SolarWinds Corporation

Moat: 3/5

Understandability: 3/5

Balance Sheet Health: 4/5

SolarWinds Corporation is a global provider of IT management software designed to monitor and manage networks, systems, and applications, catering to tech professionals, particularly in cloud and hybrid IT environments, with a primary revenue stream coming from recurring subscriptions.

Investor Relations Previous Earnings Calls

The moat, understandability, and balance sheet health scores reflect a conservative evaluation to ensure a margin of safety in any assessment.

Business Overview:

  • SolarWinds provides a broad suite of IT infrastructure management and observability software solutions. Their offerings include network performance monitoring, application performance monitoring, log management, and IT security tools. Their primary focus is on mid-market and smaller enterprises, which have different needs from the complex requirements of larger organizations.

  • The company primarily generates revenue from subscription-based models. A very high amount of the revenue is recurring, which provides more stability to the revenue, compared to software companies that earn mostly from one time licenses or hardware sales.

  • Their products are designed to be easy to use for IT professionals to help them automate and improve the efficiency of their systems. This emphasis on ease of use contributes significantly to SolarWind’s unique selling proposition.

  • SolarWinds serves customers globally, with a particular focus on North America and EMEA, although international revenue is increasing.

  • They have expanded their offerings into newer areas, such as Cloud, hybrid environments and cybersecurity.

Moat Analysis: 3 / 5

SolarWinds possesses a moderate moat, primarily stemming from its:

  1. Switching Costs: Once customers integrate SolarWinds into their IT infrastructure, switching to a competing product becomes costly and disruptive. The company’s products become a core part of the operations, making clients reluctant to shift, and creates significant switching costs. For example, switching monitoring or IT security software providers can create massive problems for IT employees in training and familiarization and can also cause significant operational disruption.

  2. Installed Base and Brand Recognition: While not as powerful as network effects, the large installed base, and a strong brand within the IT professional communities create some advantages. IT professionals trust the company because of their reputation in this area and use their tools which are well-known and used throughout the sector. This is particularly true with smaller-to-medium sized companies as SolarWinds has long focused on that market. Many professionals have used their software at previous companies they have worked at.
  3. Product Breadth and Integration: SolarWinds’ wide range of IT management tools provides an advantage, as IT professionals can use a suite of tools, reducing the need to deal with multiple vendors. Integration also makes it difficult to integrate other solutions.
  4. Pricing Power: Because they’re focused on enterprise and government clients, and because those customers are often very complex and it is extremely difficult for them to change products, SolarWinds has a high degree of pricing power (within reason). Customers are unlikely to switch based on price and are willing to pay a premium, and thus are less sensitive to prices changes.
  • Rating justification: The moat is not extremely strong since they can potentially lose the brand’s status by a major security breach (discussed later), and because their switching costs are not as high as some providers that have very specific services within their portfolio. Their product bread has many substitutes and alternatives. However, they still have good switching costs and loyal customers, making their products stickier and allowing them to charge higher prices.

Risks to the Moat & Business Resilience

  • Cybersecurity Risks: The 2020 cyber attack has put a big dent on their reputation and brand. If the company encounters another attack of this magnitude that undermines customer trust, it could significantly erode their moat and overall business prospects. This was the biggest crisis the company has ever faced.
  • Intense Competition: The IT management software space is incredibly competitive, with several established players like IBM, Microsoft, and Splunk, along with other new and smaller players. The company needs to continue innovation and to offer newer, more attractive features and services, to avoid market share losses. Competitors that have more specific value propositions in each part of their platform, could out compete them.
  • Technological Disruption: The industry is constantly evolving and thus constant reinvention is needed. Technological disruption may diminish the value of their products. For instance, cloud-native tools or other emerging trends can lower demand for their legacy on-premise solutions.
  • Debt: The company currently has a lot of long term debt which might make them less flexible to make investments and acquisitions and they might face financial problems in periods of rising rates.

Financial Deep Dive & Understandability:

  • Revenue: SolarWinds primarily earns from recurring subscription revenue from their customers, accounting for 90-93% of their total revenues, which gives a high degree of stability and predictability.
  • Margins: Gross profit margins are extremely high at 75-80%. Operating profit margins are around 18-22%, but this is lowered due to the high amount of marketing expenses that they undertake. The high gross margins indicate good product and service offerings, while low operating margin indicates higher operating expenses.
  • Capital Expenditures: Capital expenditures are small in relation to the revenues. It is a software company so it mostly sells a digital service rather than having significant investments in buildings and factories, making the company very capital light.
  • Cash flow: They generate a lot of free cash flow and that is likely going to continue, with their subscription-based revenue. This is highly attractive for investors, because they are essentially getting free cash flowing every year, which they can use in various operations like investments, buybacks, and dividends, etc.
  • Debt: Their long-term debt is a bit high. They have 1.48 billion in total debt and need to deleverage the company.
  • Profitability: The net income is at around 12-15% net income margin which is great for a software company.
  • Understandability: 3 / 5: They sell complicated software that requires IT expertise, but the general idea is fairly straightforward: Provide services and tools for IT professionals that allow them to monitor their software and hardware and improve their security. They provide recurring value through subscriptions and their revenues are predictable. It isn’t the most difficult or complex business model to understand but isn’t the most simple either.

Balance Sheet Health: 4 / 5

  • Liquidity: The company’s cash position is good, but there is a lot of debt. Their liquidity is good, but it can be impacted by further rate hikes.
  • Debt Load: They are carrying significant long-term debt, mainly from the 2020 acquisition and subsequent cyberattack. They are currently focusing on deleveraging but they are at risk in high interest rates environments.
  • Working Capital: The company has positive working capital.
  • Rating Justification: The company is not the most healthy, due to its high debt, but has good liquidity with good cash and cash flow generation.

Recent Developments & Controversies

  • The cyberattack in 2020 which exposed multiple clients to a security breach is their main controversy. The company is still under scrutiny from various regulators and government institutions regarding the hack.

  • There was concern by customers about whether the data will be protected with using SolarWind’s software, so the company is investing significant effort and resources in its security to alleviate these concerns.
  • Management is currently focused on improving operational performance and lowering costs, while deleveraging their balance sheet.
  • Management is confident about its future financial prospects and they believe that they’ve put themselves in good footing for their future endeavors.

Key Metrics

  • Over the long term, the company’s stock price has not been impressive, with recent performance showing higher volatility with many ups and downs.
  • Company is showing declining revenues with increasing operating profits.
  • The management is committed to increasing shareholders value by improving profitability, cost optimization and deleveraging.