Let us get one thing clear: investing in IPOs is a tricky, risky business. IPOs typically underperform over the long run compared to more established companies. Many IPOs are little more than a ploy by institutional investors to get cash for their early investments in a rising company by giving stocks at their peak to ordinary citizens. Said investors buy said stocks because they fall for hype or the “greater fool” theory but end up holding the bag.
Yet, despite those caveats, Datadog’s (DDOG) IPO could be different. This company looks to be one of the best companies to go public in some time. It has fantastic financial metrics in ways which distinguish it from other IPOs, good underwriters in Morgan Stanley (NYSE:MS) and Goldman Sachs (NYSE:GS), and a high potential for growth. While investing in this company may be difficult as other investors notice these positive traits, investors should be preparing to pay a premium if that is what it takes.
An Efficient Business Model
In its S-1, Datadog calls itself “the monitoring and analytics platform for developers, IT operations teams and business users in the cloud age.” Datadog’s key product is the Datadog cloud platform, which is a software as a service (SAAS) platform that helps other cloud-scale applications and businesses. It is widely used on social media platforms, such as Rallio, to provide marketing analytics. Businesses today contain and develop more and more software and technology, which can make it hard to gather unified data and figure out what is being accomplished. Datadog monitors and combines the “technology stack” into a single place, making technology easier to understand even for the non-experts.
Datadog offers a wide range of solutions, which means that it faces a huge amount of competition. The company lists Amazon (AMZN), Cisco (CSCO), and Microsoft (MSFT) as competitors in different fields. And in fact, a side-by-side comparison of Datadog to monitoring competitor New Relic (NEW) by UpGuard finds New Relic to be slightly superior.
But there are two things to consider. Datadog may not have the strongest technological moat, but it has done a good job at attracting and retaining customers. Datadog reported a dollar-base retention rate of 146% in 2019 and has consistently stayed above 140% going back to 2017. Furthermore, total customers have grown from 5,403 in 2017 to 8,846 as of June 30, 2019. By constantly getting more customers and keeping them interested with strong customer support, Datadog has become very efficient as will be noted below.
Second is the fact that Datadog’s market will grow tremendously as the cloud becomes more mainstream. Datadog in its S-1 cites market research which claims that global spending on public cloud services “is expected to increase from $60 billion in 2018 to approximately $173 billion in 2022, according to the IDC, representing a 30% compound annual growth rate.” This is in line with other research in the monitoring market which predicts a CAGR of 28.7% until 2024. With such a high growth rate, Datadog can worry less about being squeezed out by its competitors.
A Fantastic Financial Profile
We noted that Datadog has done an excellent job attracting and retaining customers, and the result has been high revenue growth. Revenue rose from $85.3 million in the first six months of 2018 to $153 million over the same time frame in 2019, a 79% increase. Revenue growth is decelerating, though this is typical for rapidly growing IPOs. Gross margins over the period decreased from 78% to 73% and have consistently stayed in the seventies.
High revenue growth is typical for most IPOs, but there are other things which set Datadog apart. Its net profit numbers are pretty good for an IPO. While the company has typically lost money aside from a miniscule gain in the first half of 2018, it only lost $13 million in the first half of 2019 and $10 million in 2018. Datadog spent $66 million on sales and marketing in the first half of 2019, and it is reasonable to believe given its high customer retention rating that it could become immediately profitable if it dialed down the said expenses.
But there is no need for Datadog to do that given that its other financial numbers are healthy. Datadog reports $145 million in total current assets against $156 million in total current liabilities, but $101 million of liabilities comes in the form of deferred revenue. Furthermore, Datadog’s net cash flow has stayed positive or at least not significantly negative, with the biggest loss being $1.3 million in the first half of 2019. Datadog will not need to raise additional cash anytime soon after this IPO, yet easily could given that Crunchbase reported it had raised $147 million in three funding rounds.
Plenty to Look Forward To
Datadog used a $100 million provisional number in its S-1, so we do not know how much it plans to raise nor its planned valuation. And there are risks in this IPO. The company is using the dual share model which will keep all voting power in the hands of current executives and does face intense competition in a market which could change rapidly.
Nevertheless, investors should be highly interested in this IPO. Datadog has massive growth potential for years to come, has shown an ability to attract customers, and has great financial numbers. If we apply its 2019 first-half growth rate of 79% to its total 2018 revenue, we can expect total 2019 revenue to be around $355 million.
Competitors New Relic and Splunk (SPLK) have P/S ratios of 6.3 and 7.9, respectively, and I could easily see Datadog reach a ratio of 15 or maybe even 20 on the high end. What we do know is that the company is looking to price its shares in the $19-22 range which, at 24 million planned shares, values the company in the $456-528 million. Investors should aim to secure stock when the company is valued in that wide range and prepare to hold it over the long term. Even at the higher end of that range, Datadog could still be a good investment given its good potential.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.