Editor’s Note: This article is part of Joanna’s Top Trades — a weekly feature dedicated toward making you money within a specific space. Joanna’s picks for this week are New Relic (NYSE:NEWR) and Palantir (NYSE:PLTR) as the top big data stocks to trade this week.
This the latest in my weekly investing series focused on thematic Buy/Sell recommendations. Today, I’ll look at Big Data stocks. First, I’ll explain why you should buy New Relic (NYSE:NEWR) stock. After, I’ll take an even deeper dive into one of the Big Data companies you really should consider selling now.
Big Data Stocks to Buy: NEWR Stock
New Relic is a comeback kid in a hot market.
Specifically, at an accessible $4.2 billion market cap, New Relic is an early, small-cap play on a very big investment theme. The company, which makes monitoring software for IT networks, sits in a roughly $6 billion Application Performance Management (APM) market. This market is one of the fastest growers in networking, expected to grow 11% annually to over $11 billion by 2027.
The investment thesis behind Big Data stocks like NEWR stock is simple. IT environments are increasingly more complicated, and New Relic’s tools are powerful software troubleshooting and performance analytics platforms that look deep into applications for bugs and issues.
New Relic has struggled relative to its faster-growing and headline-grabbing competitor, Datadog (NASDAQ:DDOG). Datadog has posted impressive 66% revenue growth last year. In contrast, NEWR grew 11% in its most recent fiscal year (ended March). Much of New Relic’s growth stagnation was because the product was very difficult to comprehend, especially at a time when Datadog was stealing the limelight. But, over the past year, New Relic made important changes to its business model, which should allow it to re-capture market share from Datadog. Strong recent quarterly results show the tide is turning.
A new, sticky model and margin ramp should power NEWR stock.
In April, NEWR announced a change in its business from a license-based subscription model to a consumption-based model (pay for what you use). The theory is that by lowering costs upfront, customers will use the service more. Other consumption-based SaaS (software-as-a-service) companies like Twilio (NYSE:TWLO) and Snowflake (NYSE:SNOW) have done really well with this model. Furthermore, both companies generate above-industry growth and premium valuations (20x and 62x EV/sales, respectively).
NEWR’s valuation should also expand as the company demonstrates consistent growth from this new model. We’re already seeing evidence that it’s working. Last quarter (FQ4Mar), NEWR delivered a revenue beat and stronger revenue retention rates than the preceding two quarters. Existing customers are clearly getting more use out of a “stickier” product.
Not only is revenue growth accelerating. So too are profitability and cash flow. The business model shift temporarily dampened margins, but these are ramping back up. Its F2020 gross margin of 73% should expand to the company’s historical >80% over the next few quarters. NEWR is also profitable from a free cash flow and non-GAAP net income basis, which are strong standouts in a tech sector where investors seem less-focused on growth. All of these factors add up to make it a standout pick among Big Data stocks today.
New Relic stock is cheap while also being a potential acquisition target.
At approximately 5x forward sales, NEWR is a deep bargain in a software sector that has most stocks trading at double-digit revenue multiples. Numbers are moving in the right direction. Revenues and margins are expanding. There are several growth levers working to get the business back on track. A cloud-based business model, recurring revenue profile and free cash flow also make NEWR an attractive acquisition target in a sector that’s clearly consolidating. As reference, private equity firm Thoma Bravo announced an acquisition of data analytics peer Talend (NASDAQ:TLND) in March at approximately 6x revenues.
Several recent national cybersecurity threats have brought data analytics back into the spotlight as a critical area of IT infrastructure spending. They’ve also put plenty of other Big Data stocks back on the radar.
Big Data Stocks to Sell: Palantir Technologies
A closer look at the government sector’s “Batman.”
Palantir’s (NYSE:PLTR) Gotham software helps U.S. counterterrorism and military agencies collect, analyze and visualize vast amounts of disparate data. The company’s “Batman technology,” as it’s sometimes referred to on popular YouTube investing sites, mines massive data sets for intelligence and law enforcement applications.
Last quarter, Palantir posted 76% revenue growth in its government business, led by marquee customer U.S. Army, where it won an $823 million contract to develop a new intelligence platform. Palantir has worked with U.S. Customs and Border Protection to track immigrants and travelers at the border. It has helped locate Mexican drug cartel members. It has even tested secret policing technology in New Orleans. Since Palantir’s IPO in September 2020, PLTR stock has soared from $10 to as high as $39 in January. Shares now trade around $24.
PLTR’s revenue guidance calls for revenue growth of 30% or more for 2021 through 2025. However, to get to these ambitious projections, the company must successfully shift its business from the world of spies and special ops to corporate America.
The mask comes off in the enterprise.
Here’s where things get more complicated. While Palantir may be Batman to its government customers, the company is very human in the enterprise market. The Street has been concerned about the growth trajectory of the commercial business (39% of Q1 sales). Despite having landed some large marquee customers, commercial growth has been disappointing relative to government growth (19% growth last quarter).
Palantir’s path into the broader enterprise market, especially among smaller businesses, hasn’t gained traction. In theory, the same tools that can predict ambushes in Iraq can help companies analyze their own data. But in practice, privacy is a massive concern for corporate customers. The marriage of Big Data and Big Brother raises obvious red flags around more invasive implications of data-driven policing.
For now, Palantir is putting hefty resources into the healthcare side of its business. This is an industry where data privacy concerns run highest. Last month, the company hired Dr. Bill Kassler, formerly of IBM’s (NYSE:IBM) Watson Health, as its first U.S. government chief medical officer (CMO). The Food and Drug Administration, Centers for Disease Control and Prevention and National Institutes of Health are all Palantir customers. However, with overall top-line growth slowing, the company will face pressure to demonstrate broader traction here.
Special Purpose Acquisition Companies (SPACs): Bruce Wayne style investing in the commercial market.
While Palantir’s business is in data-analytics, the company has been getting more attention recently for its investments. Over the last three months, the company has invested in six SPACs:
- Sarcos Robotics (robotics) – $21 million
- Lilium (high speed air transportation)
- Wejo (automotive sensors and data)
- Celularity (biotechnology) – $20 million
- Roivant Sciences (healthcare) – $30 million
- Babylon (healthcare)
Palantir’s focus on SPAC investments is a bit unusual — for two reasons. First, these are investments in later-stage companies that already have billion-dollar-plus valuations. While other tech companies, including Alphabet (NASDAQ:GOOG, NASDAQ:GOOGL) Salesforce (NYSE:CRM) and Intel (NASDAQ:INTC) have large venture capital businesses, they tend to focus on early stage technology investments.
Second, Palantir’s SPAC investments are often packaged with customer contracts. Roivant Health signed a five-year subscription contract with Palantir. Celularity, Sarcos Robotics and Babylon Health, have all signed product deals with Palantir. On May 11, Palantir signed a deal to invest $20 million in the SPAC deal of an unnamed “mobility company” and the unnamed company signed a five-year subscription deal with Palantir. Kevin Kawasaki, Palantir’s head of business development, says these investments are opportunities to “back really good management teams with big visions.” But these investments also demonstrate that Palantir is effectively buying its way into large companies that can exploit its data tools.
Time will tell whether this strategy generates meaningful revenue growth.
PLTR stock has a rich valuation.
Palantir is trading at a whopping 116x forward EBITDA — well above the sector median of 17x. Given the strong recent run and rich premium, coupled with the potential for revenue deceleration, I expect shares to trade sideways from here. At these levels, there’s meaningful downside risk to the stock without a strong enterprise ramp and a re-acceleration of growth.
It’s best to put money to work elsewhere.
Your comments and feedback are always welcome. Let’s continue the discussion. Email me at firstname.lastname@example.org.
On the date of publication, Joanna Makris did not have (either directly or indirectly) any positions in the securities mentioned in this article. The opinions expressed in this article are those of the writer, subject to the InvestorPlace.com Publishing Guidelines.
Joanna Makris is a Market Analyst at InvestorPlace.com. A strategic thinker and fundamental public equity investor, Joanna leverages over 20 years of experience on Wall Street covering various segments of the Technology, Media, and Telecom sectors at several global investment banks, including Mizuho Securities and Canaccord Genuity.