Ivy Investment Alert: Buy Datadog Under $65/share; Sell $85
Disclaimer: Ivy Investment Alerts have a medium to long-term time horizon. These do not constitute financial advice and you should contact a financial advisor before deciding whether it is appropriate for your individual circumstances.
Datadog offers a software platform for monitoring and analyzing the performance of cloud software infrastructure. The platform integrates a variety of data sources to produce actionable insights, thereby offering users a 10,000 foot view of their technology stacks. The modular platform allows for customizable solutions tailored to the specific needs of customers and is important for ensuring the reliability and scalability of a client’s technology systems.
But what about the Datadog investment thesis?
With the shift towards cloud-based IT infrastructure, the need for monitoring software is increasing yet only 5% of software applications are monitored, according to Gartner. Datadog estimates its addressable market to be worth $62 billion by 2026 and has plenty of room to grow with “just” $1.6 billion in revenue in 2022.
Another useful tidbit to know is annual recurring revenue from DDOG customers has historically increased over time, indicating a likely expansion of the company’s market opportunity.
- The shift towards cloud-based IT infrastructure is increasing the need for monitoring software, and Datadog estimates its addressable market to be worth $62 billion by 2026.
- The company has sustained top-line growth and increasing levered free cash flows over the past several years, indicating a likely expansion of its market opportunity.
- Analysts’ consensus target is $103 per share, and the company has significant upside potential with a price target of $85 per share, making the reward-to-risk ratio compelling in light of its solid financials.
Why Buy Datadog?
The first thing to look for in a high growth company is, well, high revenue growth. Obvious as it may seem, many supposedly fast-growing firms stumble at this hurdle. Take Coinbase, for example, where transaction revenues have collapsed over the past twelve months, in spite of its reputation as a disruptive, high-growth firm.
Datadog, on the other hand, has sustained its top line growth for years now:
- 2018: 96.6%
- 2019: 83.2%
- 2020: 66.3%
- 2021: 70.5%
- 2022: 62.8%
With the most important milestone, rapid revenue growth, cleared, what are the other reasons that make Datadog a compelling buy?
Management has a proven record of converting those stellar revenues into positive free cash flows. Here’s how levered free cash flow has grown over the same period:
- 2018: $1.2M
- 2019: $10.9M
- 2020: $103.7M
- 2021: $276.6M
- 2022: $383.1M
These cash flows are, to some extent, a function of the company’s ability to retain and expand its customer base over time. Its strong and diverse customer base includes large enterprises and mid-market companies across various industries. Another factor in its favor is its low customer concentration mix, meaning it’s not overly reliant on any single customer.
When we ran the numbers on Datadog, the valuation argument became ever more compelling after the recent price selloff. Valuation is a function of the company’s P&L, balance sheet, and cash flows. The balance sheet is also looking ever more impressive with cash and cash equivalents growing over the past 3 years too:
- 2020: $224.9M
- 2021: $271.0M
- 2022: $339.0M
On a valuation basis, the company has significant upside with the analysts’ consensus target sitting at $103 per share. We are a bit more conservative and have a price target now of $85 per share. Either way, the potential gain is attractive relative to the risk. In short, the margin of safety is comforting, and the fair value sits well north of current levels, making the reward to risk ratio compelling in light of the solid financials.