Subscription Model Shift And Generative AI Will Strengthen Future Competitiveness

Key Takeaways

• Transition to subscription model and tools consolidation are driving sustained revenue growth and enhancing customer retention.
  
• Enhancements in offerings and AI integration are boosting competitiveness, attracting customers, and potentially improving net margins.
  
• Economic challenges and transition risks could limit growth, impact revenue, and pose financial uncertainties for SolarWinds amid a complex macroeconomic environment.

Catalysts

Provides information technology (IT) management software products in the United States and internationally.

• SolarWinds' ongoing transition to a subscription-first model, with 30% year-over-year growth in subscription revenue and 36% in subscription ARR, is expected to drive continued revenue growth as recurring revenue becomes a larger part of their business.
  
• The consolidation of their tools and closing the hybrid observability gap make their solutions critical for customer operations, which is likely to sustain revenue growth and improve customer retention.
  
• Enhancements in observability offerings, such as system scalability improvements and expanded support for Azure and AWS, could lead to increased competitiveness and attract new customers, boosting revenue and possibly expanding net margins.
  
• Use of generative AI in service management is driving sales of premium packages, suggesting higher average sales prices and thus potentially improving net margins and earnings.
  
• Strong execution on go-to-market strategies, including leveraging partnerships and expanding enterprise service management platforms, could broaden market reach and support growth in top-line revenue and earnings.

SolarWinds Future Earnings and Revenue Growth

Assumptions

• Analysts are assuming SolarWinds's revenue will grow by 3.3% annually over the next 3 years.
• Analysts assume that profit margins will increase from 4.9% today to 20.0% in 3 years time.
• Analysts expect earnings to reach $173.5 million (and earnings per share of $0.93) by about December 2027, up from $38.7 million today.
• In order for the above numbers to justify the analysts price target, the company would need to trade at a PE ratio of 19.9x on those 2027 earnings, down from 63.7x today. This future PE is lower than the current PE for the US Software industry at 41.2x.
• Analysts expect the number of shares outstanding to grow by 3.11% per year for the next 3 years.
• To value all of this in today's terms, we will use a discount rate of 8.15%, as per the Simply Wall St company report.

SolarWinds Future Earnings Per Share Growth

Risks

• The IT spending environment is described as challenging, which could limit growth opportunities and impact SolarWinds’ revenue projections.
  
• A decline in maintenance revenue by 5% suggests potential challenges in product transition, which could affect the company's overall earnings and profitability.
  
• The company continues to face macroeconomic uncertainties, which could pose risks to financial projections and net margins if economic conditions worsen.
  
• SolarWinds is navigating significant business transformation, which involves execution risks that could impact subscription revenue growth and overall ARR.
  
• Potential currency exchange rate fluctuations, as mentioned in the guidance assumptions, could impact the company’s profitability and international revenue streams.

Valuation

• The analysts have a consensus price target of $14.56 for SolarWinds based on their expectations of its future earnings growth, profit margins and other risk factors. However, there is a degree of disagreement amongst analysts, with the most bullish reporting a price target of $20.0, and the most bearish reporting a price target of just $12.5.
• In order for you to agree with the analyst's consensus, you'd need to believe that by 2027, revenues will be $865.6 million, earnings will come to $173.5 million, and it would be trading on a PE ratio of 19.9x, assuming you use a discount rate of 8.2%.
• Given the current share price of $14.44, the analyst's price target of $14.56 is 0.8% higher. The relatively low difference between the current share price and the analyst consensus price target indicates that they believe on average, the company is fairly priced.
• We always encourage you to reach your own conclusions though. So sense check these analyst numbers against your own assumptions and expectations based on your understanding of the business and what you believe is probable.