Netsuite Needs More Resellers to Grow

The issues I raised in my comments a week or so ago on Netsuite (N - commentary - Cramer's Take) roused some concerns and comments from readers, so I spent some time digging in a little deeper. What I discovered was surprising.

As I noted, Netsuite's valuation anticipates some really hefty growth rates from the company over the near future. That growth is dependent upon a steady stream of new customers.

In reality, the historical record (press releases) created a distorted picture of customer growth as can be seen in the graph below. (The figures that are from 2007 are either from the S-1 or the Q4 results).

So what caused the big changes?

Company executives told me that Netsuite historically signed a large number of small, low-revenue customers. As the company's business changed and it began to focus on larger entities, these very small accounts were not re-signed. Sounds reasonable to me.

Click here for larger image.

However, the company also said on its conference call that it has been averaging about 300-500 new customers per quarter during the past year. But a signed contract does not immediately translate into revenue because of the lag time in bringing customers live on the service.

Therefore, a signed customer does not become an active customer until it starts generating revenue and that can take as much as six months on average. With that in mind, look at the table below in which I assume an average number of new signings per quarter at 400. If the forecasts are accurate, the results raise more questions.

As you can see in the highlighted area (red oval), assuming an average ramp of 6 months, it appears that the active customer level is running behind where it would be expected. So what's the story?

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At time of publication, Faulkner held no position in the stocks mentioned.

Bob Faulkner has been in the investment business for 18 years with an exclusive focus on technology stocks. Under no circumstances does the information in this column represent a recommendation to buy or sell stocks. Faulkner appreciates your feedback; click here to send him an email.

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