When looking at tech companies, especially software-centric firms, it’s important to take note of the split between license and recurring revenues. License revenues are the initial sales of a software offering, while recurring revenues include maintenance and subscription proceeds. Recurring revenues also carries relatively high margins because it adds to the top line without having to hire additional salespeople, spend more on research and development, or advertise.
SWI has managed to keep its recurring revenues strong through cross selling, wherein a customer adds on new SolarWinds products and features to those it already has in its tech arsenal. That means SWI can keep growing sales without spending additional dollars on operating expenses, while creating a loyal and longtime relationship with clients.
Last November, management said that their products per core customer with the company less than a year have doubled just four years later. They also noted that several hundred customers have spent more than $150,000 on SWI, with an impressive 33 average transactions per customer at an average transaction value of $8,800. As a result, recurring revenues as a percentage of total sales have grown from 40% in the depths of the recession to roughly 60% today.
That’s helped SWI maintain strong total revenue growth at a 29% compounded annual rate since late 2010. That’s an impressive number, especially considering the slowdown in commercial (license) sales through the past few quarters, as international sales fell below expectations. In the third quarter of 2013, there was an unsurprising slowdown in license sales to 5% growth year-over-year that was tied to a 20% decline in government sales (remember that shutdown?).
However, I expect this to increase as security becomes more important, especially given recent data breaches that have been in the news, and management has also said they expect a rebound in license sales moving forward.
The Street currently estimates roughly 22% top-line growth in 2014, alongside flat earnings. However, I believe margin pressure should lift on continued recurring revenue growth, helping it to move toward the mid- to upper-20% range as license sales recover. We could then see $415 million in sales and EPS of as much as $1.80. Even those estimates could be conservative, but only a slight multiple expansion would give us a target of $50, for roughly 30% upside.
SolarWinds has shown impressive growth through harsh conditions, and it is poised to continue this trend given its strong product pipeline and cross-selling abilities to a dedicated customer base. Of course, as with any fast-growing company, there is always the risk of some hiccups in that growth.