Elastic Completes Acquisition Of Endgame

About 2 quarters early. As I recall this wasn’t expected to complete until April 2020.

One of my highest conviction stocks just got an even more powerful software stack.

Adds about $23-25M in annual revenue. But I believe the long term is to eliminate as a stand-alone product and roll into the Elastic stack for proprietary and hosted.

Big announcement event Oct 15.

https://ir.elastic.co/file/Index?KeyFile=400177650

Darth

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Darth,
I have a very large sized investment in Elastic as well. I am finding that DDOG is competing with Elastic in the logging and APM markets. Market clearly believes DDOG to be a much better company as it has awarded it a P/S of 39 vs just 21 for ESTC. DDOG has had rapidly falling rev growth rates (98% in 2018 and 79% in the first 6 months of 2019) while ESTC has been at about 65%+ last year and could do 60% this year. So, growth differential not very different. Also consider that ESTC has reported several Qs already and has gone through all the share lock up issues that DDOG will have to go through. DDOG appears to have a better balance sheet but not sure if that alone would warrant such a valuation premium… What is your take on the competitive dynamics between ESTC and DDOG?

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Texmex,

The market had not Decided that DDog is better. It has decided that it thinks DDog stock well go higher. This is not the same thing.

Gordon

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Elastic had a P/S of 35 or 36 when it came out of IPO as well.

I believe Elastic is undervalued in relation to their fundamentals and market opportunity. I do not think the same for DataDog, they are either neutral or maybe slightly over valued. So I would prefer Elastic at this point in time.

Yes they have overlap. A year ago I would have said that DataDog had a more mature offering for Enterprise in this space. Elastic has surpassed them now with offerings under a single pane of glass. Having added SEIM and soon Endpoint security.

Elastic also has the advantage of such a large base using and experimenting with the product and one click deployment to the cloud. These companies are already using Elastic for the use cases that DataDog serves. Cloud SaaS should grow at 100% or perhaps more this coming quarter for Elastic at roughly $20M. It’s a product that really has rapidly matured as an offering over the last year.

One of the key ingredients for our success over the past two years is multiple expansion. Stock market going from a P/S of 15 to 25. Combined with high growth. DataDog is a great company with a very favorable product. In the interest of stock appreciation, I think they have limited upside for at least some time. While several factors, some of which you mention, indicate
Elastic could appreciate. At least they have had little of the big drops lately. They are roughly where they were when the market slide started.

One item of note for Elastic and DataDog. DataDog uses Elastic as a core part of their infrastructure. Probably open source.

They started with Postgres, but as their needs grew, they moved to Elasticsearch, which is now a core component of their infrastructure, indexing vast numbers of events every second.

The way it looks, DataDog uses Elastic to index and analyze the “events” or logs. So essentially they are using it as the search engine function. DataDog is mostly a UI built on the Elastic foundation. I don’t believe DataDog has much CAP for this reason. That doesn’t mean they don’t have a great product that is selling great.

Darth

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this is a good discussion, trying to understand differences among ESTC and DDOG.

Couple of points I noticed that are different among these two companies.

  1. On a similar revenue base, DDOG seems to be able to break even / lose less cash compared to ESTC burning ~10% of revenue. This is a big plus for DDOG in today’s market environment.

  2. ESTC seems to have a scalable base of Elastic search, growing number of use cases that are structural for data management (not just monitoring) and also a strategy to leverage open source community…
    While DDOG is developer focused, not sure if it has same leverage of open source community… Also, while DDOG seems to have better adoption of its suite of products, they are related to performance monitoring vs diverse use cases of ESTC suite.

It is right to think that ESTC may have much higher ceiling to grow revenue vs DDOG will be limited to IT monitoring?

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Darth,
I agree with your valuation comments about ESTC and DDOG. However, the following comment concerns me a little.

The way it looks, DataDog uses Elastic to index and analyze the “events” or logs. So essentially they are using it as the search engine function.

Agreed, ESTC is the king of search. So, DDOG uses the free open source version of ESTC and creates a bigger company than ESTC (at least by mcap) and ESTC cannot make any money out of it. The way DDOG is using ESTC is pretty mission critical and still it is not paying a penny.
If I recall I have heard Shay say that ESTC observes how developers are building on ESTC and then buys them out (kibana’s history if I am not mistaken, and end point). Looks like this one got away.

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Here is an older video that talks about how DDOG uses ESTC:

https://www.elastic.co/elasticon/conf/2017/sf/elastic-at-dat…

I would venture to guess that if their elastic deployment is in production, they are likely a paying subscriber of elastic (although I do not know that for sure). I think there is a common misconception: open source is not necessarily free. Sure you don’t have to pay to get your stuff running on elastic. But at some point, if you have some significant volume/processing of data in elastic in production, you are likely to subscribe as a paying customer to elastic (even if you self host elastic yourself) at some point in the future. It’s a minuscule investment for an opportunity to have elastic work along with you to help/guide you to effectively/efficiently grow your business using their products.

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It was interesting to see that one DataDog’s technical writers wrote up about the use of Elastic monitoring features “with or without” usage of DataDog. it is clear that the partnership is deep so it is reasonable to expect that ESTC are making their fair share on usage of their platform. I wonder if this would be an appropriate question to ask their IR

Though it leans heavily technical there is an interesting write up on the coinbase blog regarding their use of Datadog and Elastic.

Based on our challenges self-managing Elasticsearch combined with our short experiments at developing a reliable blue-green deploy strategy for Prometheus backends influenced our decision to choose a managed service for our metrics provider. After evaluating several providers, we settled on Datadog.

“Logs, metrics, and the evolution of observability at Coinbase” by Luke Demi https://link.medium.com/vM4ZKmDuF0

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I would venture to guess that if their elastic deployment is in production, they are likely a paying subscriber of elastic (although I do not know that for sure).

I do hope so. This link is pretty long but doesnt list DDOG - https://www.elastic.co/customers/. Anyway, I have not sold any of ESTC stock and management sounded really confident on the call. So, don’t see a need to make any adjustments as of now. But it still it is kind of weird that DDOG uses Elastic for search in a big way and still competes with it in other areas. Btw all the Roku discussions here and positive analysis by needham and others made me take a small position in it with some good results so far.

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It’s certainly possible that DataDog pays Elastic but I think it’s unlikely. A lot of modern software is built on a variety of open source components stitched together with a few add ons or an application interface to create a new proprietary product.

We could spend a lot of time on DataDog/Elastic infrastructure make up. Elastic is definitely mission critical to the core function of the DataDog SaaS applications. DataDog has other important pieces to their platform namely the DataDog agent that gets installed on the endpoints to ship to the Elastic servers. That is part of their CAP. With others in the space, I feel the UI and collector agents present a smaller CAP than having the more powerful indexing and searching function proprietary to you(and under your control).

On the other hand, having competitors have access to your core would be the bear case to that CAP. I think this and that Coinbase case are good examples of both the bull and bear cases.

Elastic is the undisputed leader for indexing, searching, and logging. Coinbase starts with Elastic clusters and x-pack. Started with open source, but they need the field and document level security features and support. Data explodes (like it is for everyone but especially them all at once). Self managing is becoming a bear and since they don’t really have the resources and know how to deploy it correctly, performance suffers. They purchase DataDog to gain visibility into Elastic, ironically using Elastic to log and monitor Elastic with a different viewing glass.

Discovering their problems and limitations they make the wise choice to host the solution. This was about a year or more ago. Elastic’s own hosted service was much smaller and less differentiated than it is today. It’s actually quite amazing how it has changed in just a year. They go with AWS Elasticsearch Service, getting the most basic version of Elastic. They mention they liked that it was in Amazon market place and AWS unified billing, both of which Elastic now has. Solves some of their problems and opens up others. Namely they don’t have the proprietary field and document level security features. They work around that by creating more clusters where they can control access by managing the higher level access to the cluster(doesn’t seem very practical and the only other option Search Guard is effectively off the table now).

This type of thing is occurring at thousands of organizations every day. Open source experimenting. Oh man this thing is really great. Holy cow it’s getting out of hand with all the data we generate and we are using it for so much of our critical uses. Now what?

Elastic is pursuing a strategy of differentiating their Hosted service go a point that the competitor services are laughably under served. If successful the payoff should be huge. AWS Elasticsearch Service was a huge success for AWS growing quite large very quickly because of the reasons we see here. The need to go hosted. But Elastic’s own service will get the bigger share of that going forward I believe. And that’s the investment thesis.

Another great case study is BPCE, France’s second largest financial institution. Which was mentioned in latest call. They now have deployed on Elastic Cloud Enterprise, which is Elasticsearch Service Hosted on Private Cloud instead of the public options. In this study they were a platinum subscriber and mention they intend to go ECE, which they did.

https://www.elastic.co/customers/bpce

Darth

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Not related to DDOG but another complaint about its version of Elastic search. Has to be a positive for ESTC.

https://spun.io/2019/10/10/aws-elasticsearch-a-fundamentally…

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Unlike Mongo stock that initially had a crash when AWS tried to replicate it (and only later eventually conceded) Elastic never crashed on AWS news. This example is a good reason why. The issue that still remains is why has Elastic well underperformed since then?

Datadog, other competitors, worry about who will and who will not pay Elastic for the service (Datadog probably pays Elastic nothing despite its entire product based on Elastic as its core offering).

I don’t know the answer. Last earnings call was great. Business doing extremely well. Perhaps there is fear that revenue growth will slow sub 50%.

I have no greater insight though. Be great if someone did.

Tinker

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Underperform is a relative term now I believe. More like underperforming not as badly as our other stocks.

On a 6 month comparison they are outperforming most of our cohort. In that they are slightly positive. Whereas most, not all (looking at you AYX and ROKU), are down over 6 months.

In relation to 52 week high, also better off.

P/S has contracted with everyone else. They started at 35 out of the gate. Most of our other companies started in the mid teens. ESTC at about 22 is in line or valued higher than most now.

Again going with the theme of multiple expansion is how we’ve gotten the best returns. Investing in ESTC earlier this year or late last year hasn’t had much return. But it’s not crashed like others either: contracted entirely by revenue growth. working with the guidance Elastic could very well accelerate already high growth overall and for SaaS in the next 2 quarters. Could that finally trigger some expansion?

Darth

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the open source paradox
https://community.cadence.com/cadence_blogs_8/b/breakfast-by… .

There is a big paradox about open source though. It is clearly the most effective method of developing software. As Eric Raymond famously said, “given enough eyeballs, all bugs are shallow”. His book The Cathedral and the Bazaar is still one of the best books on open source, a term which was actually coined by him…
.The open-source paradox is that once the source code is open source, available to anyone, there is not a good business model to pay for the developers .
Open source suffers from another major weaknesses. It only seems to work when it is not necessary to have a spec of the product, which happens only when the developers are also its users.

If the world is being eaten by software, large portions are being eaten by the cloud and by open source.
How to be open source and attract developers and train users while still making money with the paid part is a tricky road to navigate. It’s all so new , and really so revolutionary that the answer may be hard to find for many companies. Who would have thought 100 years ago that so many complex products would be developed and be made available for free? The worlds of software and hardware are different but the real can opener allowing this collaboration has been the Internet. Perhaps the greatest invention of the 20th century.

As investors we need to try to look for situations or policies that allows good open source products to be monetized. Lots of users wanting just enough more than they can get for free, wanting just enough more to fork out money for the paid version. The best way to see this is in corporate revenue but of course everybody else can see it by then.

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