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Datadog Earnings Review - Mid-Term Prospects Dimming, Acquisitions to Reaccelerate Growth

1 Corinthians Chapter 13 verses 6-7 state, "Love does not delight in evil but rejoices with the truth. It always protects, always trusts, always hopes, always preserves."


The Bible talks a lot about love, as it is they key quality that God through Jesus Christ imbues on humanity. I find myself reading the first sentence and considering what is evil and truth in my own life. What I may think is good, can always become evil, and detract my love for those closest to me. This is the beauty of the word of God, it cuts through my own version of what I see as truth, every time I read it.


For investing, I like the idea of rejoicing in truth. The problem is, no matter how well I can analyze a company or assess a situation by reading between the lines and defining the truth, the market will always be the driving force of any particular companies' valuation and corresponding SP. It is important nonetheless, to always attempt to be as unbiased as possible in assessing valuation, and future potential. For Datadog, Inc. (DDOG), the mid-term prospects are not looking as promising as they did last year, and it makes perfect sense that the company announced two acquisitions.


Datadog

Datadog is a monitoring and analytics platform for developers, IT operations teams and business users in the cloud age. The company's SaaS platform integrates and automates infrastructure monitoring, application performance monitoring and log management to provide unified, real-time observability of a customers’ entire technology stack. Datadog is used by organizations of all sizes and across a wide range of industries to enable digital transformation and cloud migration, drive collaboration among development, operations and business teams, accelerate time to market for applications, reduce time to problem resolution, understand user behavior and track key business metrics. Datadog's key financial metrics as of today's filing and on a Last Twelve-Month, LTM, period are as follows:

  • Net Cash Position: $940 million

  • Revenues: $603 million

  • Gross Margin, GM: 78.5%

  • Operating Cash Flow, OCF / Margin: $109 million / 18%

  • Free Cash Flow, FCF / Margin: $113 million / 19%

  • Shares Outstanding 332 million

  • Customers with Annual Recurring Revenue (ARR) > $100,000: 1,253

  • Customers with ARR > $1,000,000: 97

Datadog's fiscal year ends every December 31st of each calendar year. For the full 2020 year, Datadog witnessed Revenue growth just above 66%. GM improved by 300 basis points, and OCF/FCF margins also increased by 170% and 680% respectively, while nominal values increased by 350% and 1,150% respectively.

All the results for Datadog were very impressive, especially during the challenges that were posed during 2020 stemming from COVID. However, growth at the midpoint as provided by the company for 2021, is expected to decelerate to 37%. It wouldn't be shocking to see growth thereafter dropping further towards the 20% level over the next few years. The company also saw a peak OCF margin at 20% before dropping back to 18% for the entire year. For these reasons, it makes perfect sense that Datadog announced two new acquisitions today with Sqreen and Timber Technologies. For those looking to read up on Timber, it is best to search for Vector to land on the homepage.


Sqreen’s application security management platform provides Runtime Application Self-Protection (RASP) and in-app web application firewall (WAF) that is already used by hundreds of development, operations and security teams in production to detect and block code level exploits while allowing legitimate traffic. Timber's Vector allows customers to collect, enrich, and transform logs, and other signals across multiple tools and data sources, in both on-premises and cloud environments, and route this data to the destination of their choice.


The Sqreen move provides a premium security management product into the technology solution stack, while Timber gets Datadog more competitive directly against Splunk, Inc. (SPLK). As a reminder, Splunk is undergoing a transition to a cloud service business model, similar to Adobe, Inc.'s (ADBE) transformation, and has had a rough go of it through the process financially, even removing mid-term guidance.


I actually like the moves by Datadog, and it will be nice to get a sense of what the costs of the acquisition deals were during the next quarter. But despite all the good news and potential from these deals, Datadog's valuation is where my concerns lie moving forward. Key updated valuation metrics for Datadog include:

  • Enterprise Value, EV: $38 billion

  • EV/Revenues: 63 times

  • Net Debt/OCF: N/A

  • Stock Price, SP/OCF per Share: 358 times

Over the past month or so, four analysts have updated their PTs on Datadog with the average being at just below $115. Today, Datadog is trading with a steep premium at 63 times EV/Revenue, and an OCF/share at over 350 times. The company has displayed growth into its valuation as OCF/share was at nearly 600 times in 2018, but my main concern is regarding growth over the next five years. If Datadog were to generate $2 billion in Revenue by 2025 assuming an annualized Revenue growth rate of 25%, while maintaining the current OCF margin and accounting for share dilution, I can't get a SP close to $200 per share without going higher than 35 times EV/Revenue and 200 times OCF/share. This is not a compelling amount of growth into valuation over the next five years to entice me to consider adding to my position at today's SP.

My average SP sits at $72/share. Even at that SP, if the above scenario were to play out, I'd only have an annualized return of 19% over a five-year period, when the goal of my overall portfolio is to generate 25-30% annually. I don't think it's time to jump to conclusions and sell, but I do think it is time to dig deeper into Datadog's performance in 2021, especially considering the recent acquisitions.


Datadog has strong relationships with major companies including Amazon (AMZN), Microsoft Corporation (MSFT), Oracle, Inc. (ORCL), among others, and really had a tremendous year overall for 2020. I just think that the company needs to either show stronger sustained Revenue growth, and/or an expanding OCF margin to garner investment interest at today's SP levels. I'm not going to be considering Datadog anytime soon.


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