Datadog proves the naysayers wrong

SaaS stocks have faced significant challenges over the past two years, primarily due to the impact of rising interest rates on their growth rates. Datadog ($DDOG), a leader in cloud observability, is no exception to this trend. Its growth has recently decelerated, with Q3 revenues showing a 25% y/y increase, in contrast to the 60% annual growth seen in the same period in the previous year.

Despite this deceleration in growth, the stock surged after Q3 earnings. The reason behind this market reaction is the company's strong outlook that indicates sustained high demand for its platform despite the tightening monetary environment.

DDOG may no longer be a hyper-growth software company, but it leverages powerful secular tailwinds that position it for rapid long-term growth. Its comprehensive platform and leading market position also contribute to the potential for DDOG to maintain high growth rates in the foreseeable future. Let's delve deeper.

Enabling Efficient Operations in the Cloud Era

Datadog stands out as the largest and most successful cloud monitoring platform in the market. With a market value of over $33 billion, it surpasses its competitors, such as Dynatrace ($DT), by more than two-fold. Despite being one of the newer entrants in this space, DDOG's aggressive innovation have set it apart.

Datadog offers a holistic approach to observability, which includes application performance, infrastructure monitoring, and log management. By integrating these key components into a single platform, Datadog allows businesses to gain a 360-degree view of their environment, which is crucial for identifying and resolving issues promptly.

Datadog is designed to be user-friendly, enabling both technical and non-technical users to access and understand complex data. This accessibility is particularly appealing to a wide range of professionals, from IT operations to software developers, and business executives. It empowers teams to collaborate seamlessly and solve problems efficiently.

Datadog’s aggressive innovation and keen understanding of the market have allowed it to become a leader in cloud monitoring. With more than 26,800 customers globally, up 20% y/y, Datadog has established itself as a trusted partner for cloud monitoring.

The company's dynamic approach includes regular product updates and feature enhancements, ensuring that it stays ahead of emerging trends and challenges in the cloud technology landscape. Datadog's commitment to innovation has been instrumental in driving its growth and cementing its dominance in the industry.

Datadog is also reaping the rewards of the AI revolution. As AI adoption proliferates, observability becomes indispensable for comprehending intricate AI systems. This translates into increased demand for solutions like Datadog's. The company has already introduced AI observability tools, such as the Bits AI assistant, AI-generated synthetic tests, and AI-led error analysis and resolution. These additional tools further enhance Datadog's competitive edge, allowing it to gain more market share.

Solid Performance on All Fronts

Although Datadog's recent growth has slowed compared to its hyper-growth phase, this is a natural progression for high-growth companies. In Q3, its revenue rose 25% y/y to $548 million, easily surpassing analyst estimates.

Datadog continues to experience strong demand for its observability platform due to the ongoing shift toward cloud adoption and platform consolidation. The company's strategic focus on large enterprise customers, who can increase their spending by utilizing more of its products over time, has proven to be extremely effective. In Q3, Datadog increased its number of large customers (spending over $100K per year) by 20.4% y/y to reach 3,130. Also, it achieved a robust net retention rate (NRR) of slightly below 120%, one of the strongest in the SaaS space. This indicates that existing customers are consistently increasing their spending on the platform, even in the face of a challenging macro environment.

The rapid growth in spending by existing customers is a primary driver of Datadog's profitability and cash flow. In Q3, its adjusted operating income surged by 75% y/y to reach $130.7 million, while operating cash flows jumped by 83% y/y to reach $152.8 million. This remarkable bottom-line performance was achieved through effective cost management, with total operating expenses increasing by less than 20% year-over-year in Q3.

What About Valution

Datadog is one of the most profitable SaaS companies on the market, boasting an Operating Cash Flow margin of 28%. It’s also one of the fastest-growing SaaS names, and investors have rewarded the company, pricing the stock at a Price/Sales (PS) ratio of 17.1x. While this is a premium valuation, Datadog's robust performance provides a solid foundation for these multiples to increase further if the company maintains its strong performance.

Assuming that the company exits 2024 with a revenue run rate of $2.5 billion, based on analyst estimates, and at a PS ratio of 20x, Datadog's stock could rise by 54% from its current prices, reaching $154 by the end of 2024.

What Else

Datadog's journey, from its inception as a startup to its current position as a market leader, underscores the transformative power of innovation and forward-thinking strategies. The company's comprehensive cloud monitoring platform, unwavering commitment to innovation, and expanding customer base make it a standout player in the competitive tech landscape.

As the global cloud tech market continues to expand, Datadog's role in helping businesses optimize their operations, enhance user experiences, and reduce downtime remains pivotal. While the company is premium priced, its valuation is justified by the world-class cash flow margins and continued rapid growth.

DATADOG RATING

Short Term: Buy

Long Term: Buy

🎯 2024 Price Target: $154

I’m long DDOG.

The boring Disclosures: Newsletters express the opinion of the authors. Nothing in this email is a buy or sell recommendation. I'm not a financial advisor; make your own decisions.