but when we factor next quarter guidance and full year guidance, we find revenue growth rates have slowed into the mid-20s. I created this year-over-year revenue growth rate chart, so its easier to get a sense of the trend: Where we were, where we are, and where we're headed. This isn't a great look when NEWR is constantly compared to peers in terms of valuation. As cloud companies begin to mature in the public markets (five-plus years of trading), valuation will begin to matter more. A rich valuation will need more than growth rates in the teens on revenue for the cloud space. Unfortunately, New Relic is projecting itself to be closer to the teens than the thirties before the end of the year. In terms of the profit, we need to look no further than the Net Dollar Retention Rate/Net Dollar Expansion Rate for the company. This should be a key metric investors in the cloud space hone in on for any SaaS/PaaS -- that's software as a service and platform as a service -- company that uses the land-and-expand strategy. Spoiler alert -- almost all of them do. What we see here is how much more a client is spending the following year vs. last year. It's termed in percentages with 100% meaning no change from the year before. A client spent the same; therefore, the higher the number, the better. Anything below par is a huge red flag. When numbers on a younger company are under 110%, it is a yellow flag. During the first quarter, New Relic reported a dollar-based net expansion rate of 109%. A year ago that number was 118%. Last quarter that number was 131%. I understand the law of large numbers, but New Relic is experiencing rapid decline in both the growth of its revenue and expansion rates before it actually hits large numbers. Ultimately, I believe New Relic will right the ship and turn things around with its New Relic One product, but the stock may be dead money, especially compared to the overall market, for several months. If I were a player here, I would certainly consider covered calls or shorting out-of-the-money puts to gain a lower entry. Sept. 20 $55 puts can be sold for $3.30 (net entry of $51.70) or the Sept. 20 $50 puts can be sold for $1.70 (net entry of $48.30). Thursday, we'll likely see $45 contracts open for September and I'd expect them to be around 80 cents to 90 cents if the stock closes in this $56 to $57 range; however, unless you are intraday scalping this one, there's no hurry to rush in.

Here's Why New Relic Is Sinking Fast

Ultimately, NEWR should right the ship with its New Relic One product, but the stock may be dead money for several months, as it's now rapidly declining in both revenue growth and expansion rates before it actually hits large numbers.

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