I feel a bit frustrated and quite excited with Datadog’s earnings. Not because of the result, or because of the market reaction, but because I feel like some of the trends might be being missed. Datadog met my expectations for top line growth, and management comments have given me great confidence that the days of very high growth are still ahead of us.
If you are someone who feels disenchanted by Datadog’s Q3 report, I encourage you to think again.
I have seen a few comments about Datadog’s ‘deceleration’ and I am wondering if it’s me, or seemingly everybody else, who might be looking at this wrong! What deceleration…
Datadog’s underlying growth rate is accelerating here, in my opinion. Let me explain.
Two months ago I posted:
“My worst case Q3 result would be $150m, which would represent +7% sequential increase or +56% year on year, and best case $161m (+15% sequentially, +68% year on year). Anything in this range would beat management guidance.”
https://discussion.fool.com/so-most-of-this-has-already-been-tou…
Datadog have just reported $155m, right bang in the middle of my best and worst case range. In other words, ‘par for the course’.
So the top line revenue growth was, for me, as per (my) expectations.
I had then followed up with a post on the same thread saying:
"We have to consider that Datadog might grow +15% sequentially, which would be a return to its pre-covid growth rate and a big beat (to my mind), but that would ‘only’ be +68% YoY. How would the market perceive that? Equally a flat sequential growth rate of 7% would be in fact maintaining its growth rate but might be construed as deceleration by the market. A few more quarters of simply maintaining its new growth rate and up against a tough Q1 comparative, Datadog would go from a 87% grower to a 31% grower in a year. Or at the ‘best case’ 15% sequential increase each quarter, in Q221 this would ‘only’ be a 62% grower YOY. Datadog has been awarded a high multiple because of its perceived dominance of its market. But how quickly will the market’s perception change if Datadog growth ‘perceptibly’ changes YoY, and what will happen to its multiple then."
Again, the market reaction in after hours, as per expectations. Perhaps the scenario above is now playing out. Datadog’s ‘high’ relative valuation demands a higher level of growth, and underlying trends are overlooked in favour of the headline TTM YoY number. But I think the market might be missing something obvious.
The key here for me is Datadog’s sequential growth, which has in fact been accelerative in Q3. I have been told on a separate platform that sequential growth isn’t a relevant metric to look at here, because it doesn’t take into account contract timings, seasonality etc. I would argue that actually, it’s imperative to look at sequential growth for Datadog’s usage based model, because this tells you what the underlying growth rate of the business is. I also don’t think seasonality is a significant factor for Datadog, and actually if anything looking at prior year trends Q3 would be ‘seasonally’ weaker for Datadog than Q2 for instance. Datadog’s revenue is predictable, as management has often expressed.
Growth rate vs YoY growth
While the TTM (Trailing Twelve Months) YoY revenue growth decelerates, the NTM (Next Twelve Months) growth is accelerating. YoY growth will follow sequential growth eventually. Let me explain:
Revenue Growth
YoY% QoQ%
Q219 82% +19%
Q319 88% +15%
Q419 84% +19%
Q120 87% +15%
**Q220 68% +7%**
**Q320 61% +11%**
Now let’s compare it to the Enterprise customer (spend >$100k ARR) growth that I called out in my Q2 post, populated to Q3. Can you see the trend here?
YoY% QoQ%
Q219 89% +17%
Q319 93% +22%
Q419 89% +18%
Q120 89% +12%
**Q220 71% +6%**
**Q320 52$ +9%**
Datadog have just added 1000 new customers in Q3, up from 600 in Q2. The trend of Enterprise customer spend is usage based.
So what is Datadog’s underlying YoY growth rate, forward looking NTM?
+11% QoQ growth is still below the sequential growth of quarters in the prior year (hence the lower TTM YoY %), so the run-rate is not back at full throttle yet. Worst case, if we assume that 11% sequential acceleration was not incremental each period but phased flat through the quarter, annualised this represents a +52% YoY underlying NTM growth rate.
If we can assume it was accelerative each period, as management comments suggest, then we might infer that the +7% sequential rate in Q2 then +11% rate in Q3 will continue to accelerate to +15% in Q4 and so on. A 15% sequential growth rate is +75% YoY, annualised. +19% sequential growth is +101% YoY, annualised. This is why it’s important to understand what the run-rate is month by month, as best as we can.
In a nutshell, Datadog has accelerated it’s forward looking YoY growth rate from 31% in Q1 to 52% in Q2.
Management comments and Usage
Management in the Q2 earnings call, speaking in August:
We saw over the last month a notable improvement in usage growth relative to Q2, driven by broad-based strength across our customer base…. To put it plainly, customers with large cloud deals from AWS, Azure or GCP look for short-term savings. Note that this is not a new motion as we see many enterprises go through these optimization exercises on a regular basis. What was unusual this quarter was to see a large number of companies going through it at the same time.
The story appears to be holding up now for Datadog. The company’s usage was impacted through these ‘optimisation’ exercises in Q2, and has recovered through Q3.
In the Q3 earnings call, Oliver Pomel CEO:
Throughout the quarter, usage growth of existing customers was robust, which was a return to more normalized levels after slower usage expansion in Q2. To be more specific, the pace of usage growth in Q3 was broadly in line with pre-COVID historical levels. As a result, we feel comfortable that some of the rationalized cloud usage from our larger customer that we’ve seen in Q2 was transitory, as many of those customers have now returned to steady growth from multiple consecutive months.
David Obstler, CFO
After some pressure seen in Q2 driven by optimization efforts from larger customers that scale in the cloud, Q3 was characterized by a decisive return to more normalized growth from our existing customers.The trend was broad based and sustained throughout the quarter. This provides us with confidence that what we experienced in Q2 was a transitory optimization effort that were related to the challenging macro environment. Recall that we have a ratable SaaS model, therefore while Q3 usage growth was back to pre-COVID levels, the pressure experienced in Q2 can still be seen in our year-over-year comparisons for a number of quarters.… Usage growth was strong as companies are prioritizing cloud migration and digital transformation more than ever and we continue to execute at a high level.
This is ALL we need to know about Datadog’s usage growth!!! Q2 was a usage blip due to these optimisations and during Q3 the usage PACE OF GROWTH is returning to pre-pandemic levels
(we can infer 16-19% sequentially). THIS is why sequential growth is important here. Management is telling everybody exactly how it is!
Looking into Q4
Azure and Google Cloud
Analyst:
In terms of the timing of the ramp of the partnerships not only for Azure, but also what you announced with Google as well. How should we think of the timing of that flowing into revenue?
Olivier Pomel — Chief Executive Officer and Co-Founder
It’s not going to be immediate, all right. So the Azure one is just in preview right now. It’s not completely live yet. The GCP partnership involves a number of new technical things need to happen, but also some new go-to-market motions we’re putting in place. So there’s not going to be an immediate impact, but we see that as being potentially meaningful contributed in the mid to long term.
So without the new revenue contribution from Google Cloud or Azure in the near term, what might Datadog’s growth look like in Q4?
Datadog revenue beat vs management guidance:
Q319 +13%!!!
Q419 +12%!!!
Q120 +11%!!!
Q220 +4%
Q320 +8%
Going into Q4, Datadog have just guided for +6% sequential growth. If we assume Datadog will beat this guidance by its average beat of 10% (now its pace of growth is back to pre-pandemic levels), Datadog might be expected to hit $179m in Q4. This would represent +16% sequential growth, or an underlying NTM growth rate of +81%. In two quarters Datadog’s NTM growth rate will have gone from 31% to 81% (!!), while it’s TTM growth rate decelerates from 68% to 58% over the same period (due to Q2’s potential one-off usage blip). I don’t think this is an unrealistic expectation at all.
In this scenario, the market might only be looking at 58% YoY growth (TTM) in Q4 from its 61% growth this quarter, and assume continued deceleration. Silly market! In this scenario, I would then likely add significantly to my position while the underlying NTM trend develops.
It strikes me, for anyone selling shares now, that they are selling because of Datadog’s Q2 report, not their Q3 report. Or did anyone really believe a return to >68% YoY growth was likely in Q3. Datadog was growing from a lower usage run rate because of Q2, it was always likely to decelerate YoY TTM. That’s not a very good tell for its underlying growth rate, in my opinion.
The story is in tact. What we can surmise from Datadog’s Q3 report is that it is accelerating at an underlying forward looking YoY revenue growth of 52%, with good prospects to accelerate this further in coming quarters, perhaps to a NTM growth rate of 75% or above.
The question is now, how much patience will the market reward the company until it’s TTM YoY growth rate catches up with the underlying trend. Is the haircut after hours now redefining expectations for Datadog’s NTM growth. Isn’t the market supposed to be forward looking, not backwards looking? Perhaps we will find out in the coming quarters. I have no intention of missing out, while the market plays catch-up.
I have kept Datadog a smaller position while I expect this catch-up to play out. I fully intend to make this a significant position if the trend plays out in Q4 as expected.
(I had written the following example then decided it was too obvious. But if anyone is interested, how I look at a usage based model):
When looking at a usage based model, it seems important to understand what the usage run-rate is. I like to conceptualise a usage based model like so:
Imagine you have an average customer who uses 100 Terabytes (TB) of data per month on average in Q4 of the prior year. Due to Covid impact, in month/period 1 (P1) of the new financial year this drops to 75TB. In P2, this drops to 70TB of data usage. In P3 the Covid impact is recovering, and the usage is back up to 75TB. In the earnings call, management announces that the usage blip was a one time impact and is recovering towards the end of the quarter.
Therefore in Q1, your customer has used a total of 220TB of data, down 27% from Q4 exit rate. However, your usage run rate has actually increased back up +7% in the final month of the quarter, but all the market cares about is the 27% total decline, and the decline in YoY revenue growth that comes with it. The market sells off.
Fast forward to Q2 of this example, and your usage is working up from Q1 exit rate of 80TB. In P4 your usage is back at the prior year exit rate of 100TB, in P5 the acceleration continues to 125TB, in P6 150TB of data. Your Q2 total usage of 375TB is +70% up from your Q1 usage and +25% up on your Q4 total rate, and YoY revenue growth is now accelerating again. Management had told the market that the usage was recovering in the previous earnings call, but the market was so focused on the YoY revenue growth that they ignored this. The market is playing catch-up on the usage based model.