- Dynatrace's recent resurgence has been compelling.
- Besides its unattractive leverage ratios, other investing factors are improving.
- The market has priced in near-term gains, making the stock frothy to acquire.
- Regardless, I find the overall value proposition compelling if DT can sustain its growth momentum.
- I will be reiterating a Hold rating until the near-term macro headwinds subside.
Dynatrace (NYSE:DT) reported strong growth results last quarter. The thesis for the company to keep dominating in the APM and DevOps space is intact. Favorable market trends like digital transformation and global cloud adoption have helped bolster ARR growth and strong ARR guidance, margins expansion as revenue outpaces cost, and improvement in cash flow as margins improve owner's earnings. I will be reiterating a Hold rating, though I see strong potential for more multiples expansion in the near term as more enterprises adopt DT's solutions.
Demand (Rating: Bullish)
ARR came in strong last quarter at 44% growth y/y. This was mostly driven by new customers and lesser contribution by existing expansion and migration to the new SaaS platform. Going forward, management is guiding for ARR growth of 40% to be driven by demand for its subscription and service offerings.
Dynatrace will continue to record solid growth due to its strong positioning in the expanding DevOps space. Also, the potential to cross-sell new products will drive margins. As a result, I remain bullish on the demand for DT's solutions in the near term.
Business/Financials (Rating: Neutral)
Source: Author (using data from Conference Call)
Dynatrace's leadership in the magic quadrant for APMs is solid. This is also reflected in the strong third-party product reviews. I expect add-ons like the business analytics module and its Logs products to continue to drive expansion. Also, its OpenTelemetry initiative is compelling as this will drive intelligence and the market footprint of its products.
"The ultimate goal of OpenTelemetry is to become the default way that developers and operators capture performance information from their services," said Morgan McLean, Product Manager at Google. "We cannot reach that goal without the support of a strong ecosystem. We are thrilled Dynatrace is a core contributor to OpenTelemetry. The broader community will benefit from its nearly 15 years of experience in automated and distributed tracing for enterprises."
There has been a spike in reviews from companies with $1b+ revenue on Gartner in recent quarters. This might be a leading indicator of its strong positioning with large enterprises.
Its leverage ratios are a concern, though management's guidance was reassuring. Given that its margins and operating cash flow are nearly breakeven, I'm not too worried in the near term. Though, it will undoubtedly drive a huge risk premium for risk-averse equity investors. This means more volatility down the line.
Macro/Competitors (Rating: Neutral)
Source: Author (using data from Conference Call)
The macro-environment is volatile, and there is enough runway to accommodate more competitors in the near term. My biggest concern revolves around its products and financials. Asides missing product functionalities which can be fixed with time, customers think Dynatrace's products are pricey. This also echoes Gartner's sentiment in its APM report. Dynatrace's strengths appear to be in its ease of deployment and implementation in addition to its AI-first approach to DevOps. This will continue to solidify its positioning with large enterprises.
Investors/Valuation (Rating: Neutral)
I find valuation to be expensive at 18x P/S. DT is currently trading close to the average analysts' price target of $35, indicating little upside from here. Regardless, bulls can point to the strong double-digit growth guidance as a factor that will drive multiples dilution. Given the ample market share runway, I will be reiterating my hold rating, while anticipating a dip or correction to acquire some position.
Source: Author (using data from ycharts)
Investors seem to be bullish about Dynatrace. The expanding corona pandemic has taken front and center stage as the biggest macro risk. Given the depth of the interconnection of global supply chains, investors should be worried. Bloomberg has pegged the cost to the global economy at $2.7 trillion.
Baring the bearish prints highlighting the downside effect of the lockup expiration and the huge ownership by PE Thoma Bravo, whose exit execution will increase the supply of DT's shares, other risk factors will be masked by its strong growth factor.
Conclusion (Overall Rating: Hold)
DT is a solid growth play. The fear of the global coronavirus pandemic is the overarching valuation narrative, which will mask other factors in the near term. After the virus has been defeated, investors will have to battle the supply/demand dynamics from the post-lockup period. While its growth factor will continue to be propelled by strong demand among mid and large enterprises, I still find valuation a little pricey at this level. As a result, I will be unwilling to acquire shares at the current valuation.
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