With the rotation out of tech stocks underway, I believe the next few weeks would open up opportunities for investors who got left behind in the initial run to accumulate shares in some good companies. One such company that seems to have negative short-term sentiment is Datadog (DDOG). However, as we will discuss below, the long-term story is still intact and any weakness may be a chance to buy.
Just a brief background on the company. Datadog is a SAAS company that focuses on infrastructure monitoring, application performance monitoring, and log management. Datadog’s main selling point compared to its peers is that it provides a unified view of the customer’s entire technological stack in a single platform. This integrated monitoring and analytics platform makes data available to all stakeholders and breaks down the silos between development and operations teams. Forrester has the company highly ranked and in the “leader” category.
Datadog offers a software-as-a-service SAAS-based solution built on the premise that operations and development professionals all have skin in the game and should be able to measure application performance from any angle. A unified dashboard keeps the practitioner in-context when troubleshooting performance issues, and integrations for collaboration and notification tools. Customers noted that the solution gives them far greater visibility than previously deployed tools, allowing staff members, armed with precise troubleshooting data, to react faster.
The Forrester Wave™: Intelligent Application And Service Monitoring
A simple example of a typical use case for Datadog’s services would be, for example, a technology company with a cloud-based app product. The operations team would like to monitor the status of its app in the case of the app being down. The operations team can then identify the portions of the app that fail and can properly escalate the issues to the proper development team. Business leaders can be alerted in case of any failures and be properly forewarned to manage their customers. The use cases for the company’s platform go beyond the IT department.
Datadog’s software solution is simple, cloud-agnostic, and has a lot of out of the box functionality. The company has seven products each of which is impressive on its own but taken together are worth more than the sum of its parts. The company also recently announced 8 new products at its annual user conference. Some of the products such as Security Monitoring and Incident management are particularly promising as it directly solves certain pain points.
The company also launched a “Datadog Marketplace” which according to the company will allow “Datadog Partners to use Datadog as a development and collaboration platform to build custom apps, including third-party integrations and monitoring tools, and offer them to their customers and the Datadog community at large.” Given the large trove of data present in the Datadog platform, I can see the marketplace vastly expanding the use cases of the platform similar to how Salesforce (CRM) functionality is expanded by third-party apps.
As disclosed in the company’s 10-K, research firm Gartner estimates that the IT operations management market has a total addressable market of $37 billion by 2023. Datadog is well-positioned to capture a significant portion of that market as it can operate in an on-premise, cloud, or hybrid environment. The trend towards digital transformation, I believe is still in its early stages, and this has only been accelerated by the coronavirus pandemic.
Short-term growth could be slower
In terms of short-term results, Datadog recently announced its Q3 2020 financials. Revenue for the quarter was $154.7, an increase of 61% compared to the same time last year. The company had an operating loss of $9.3 million for the quarter. However, using non-GAAP measures, the company had $13.8 million operating income. The non-GAAP difference being primarily driven by stock-based compensation and amortization of acquired intangibles.
As of the end of the quarter, Datadog had 1,107 customers with Annual Recurring Revenue of $100,000 or more which is up 52% from 727 customers the same time last year. However, despite the upbeat quarterly results, the stock is in a bit of a rut the past few weeks. This is mainly due to management’s lower guidance popping the air from the stock’s meteoric rise. Management has guided for revenue of $162 million-$164 million in Q4 2020 which only represents a 4.7%-6.0% growth from this quarter’s results.
I’m not really worried about the weaker guidance for next quarter and next year, as IT budgets are tightened during times of economic uncertainty. The long-term story remains intact, as I suspect that the vast majority of companies are only starting their “digital transformations” and thus have not yet built in the proper analytics and monitoring tools in their processes.
From a technical analysis standpoint, though, it would seem that the stock is facing the possibility of weakness for the next few weeks. However, I tend to take the longer view with regard to companies I like and I believe Datadog has hit several important milestones this year. Apart from the new products discussed above, the company announced a strategic partnership with Microsoft (NASDAQ:MSFT) which will make Datadog available directly from the Azure console.
Datadog and Azure sales teams will also collaborate to land enterprise clients as part of the partnership. Having Datadog already easily available to Azure clients would make cross-selling other non-cloud monitoring products much easier. The company also has partnerships with Google (GOOG) (NASDAQ:GOOGL) and Amazon (AMZN), which showcases the strength of the company’s product offering. In fact, Datadog recently won “Best Mission-Based Data Solution” as part of the 2020 AWS Public Sector Partners Awards.
A common bear argument against Datadog is the company’s current valuation as the company is trading at 764x forward earnings and 49x Sales. Datadog currently is an expensive stock but when it comes to technology companies, you get what you pay for. The company is constantly innovating and has received accolades from multiple sources. There are short-term headwinds with regard to IT budgets being tighter due to the economic situation however, that is only temporary. Datadog’s TTM revenue is $480.8 million, which is just a fraction of the $37 billion TAM forecasted.
I believe even at these levels, Datadog is a good buy just thinking about where the company will be 3-5 years from now when the economy restarts and digital transformation is in full swing. Market-timers can try to position their limit orders at the $80 price level. I have Datadog as a buy.
Disclosure: I am/we are long DDOG. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
Additional disclosure: Caveat emptor! (Buyer beware.) Please do your own proper due diligence on any stock directly or indirectly mentioned in this article. You probably should seek advice from a broker or financial adviser before making any investment decisions. I don’t know you or your specific circumstances, therefore, your tolerance and suitability to take risk may differ. This article should be considered general information, and not relied on as a formal investment recommendation.