SPLK - Dogged Determination - Digging Deep At Datadog Just Delivered A Great Q3

2023-11-07 11:40:50 ET

Summary

• Datadog printed a very strong quarter today before the open.
• Growth ticked up, as did cashflow margins, and the balance sheet is rock solid.
• The company's valuation multiples are high, but this is typical for a high-growth, cash-generative software company.
• We rate at Hold over $96, and believe the stock can reclaim its all-time highs of $200, if one is patient.

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How To Run With The Big Ddogs

Datadog, Inc. ( DDOG ), we believe, will benefit from the sale of Splunk Inc. ( SPLK ) to Cisco Systems, Inc. ( CSCO ). (Recall we cited SPLK as an M&A target for the last 18 months or so, payday came long, thank you and goodnight to that one!).

When point solution companies like SPLK get sold to major suite vendors, customers don't love it. The best developers leave, the most productive sales execs leave, it all goes much more corporate than it used to be. This is great news for competitors. In application performance monitoring (sorry: AI-driven opsec or whatever these companies say they do these days), two names have been taken out lately - New Relic, Inc. ( NEWR ), sold to a financial buyer, and Splunk to Cisco. That leaves Dynatrace, Inc. ( DT ) and Datadog as the leading independents. If the two remaining companies were laggards, shareholders should worry, because it would mean probably a lessening of M&A exit opportunities. But it was SPLK and NEWR, the old lags of the sector, that got sold. So this is a great time to be a DT or a DDOG shareholder we think. Because both names should be gaining market share and have access to a range of highly qualified developers and sales folk to hire.

DDOG's Q3 was rock solid. Growth held steady and did not slow, contrary to the guidance. Q4 guidance is probably cautious too. EBITDA and UFCF margins look good and the sequential and YoY performance in deferred revenue (= invoiced, yet-to-be-recognized sales) is good news. Most likely RPO (= total order book incl. yet to be invoiced orders) looks good too, though we won't have the numbers until the 10-Q or perhaps till the earnings call transcript is available.

Datadog Financial Analysis

Highlights:

• Revenue grew at +25% YoY in the quarter, bringing TTM revenue to $2bn with a growth rate of 31% on a TTM basis. The guide is for a slowdown to 21% growth, which we expect is a little on the cautious side given the acceleration in deferred revenue (= invoiced sales, yet to be recognized as revenue).
• Gross margins moved up to 80% on a TTM basis - that's fair best in class today for an enterprise software company.
• TTM EBITDA margins moved up to 21%, almost a lifetime high for the company.
• TTM unlevered pretax free cashflow (= TTM EBITDA minus capex minus change in net working capital) margins moved up to 19%. Note the minor difference between account profit and cashflow margins, which tells you that the company is parsimonious with capex (good) and good at getting paid quickly and paying others slowly (also good, at least if you are a shareholder).
• A second successive quarterly acceleration in deferred revenue growth - now +34%.
• We expect RPO (the total order book including yet to be invoiced orders - this is a superset of deferred revenue) to be good too - we'll update this note once the 10-Q is published with that data.
• $1.6bn of net cash on the balance sheet ought to keep the wolf from the door.

Datadog Stock - Valuation Analysis

Valuation multiples are punchy, but this kind of high growth, recurring-revenue, cash-generative software company has always, since the dawn of computer time, traded at prices which are "too expensive". Is what it is. Don't like it, don't invest.

Datadog Stock - Technical Analysis

You can open a full page chart, here .

In our service here on Seeking Alpha we have rated the stock at 'Accumulate' below $96. The stock is above that at the time of writing following today's earnings print - we rate at Hold accordingly as the name moves up into our 'Markup Zone' where late money comes to buy. We believe the stock can reach at least the prior all-time high of $200, and, given time, beyond that.

Cestrian Capital Research, Inc - 7 November 2023.

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