Datadog (DDOG) provides a leading monitoring and analytics platform for developers, IT operations teams, and business users in the modern cloud age.
The company’s SaaS platform incorporates and automates infrastructure monitoring, application performance monitoring, log management, and security monitoring to provide unified, real-time observability of its customers’ entire technology stack.
With organizations of all sizes and across most industries striving for digital transformation and cloud migration, Datadog’s platform is extremely useful in terms of driving collaboration among development, operations, and business teams, which reduces time to problem resolution and understanding user behavior through its critical business metrics. Consequently, the company has been experiencing robust demand for its platform, growing its revenues sequentially at a rapid pace.
I believe Datadog is set to continue reporting solid growth across the board in the medium term. That said, investors need to be wary of the stock’s expanded valuation, which could result in headwinds when it comes to investors’ total return prospects. For this reason, I am neutral on the stock.
Latest Results
Datadog’s latest results came in quite strong, with the company delivering robust revenue growth of 74.9% year-over-year to $270 million. Revenues also grew by 15.8% sequentially. What’s most impressive to note is that revenue growth has actually been accelerating. In Q1-2021 and Q2-2021, it grew by 51.3% and 66.8%, respectively, clearly forming an upwards trend following the company’s Q3 results.
Powered by enterprise customers growing by 62.6% year-over-year and by 11.8% sequentially, Datadog’s total customer base grew 33.6%. Combined with a consistently solid net revenue retention rate of 130%, Datadog’s highly scalable platform features robust customer validation.
Datadog believes that it’s still in the early phases of its market opportunity, with companies continuously shifting their workloads to the cloud. It’s also worth noting that Datadog’s platform is cloud-agnostic, which means it can scale in multi/hybrid cloud infrastructures frictionlessly.
In its Q3 results, Datadog’s gross margins stood at 77%, which is quite a rich level and should allow for quite high net income margins once the company matures. Still, Datadog remains unprofitable, with its GAAP operating margin at a negative 2%. The company’s R&D comprises around 30%+ of total sales due to the company allocating its growing top line to reinvest heavily in building and improving its platform. However, with scale, this percentage should decline, allowing for a richer bottom line.
The Valuation
As I just mentioned, Datadog remains unprofitable. For this reason, it’s more meaningful to value the company based on its sales. The company expects to deliver revenues between $290 million and $292 million in its upcoming earnings and FY-2021 revenues between $993 million and $995 million.
The stock is essentially trading at around 56 times its sales at its current market cap, which is a very steep valuation multiple. On the one hand, the company is growing rapidly and accelerating sales growth. Further, its rich gross margins could justify a premium on sales.
That said, this is a remarkably rich valuation that provides a zero margin of safety, assuming Datadog’s growth was to decelerate from here. In my view, the stock would be more reasonably valued at a P/S closer to 40.
Wall Street’s Take
Turning to Wall Street, Datadog has a Moderate Buy consensus rating, based on 12 Buys and three Holds assigned in the past three months.
At $211.14, Datadog stock projections suggest a 15.08% upside potential.
Disclosure: At the time of publication, Nikolaos Sismanis did not have a position in any of the securities mentioned in this article.
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