First, the EU elections are UKIP's priority, they are a party founded to oppose the UK's continued membership of the European Union and as such the EU elections provide the best platform for gathering votes from those sympathetic to that view. To stand in the Newark by-election would mean a dilution of the, comparatively, meagre UKIP resources.
Second, whilst standing in the Newark by-election would be tempting and Nigel Farage might even win it, most stunning by-election victories are reversed at the following general election and in this case the next general election is a year away. Any positive publicity from winning the by-election would be more than negated by the negative publicity arising from losing UKIP's only seat (the BBC would love the headline 'UKIP lose 100% of House of Commons seats') next year.
I believe that Nigel Farage was in a no-win position: stand and risk losing focus on the EU elections this year and garnering negative publicity next year when/if he lost the seat, not stand and be called a 'bottler'. I think he's made the best decision for UKIP and himself, and maybe consequently the UK.