Good afternoon, Everyone –
It has been a rough earnings season so I hope you are hanging in there and taking care of your mental health. We’ll get through this rough season just like all the other ones.
I wanted to drop a quick note with some thoughts about DDOG’s latest quarter. I was disappointed in the Q, especially the decreasing number of new customer adds. But Bert Hochfeld just dropped an article on SeekingAlpha with his take on the quarter, which made me reconsider my disappointment. For those that don’t know Bert, he runs the TickerTarget investing service (tickertarget.com). I have been a subscriber of his for years, and his service is by far the best one I’ve used. He also consistently ranks as one of the best analysts on tipranks.com (he’s current number 32 out of 34,641 experts – so he’s in the top .08%). I provide this backdrop just to say that I personally have a lot of faith in his analysis.
Here is the article:
As several very smart board members pointed out, DDOG reported that its new customer additions were slowing. This was (and is) a concerning problem for any company. Bert’s take on this problem was interesting:
“Again, there are observers who look at the net number of new users and conclude that DDOG is losing share or its sales process is broken. The issue is that these observers aren’t just looking in the wrong pew, or the wrong church, but are looking in the wrong diocese. When Datadog started, its tool was primarily sold to small users who wanted an inexpensive way to evaluate the performance of their applications. It was a successful strategy, and the company rapidly sold thousands of users. At this point, the company has a revenue run rate that is greater than $2 billion. Its focus is on enterprise sales, and even within enterprise sales, its focus is on the largest users. The reason for that is that the math mandates finding large customers who can spend millions of dollars on the company’s extensive set of solutions. Any other focus simply will not achieve adequate percentage growth. I can say with some confidence that these days DDOG pays its sales reps not on the number of new accounts they open, but on net new ARR. So focusing on the number of new accounts that Datadog opens in a particular quarter is really of little relevance at this point in the evolution of the company.”
Bert’s article talks in detail about how a better number than new customer adds to focus on for DDOG’s performance is its bookings, which was near a company record. Here are some quotes from the article:
“Datadog’s guidance was what it was. But the rest of its earnings presentation presented a far different picture including a possible inflection in usage trends and a quarter of record new Q2 bookings. Drawing a negative conclusion from the company’s holistic earnings presentation simply flies in the face of the preponderance of the evidence. Neither this company nor its peers can control usage, although I believe that usage will resume its growth trend simply as customers need to measure more workloads and more data. What the company can control, i.e. bookings showed a record trend for the period last quarter … Management said it was too early to call an inflection, and I certainly have no way of doing so independently of what management of this company says about usage. But it seems to me that one can look at some encouraging signs in the numbers themselves. One sign is that bookings, which basically include revenues + the increase in backlog (RPO) were at a record for Q2 and the 2nd highest the company has ever seen. What is happening is that as the ability to optimize usage further wanes, large users in particular, are making longer and larger commitments to Datadog usage and that is what shows up in the RPO balance increase. The data suggest two things: 1) Datadog is not losing share in the observability space but is actually continuing to gain share and 2) Large users, and in particular those hyperscalers who use Datadog as the observability solutions for their own networks, and who are lapping the start of their observability optimization initiatives, are now resuming the growth in their usage. I think this plays out over several quarters there are still macro headwinds and not all large customers will exhibit the same behavior at the same time, But strong bookings growth portends significant revenue growth; about 40% of the company’s revenue growth has been a function of bookings over the prior year.”
Bert’s article also talks about management hinting on the conference call that we may be at an inflection point on optimization (they referred to seeing “green shoots”) but did not want to call it yet (i.e., they are still being overly conservative).
Jamin Ball, who writes the newsletter Clouded Judgement, posted a very interesting chart on DDOG’s net new ARR:
I am not sure how he calculates net new ARR. But, if we assume he’s right, the net new ARR appears to show an inflection point with the low in Q1 ’23 and ARR picking up in the latest reported Q2 ’23. We could definitely use more data, but maybe managements’ hints about inflection were more than just hints …
After the earnings, an analyst at Stifel downgraded DDOG, because he thought NOW and SNOW were better investments. But there was an interesting upgrade by Peter Weed – an analyst at Bernstein:
“Into last Tuesday’s earnings we worried about over-exuberance, and saw it as a possible discount buying opportunity if it came to fruition. It did! And then we encouraged investors to buy the cut, while consensus went the opposite direction, reducing FY24E growth from ~27% pre-earnings to 23.2% as we write this note. Today we lay out the evidence that investors should think GROWTH (not deceleration)! And consensus’ quarterly YoY growth expectations could be off by as much as ~1/2 in 2024, as the company growth may rebound to ~40% or more in a year (before slowing to still heady >30% levels in 2025).”
I don’t think any of us are anticipating a re-acceleration to 40%, which would be huge for the stock price. Peter Weed has a decent ranking on Tipranks so maybe 40% is not so crazy: Peter Weed | Bernstein Stock Analyst - TipRanks.com
In closing, I want to be very clear that I was disappointed in DDOG’s earnings report. I also want to be very clear that decreasing customer additions is bad for any company, not good. I would have loved to have seen accelerating customer additions and record bookings. But my thought is that maybe the future for DDOG is not as bad as the stock market’s reaction.
My investment thesis is still that the pandemic did not create “one hit wonders” that will disappear into obsolete-ness. Rather, the pandemic gave us a peak through a window of who will be the big winners of the future. It just sure feels like the future is taking much longer to get here than I would like!
Thanks for reading and hang in there.
Best,
BTL
@LaneyLawyer
Long DDOG