Credit Suisse expects strong stock and fundamental performance from NetSuite Inc. (NYSE: N) in the second half of the year.
"We recommend investors start thinking about positioning ahead of a back-half in which we expect strong stock and fundamental performance from NetSuite. We believe the company’s first user conference May 8-12th in San Francisco could serve as the inflection as investors become more comfortable with the sustainability of the company's growth," said Greg Dunham, an analyst at Credit Suisse.
While the valuation sits at a premium (6.8 times of 2012 sales versus the group at 5.8 times), Dunham sees consensus numbers as too low and believe many on buyside question the company’s ability to grow. He expects sentiment to change dramatically as the year progresses.
Dunham said NetSuite has one of the best sustainable growth opportunities in his coverage long-term and is benefiting near-term from a much improved demand environment, higher ASPs, a revived partner channel, and increased capacity. Dunham expects billings growth to continue to accelerate in the back half of 2011 with overall growth for the year eclipsing 24 percent.
Dunham expects partner contribution of 20 percent to continue to increase as growth in 2010 (partner new business billings up 67 percent in 2010) continues to build off a small base. NetSuite’s ongoing ramping of Systems Integrators (adding over 20 in second half of 2010) should also enhance the productivity of its distribution channel.
While Dunham estimates that NetSuite spent roughly $1 to capture new billings of $0.35 in 2010, he believes returns should increase as ASPs continue to creep up and partners drive an increasing mix of customer acquisition. He believes his forecasts for productivity to return and eclipse 2007 levels over the next three years is reasonable.
While Dunham is not making an aggressive quarterly call, he believes first quarter will be solid and sees potential upside to his $56.7 million billings estimate (about 19 percent year-over-year growth).
"For 2011, we expect billings upside to be more back-end loaded as billings growth will be more reliant on new business generation versus the benefit from reduced churn/downsell that the company garnered in 2010. Still, the environment is much improved from last year and NetSuite is investing more aggressively in 2011 to drive growth with capacity hiring," said Dunham.
Dunham believes investors will increasingly see NetSuite’s market, leverageability, and competitive position supporting near-term business acceleration and sustained top-line growth in the mid-to-high 20s over the next several years.
Dunham believes NetSuite has improved its quality of business dramatically over the past three years. The company has increased its mix of subscription revenues to 85 percent from below 80 percent several years ago and he expects this to continue to increase with higher partner involvement (now just 20 percent of the business).
NetSuite is also seeing higher revenue contribution from more stable and profitable customers (customers spending more than $100,000 annually have doubled from recession levels). In addition, the contribution from new customers is improving as new customers signed in 2010 contract at 20 percent higher recurring revenue than new customers in 2009.
Dunham believes this enables the company to drive significant cash flow margin expansion, even with added investments, as gross margins continue to expand, productivity levels improve with higher pricing, churn lessens, and partners take on more capacity investment.
"Our research over the past several months increases our confidence in NetSuite’s ability to have success in mid-market enterprise resource planning (ERP) with its software as a service (SaaS) solution. We believe the market, which can support tens of billions of revenue, is one of the most attractive segments given its size and stickiness of the solution. We also believe NetSuite’s competitive position will continue to strengthen as its product evolves with time and experience," said Dunham.
NetSuite stock closed Wednesday's regular trading up 1.14 percent at $29.28 on the NYSE with a volume of 297,200 shares.