DataDog, Dynatrace, NewRelic - Which Cloud Monitoring Stock Should You Buy?

Posted by Minerva on Aug 19, 2020 9:49:04 PM

Look underneath the simple browser- or mobile app-based user interface of most enterprise software applications today and you will find a veritable spaghetti bowl of code, pulled together and orchestrated from multiple different sources, locations, owners and indeed underlying languages.  The construction and operation of application software today is far more complex than ever.  At the same time, user expectations of uptime, latency and responsiveness are way higher than ever before.  Taken together this means that the user acceptability level for application downtime is very low; but the potential likelihood of application downtime is very high.  To resolve this big enterprise IT problem, you need cloud monitoring software.  There are three vendors in the news right now; DataDog ($DDOG), Dynatrace ($DT), and NewRelic ($NEWR).  Which of these stocks should you buy?  Depends who you are.  We explain below.

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The Systems Monitoring Troika

There are three story stocks in systems monitoring right now. NewRelic ($NEWR), a founder-CEO led company that is currently suffering some headwinds; Dynatrace ($DT), a private equity-backed recent IPO; and DataDog ($DDOG) a VC-backed cloud darling, also a recent IPO.  Here we compare the three.

 

1. NewRelic ($NEWR).

$NEWR is a $3bn EV business founded in 2008.  In 2014 the company went public.  The stock enjoyed relatively rapid gains as the company grew, reaching a peak of around $113 in July 2018.  The stock has trended down since then, punctuated by the occasional rally.

NEWR 19 Aug 2020

NEWR Stock Price, 2015-date.  Source: YCharts.com

That drop you see at the right hand side of the chart is what happened when they reported their Q1 earnings (for the quarter ending 30 June) earlier this month.  The stock dropped some 24%, from a prior close of $73.50 to a close of $55.77 the day after earnings.  The cause was partly a miss on GAAP earnings per share but mainly the view expressed by the company's management team that they needed to restructure their pricing model, and aspects of the products themselves, to contend with a shifting computing architecture model.  In essence, this company's products and pricing were configured for cloud as it was in the early 2010s, rather than the more complex, atomized and distributed beast it has become today.  You can read the company's earnings call transcript here.  It's not pretty.  We think the company has a hill to climb from here.  They have to get revenue growth moving up whilst at the same time reducing and restructuring prices, and investing in product development.  To us that means revenue growth is likely to be challenging and at the same time earnings and cashflow will likely take a hit from the additional development work.

Who should buy $NEWR?  People who have $4bn in loose change, together with the time, inclination and skills to get to work on improving the business away from the glare of the public eye, to then sell it on to a larger buyer or, perhaps, rehabilitate the name back into public ownership after a spell of detox.  In other words, private equity funds.  We would be unsurprised to see a bid at some point.

 

2. DataDog ($DDOG).

$DDOG is the new kid on the block, and it is sporting one fancy haircut.  Established in 2010, the company has been public for less than a year.  Its stock price ascent in that short time has been vertiginous.

DDOG 19 Aug 2020

DDOG Stock Price, IPO-to-date.  Source: YCharts.com

This company also hit turbulence on their earnings, although in this case the stock dropped from a valuation of around 58x trailing twelve month (TTM) revenue - yes, revenue - down to a mere 45x TTM revenue at closing the day after their Q2 numbers.  Absurd valuation, you may say.  And you may be proven right, should the Fed one day tighten their largesse.  But for now, relative to other cloud stocks? $DDOG trades at something of a premium to the others as a function of its revenue growth, but not a huge premium.  And in support of that premium, it has one of the most compelling blends of high revenue growth (+50%-ish p.a.) and cashflow margin (2% unlevered pre-tax free cashflow, on a TTM basis).  We expect $DDOG's premium quality fundamentals vs. the cloud cohort to persist. 

Who should buy $DDOG?  Growth junkies.  People who love growth stocks and can look beyond the short-term outlook in pursuit of a much bigger prize 3-5 years out.  And if the Fed keeps printing - your gains might come faster than you expect.

 

3. Dynatrace ($DT).

$DT has a short but busy history.  Founded in Austria in 2005, the company wound up under private equity ownership when its then-parent Compuware was acquired by Thoma Bravo in 2014.  The Dynatrace division was spun out by way of a 2019 IPO.  The stock has moved up in fits and starts since that time.

DT 19 Aug 2020

DT Stock Price, IPO-to-date.  Source: YCharts.com

Thoma Bravo has been selling down its stake of late, causing a little turbulence in the stock price.  So despite solid earnings performance and recently raised guidance, the stock can be picked up for a little way below its all time highs - unlike larger, more glamorous cloud stocks.  Today $DT closed at $39.33, representing around 19.4x TTM revenue in exchange for forward growth of around 19%.  That's a little above the cloud cohort as a function of DT's revenue growth.  However, $DT operates at a very high level of unlevered pre-tax free cash flow margin relative to its revenue growth. On a TTM basis as of the June quarter, $DT achieved revenue growth of 27%, and unlevered pretax FCF of 22%.  That is a remarkably strong combination.  In addition, prepaid yet-to-be-recognized (deferred) revenue constituted some 70% of TTM recognized revenue - meaning a relatively predictable revenue outlook.  We expect this strong balance of cashflow and growth to continue.

Who should buy $DT?  Anyone who wants rock-solid cashflow to fall back upon should this Fed-supported market start to drop back meaningfully.  Because if it doesn't - drop back - then that solid revenue growth could well keep $DT moving up.

 

Disclosure: Cestrian Capital Research, Inc staff hold personal account long position(s) in DT.

 

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Topics: Multibagger, Public Posts, Cloud, DDOG, DT, NEWR

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