Though New Relic (NEWR) delivered fiscal first-quarter results that beat its guidance last week, its stock price plunged 24% the following day. The market, it seems, is skeptical about the company's new strategy to boost long-term revenue growth. Yet the software-as-a-service (SaaS) monitoring and observability specialist remains exposed to the secular growth of its market. Given that, investors may wonder if this steep pullback -- the stock is down about 40% since Aug. 1 last year -- has created a good opportunity for them to buy into a growth stock at a reasonable price.

Underwhelming performance

New Relic's software collects, stores, and analyzes data from cloud applications and infrastructure to monitor performance and troubleshoot issues. Management estimates that the company's total addressable market is $21 billion -- a vast opportunity.

After several quarters of underwhelming results, the company last year launched its latest product, New Relic One, to group its various capabilities into one programmable and integrated platform aimed at accelerating its growth. 

A man looking at a wall screen that includes a map and various charts

Image source: Getty Images.

However, customers complained about the new platform's poor user experience and the company saw disappointing top-line results. With $599.5 million of revenue in its fiscal 2020, which ended March 31, the company's annual growth rate decelerated to 25%. That pales in comparison to some of its competitors. For instance, cloud-based monitoring specialist DataDog grew its revenue by 83% to $362.8 million last year thanks to its simple and integrated monitoring platform. And another competitor, Elastic N V, posted a strong year-over-year 53% revenue growth during its last quarter as it leveraged its search capabilities.

NEWR Revenue (Quarterly YoY Growth) Chart

NEWR Revenue (Quarterly YoY Growth) data by YCharts

So the company's recent results indicate that the challenges didn't disappear with the shift to New Relic One. Despite spending 52% of its revenue on sales and marketing expenses in the first quarter, revenue grew by only 15% year over year to $163 million, and losses increased from $15 million to $30 million because of the higher operating costs it incurred to fuel growth.

And that slowing growth trend appears likely to continue: Management forecast that year-over-year revenue growth would only hit 12% in the current quarter.

Risky long-term bet 

In light of the company's modest performance, management recently announced a series of measures -- only one year after the launch of the long-awaited New Relic One platform -- to boost long-term revenue growth. That new strategy includes the following  moves: 

  • Hand over the company's agents (pieces of software that collect information from systems and applications) to the open-source community, which would allow New Relic's developers to focus on the core platform.
  • Reduce the company's offering from 11 products to three.
  • Propose a perpetual free offering that would compete with solutions that would cost approximately $10,000 annually, according to management.
  • Convert all customers to the New Relic One platform.
  • Replace consumption-based pricing by per-user pricing to simplify the company's offering and make it more predictable.

These changes will most likely have a negative impact on the company's revenue growth over the medium term as many small customers convert into non-paying customers. In addition, simplified pricing and offerings should also be favorable to its clients.

The strategy consists of gaining market share with short-term incentives and upselling customers extra features to generate more revenue over the long term. But that will demand strong execution at a time when competitors are not standing still with similar offerings and strategies.

For instance, several quarters ago, monitoring specialist Splunk replaced its variable, volume-based offerings with predictable pricing based on infrastructure, which provides more certainty and clarity to customers. And Elastic N V, which embraced the open-source model several years ago, has made some security features free since last year.

As a result, New Relic CEO Lew Cirne said during the earnings call on Aug. 4 that it was "no longer reasonable" to expect New Relic to reach $1 billion in annual revenue by fiscal 2023 -- a goal announced during the company's 2019 analyst day. "I would say we are taking a temporary disruption in the short term to set ourselves up for accelerated growth in the back half and then particularly as we head into fiscal '22 and '23 on our path toward -- getting back toward market-rate growth rates," he said.

An opportunity to buy?

Due to the market's skepticism about New Relic's new strategy, the company's market cap dropped by 24% overnight after the recent earnings report. The tech stock is now more than 40% cheaper than it was on Aug. 1, 2019, and,  it still trades at a high enterprise value-to-sales ratio of 4.9.

That valuation doesn't leave much margin of safety, which is why prudent investors should stay on the sidelines. Management gave up its goal of reaching $1 billion of annual revenue in the next couple of years, while long-term growth will depend on flawless execution over many years against strong competitors. In addition, given the high operating expenses required to fuel this company's growth, profitability seems far away.