Enterprise software companies are in the midst of an epic growth spurt. Investors are bidding up share prices at a frantic pace.
You may have noticed Datadog (Nasdaq: DDOG, Rated “D”) shares sprinting to record highs. Catchy name aside, the New York company is at the epicenter of digital transformation, the hottest trend in tech.
Datadog makes cloud-based subscription software. The no-code platform helps information technology pros keep tabs on all of their enterprise software applications running in the public cloud and on premise data centers.
It’s a collection of catch-all dashboards, with real-time monitoring tools for key data metrics, traces and logs, all the way to the most granular level.
IT departments can drill down to make sure everything from cybersecurity to infrastructure is running smoothly. In an era where businesses are racing toward business models informed by data, that’s a mission critical, can’t live without tool.
Its importance is being reflected in the company’s heady growth.
CEO Olivier Pomel met with analysts in May following blockbuster first-quarter financial results. Although the period missed most of the start of the COVID-19 crisis, revenues surged to $131.2 million, up 87% year-over-year. Customers with revenues in excess of $100,000 annually jumped to 960, an 89% gain over the same period. Datadog ended the quarter with 11,500 customers, up 40% from a year ago.
The scalability of Datadog software is pushing that growth. The architecture allows for the simultaneous monitoring of thousands of applications, running in tens of thousands of siloed software containers. The data from all these apps can be collected and immediately turned into actionable insights.
The concept is winning over large customers. For example, Pomel told analysts that during the quarter, the business locked up a seven figure contract with a large pharmaceutical firm. Following that, they inked a six figure deal with a large health insurer. They also landed a big upsell from a mid-market logistics company which brought its annual billings above $1 million.
Managers at Datadog take great pride in upselling. Its land and expand business model often starts with free trial software. Pomel says firms typically begin their Datadog experience monitoring cybersecurity threats, then expand services to machine learning modules for infrastructure.
Threats and potential problems are packaged and sent automatically to IP staff using integrations for email, Slack (NYSE: WORK, Rated “D”), PagerDuty (NYSE: PD, Rated “D”), ServiceNow (NYSE: NOW, Rated “C+”) and other platforms.
The story ticks all the right boxes. The company is scalable and growing fast in the middle of tech’s biggest story. Its potential seems unlimited. Investors have bought in, too, pushing Datadog’s valuation out of the stratosphere.
Following an initial public offering at $26 in September 2019, Datadog shares have ripped higher. In June the stock pushed to $94, nearly 4 times the IPO price. Shares now trade at 67 times sales and 1337 times forward earnings. The market capitalization has ballooned to $28.5 billion.
Investors are betting demand for Datadog software will accelerate as more firms ramp up spending to ensure the reliability of their networks and backend software applications.
At current prices, that is not a great bet.
During the call in May, Pomel was careful to remind analysts increased sales due to COVID-19 readiness might normalize going forward. He also warned it was prudent to expect delays in new cloud migration projects amid the worsening macroeconomic outlook.
The idea that sales might slow, or even be pushed out as companies grapple with missed internal revenue projections, is not factored into the current valuation.
Investors may also be misinterpreting Datadog’s place in the networking performance monitoring and diagnostics competitive marketplace.
In April, Gartner (NYSE: IT, Rated “C-”), a global IT advisory firm, placed five firms ahead of Datadog in its magic quadrant: App Dynamics, a Cisco Systems (Nasdaq: CSCO, Rated “C+”) company, Dynatrace (NYSE: DT, Rated “D”), New Relic (NYSE: NEWR, Rated “D”), Broadcom (Nasdaq: AVGO, Rated “C”), and Splunk (Nasdaq: SPLK, Rated “C+”) all fared better.
Digital transformation is the single biggest investment idea in a generation. Many companies, large and small, will benefit as enterprises use digital to make their workflows more efficient and measurable.
Datadog is growing fast. The firm is capably managed. It’s a good story with bright longer-term prospects. However, the share price is far ahead of the current outlook.
Investors should not chase the stock at current prices.
Best wishes,
Jon D. Markman
