Listening to management and DDOG

Listening to management and DDOG,

There has been a lot of discussion on our board about the difference between when low guidance is sandbagging or excessive caution, and when low guidance is foretelling bad news,. I thought that a brief discussion of Datadog would be useful.

Their earnings growth last quarter was 68%, down from 87% sequentially. They guided to 50% next quarter saying that they were being very conservative. However a lot of people believed the low guidance.

If you actually read the conference call transcript, you get an entirely different picture. First of all, all the way through, they were talking like an 80% plus growth company that was embarrassed by only growing 68% last quarter.

But more importantly, they clearly described their June quarter. They exlained that in April, the first full month of Covid, their rate of growth was dropping (as customers were in shock and trying to understand and adapt to the pandemic). The low month for growth was May. In June the growth rate was moving back up. The conference call was on August 6th, and they were able to tell us that, in July, the first month of the September quarter, the growth rate had continued to move up from June’s rate. That was all clearly stated.

Let’s look at that a little,. If the average of April, May, and June was 68%, then May, the lowest growth month, had to be below average, below 68%. Thus April and June were likely a bit above average. In other words, June’s growth was above 68%, and they told us July was higher than June.

Given that, how can anyone take seriously an estimate of 50% for the September quarter? Yet I see that some on our board were worried about it, and even the intelligent guy who writes the SSI articles accepted the 50% growth guidance in his recent discussion. I’m sorry but that just makes no sense to me. Didn’t they read the transcript? The company clearly said… Lastly, in July we saw a notable improvement in usage growth compared to Q2, driven by broad-based strength across our customer base…. Back to where we are today, we’re super confident about where we are,…

Does that sound anything remotely like what Alteryx said?

I hope this was of help.

Best,

Saul.

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Such great insight, thanks for posting this Saul. Clearly the details matter, a whole lot!

I’ve continued adding to DDOG and excited for their continued growth.

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“Given that, how can anyone take seriously an estimate of 50% for the September quarter?”

Just thinking through the numbers on this.

The last 5 quarters revenues were:

$83
$96
$113
$131
$140 (+68% from $83M)

We can be fairly sure that if mgmt estimated +50% for next quarter, it is really going to be higher than that. The question is, how much higher. If we assume they can hit 60%, that would be $154M (+$14M sequential). 70% would be $163M (+$23M sequential). Q2 was only +$9M sequential. So, it seams like it’s going to be hard to grow 70% or more vs previous year starting from the low base of $140M Q2 revenue.

I don’t have a prediction - but I am lowering my expectations for Q3 (but still hoping for a pleasant upside surprise).

Long DDOG 2%.

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Hi Analog, I may be wrong. It’s happened before many times. I may be misinterpreting, but how else can you interpret the following?

Lastly, in July we saw a notable improvement in usage growth compared to Q2, driven by broad-based strength across our customer base…

Saul

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Hi Saul,

I’m not saying I think you are wrong - I’m just trying to quantify the level of your “rightness”. The statement from management of “improvement vs. Q2” is kind of vague, so we need to do our best to guestimate what exactly that means. I was just showing the actual numbers in order to help all of us think through the puzzle. The sequential growth in Q2 was only $9M vs. Q1 (if my numbers are correct). So “improvement” vs. that low Q2 number could still be less than the 70% YoY we have seen from them previously.

All I’m saying is that the one bad quarter makes it that much harder for them to reach the YoY growth because they are starting from a lower base. I certainly am not saying I have any clue what they will actually deliver. I’m just pointing out that once they have a low quarter like that, it makes it that much harder to achieve the 70%+ YoY because they have to first make up for the Q2 shortfall.

Still holding - just cautious.

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Hi Saul,

There may be a logical flaw in your post, just because June was moving up from the low of May doesn’t mean it was above average.

I note you said ‘likely above average,’ not definitely, but that may account for how you are seeing this differently than others.

No position at this time, best,

Naj

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There may be a logical flaw in your post, just because June was moving up from the low of May doesn’t mean it was above average.

The logical flaw would be in that June growth was necessarily above 68% and that usage-based growth is equivalent to revenue growth.

Some of the revenue growth comes from signing new customers (NER is only ~130%, so likely that’s where usage-based growth comes in). Also, growth dropping in April could still mean April was far above 68% (say, 80% which is still slower than 87% in Q1), and if the low point in May was still closer to 68% (like 60%), June would only be ~64%, still below average.

But the other issue is that NER was still “> 130%” which is where I understand usage-based growth would come from, so more of the growth deceleration might come from lack of new deals.

I do believe that some of these companies provide guidance just based on historical NER plus already signed or nearly signed deals in the ongoing quarter, which almost entirely eliminates the possibility of missing guidance. Any added business in the rest of the quarter would then be to the upside.

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One small thing that has stood out to me, from DDOG’s CC’s, is their use of the words “efficient”, particularly combined with “capital” and “business model”. On the last call, the CEO used it three times, and, has said it in every CC since they’ve been public. From the last call:

We also continued to be capital efficient with free cash flow of $19 million.

We have a very efficient business model and experience a high return on our investments in sales and marketing and R&D.

We have a highly efficient business model and are making investments across the organization today in order to capitalize on the large opportunity ahead of us.

I’ve tried to learn to be perceptive to these types of things – to read between the lines. It’s a small thing, but also, to me, for them to say that three times in the call, it’s like the CEO and CFO are saying, “hello!! we’re are absolutely running on all cylinders.”

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“Efficient” can mean several things.

My assumption is that they are trying to run lean. My CEO likes to say “spend money as if it’s your own money”. That could be interpreted as “capital efficient”, too. That doesn’t mean they aren’t running on all cylinders, but I’m not sure I agree with your interpretation of “efficient” in this context.

I’m long DDOG. Even if their growth is slowing, it is still outstanding. And the growth, as Saul said, may pick up again (or may have already). I’m comfortable with that investment for now.

Just my 2cents.
1poorguy

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To me, the major point out of DDOG call was that they saw customers trying to be cautious / efficient / reduce waste… whatever the right term was… all at the same time… which reduced usage during the quarter…

I read these as, customers were looking at their overall cloud spend and trying to optimize… they have seen customers do that on a regular basis… and after a round of ooptimization, their cloud usage start climbing back up again… which makes sense as a lot of DDOG customers are in early innings of cloud migration…

What was different in last quarter is that all (most!) customers worked on optimizing at the same time… which makes sense due to pandemic and sense of panic in the economy…

So, with all the other color that Saul added, this above context to me says that they are very likely going to beat next quarter by large enough margin…

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So most of this has already been touched on in this thread, but trying to piece it together to make it easily digestible. And answer the case question what is driving deceleration of Datadog’s revenue growth quarter on quarter, and what does this means for Q3?

First, let’s have a look at Datadog’s revenue growth:


     YoY%   QoQ%
Q219 82%    +19%
Q319 88%    +15%
Q419 84%    +19%
Q120 87%    +15%
Q220 68%    +7%

So what is driving that revenue growth and the slowdown in Q220? Very simply, I view revenue growth as (existing customers - churn) x DBNER + new customers.

New customers: in Q220 Datadog saw ‘robust’ new logo, with total customers up +37% year on year (compared with +40% in Q120). New logo, in itself, is not a significant driver of this slowdown.
DBNER: ‘over 130%’ for a 12th consecutive quarter. Without more detail, it is hard to see usage impact here.

Where does the slowdown show in the numbers then? The key is in the number of Enterprise customers.

Datadog’s Enterprise customer growth:


     YoY%   QoQ%
Q219 89%    +17%
Q319 93%    +22%
Q419 89%    +18%
Q120 89%    +12%
Q220 71%    +6%

There is a clear pattern between the Enterprise customer growth and revenue growth, and so you can generally expect the latter to mirror the first. Enterprise customers are those which have ARR (Annual Recurring Revenue) of >$100,000. In Q220 these customers represented 75% of total Datadog revenue (consistent with Q1 and prior quarters). It is therefore here that the slowdown is happening.

So the natural follow up question is, what is driving these Enterprise customer numbers? In other words, why are fewer companies spending >$100k than what Datadog is used to or can normally expect? From the Q2 earnings call:

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.

I would also note that while these customers are at a greater scale in the cloud, they mostly remain at a low penetration relative to their overall IT environment. Therefore, these customers continue to have a long runway of growth in their cloud adoption over time. Lastly, while we do not want to get into the habit of providing intra-quarter updates, I’d like to provide some commentary on what we saw in July, given the unique macro circumstances. We saw over the last month a notable improvement in usage growth relative to Q2, driven by broad-based strength across our customer base.
It is however too soon to know if this growth will sustain given the macro environment. As a result and while we are encouraged by this trend, we remain prudently conservative in our outlook for the remainder of the year.

So let’s take management at their word. The reduced spending of these Enterprise customers in Q2 is ramping back up to more normal levels. If we can assume the average sequential increase pre-Q2 of about +15%, this would equate to +68% revenue growth year on year in Q3. Management guiding to 50% implies that sequential increase will only be 3% - i.e. another deceleration quarter on quarter. This seems overly prudent given the above, and therefore we can be comfortable that Datadog will beat guidance in Q3.

I do generally think that companies benefiting from the Covid environment will continue to have tailwinds longer and stronger than many expect, and the reverse is true for those with headwinds. But regardless of that, I think it’s clear that Datadog is well placed to beat its guidance in Q3 and benefit long term from the shift to cloud.

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.

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Hi Thinker & Saul,

Thanks for the food for thought. I have been thinking about how to separate the management speak BS from the actual business results. My tendency is to to give less and less credence to what management says and give 90% of the weight to the results (e.g. deceleration of revenue growth).

I sold half of my DDOG position when the quarterly results came out because of this. I think that I was mistaken. So how do we separate management speak BS from facts that support a great business: details. Details separate liars from stand up operators. This is related to the work I have done auditing and qualifying chemical manufacturing facilities. When the operation team offers scant details into my questions, I dig for facts. Liars almost always keep details limited so that (1) they can remember their lie and (2) they can come up with plausible deniability. Larry Page of Google Fame once said that many operations manager’s are “worth their weight in plausible deniability”. I think that’s true for CEOs/CFOs too. I have used my observation of short, terse answers combined with procurement records to ID liars and correct operational deficiencies about a dozen times through the years. I have used this to better Fortune 500 operations (e.g. GE) with great effect.

With AYX, there was always talk of TAM, that there is no significant alternative to AYX products, and how mission critical their software is. Statements tended to be vague and general during the conference call. Problem is that their business results didn’t quite match up with those statements during the pandemic.

DDOG on the other hand, while expensive, does seem to continue to execute. Their story is backed by specific facts on enterprise customers and improving usage growth this quarter.

In the future, I plan take a more nuanced approach to management comments. I am repurchasing the 50% of DDOG that I sold. Thanks for shedding light on DDOGs situation, and how they appear to remain viable. Posts like yours help me to learn and refine my investing.

Best,

bulwnkl

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In the future, I plan take a more nuanced approach to management comments. I am repurchasing the 50% of DDOG that I sold. Thanks for shedding light on DDOGs situation, and how they appear to remain viable. Posts like yours help me to learn and refine my investing.

That’s a really great insight you gave into interpreting management guidance, and offers some more reassurance that we can take Datadog’s management at face value.

However, on reflection I feel I may have been a bit too one-sided. I didn’t mean my suggestion that Datadog is likely going to beat its Q3 guidance to be a recommendation to buy, because 1. I could be wrong and 2. who knows if management comments are already priced in.

There are many reasons why I could be wrong:

The first few weeks of April were very good growth in new logos. New logos remain for the rest of the quarter, but what we saw is toward the end of April and then the full month of May, we had much lower growth.

Perhaps our presupposed usage recovery is either overstated, or substantially offset by deceleration of new logo. Our equally it could be understated by achievement of non-underpinned pipeline.

Analyst: David, I know you don’t guide to billings, but I believe, looking through my notes, next quarter, you have some difficult comps with pretty significant contracts that paid up last 3Q. Any color on that would be super helpful. Thank you.
Sorry. Any issues for 3Q with difficult comps than the year before?

David Obstler – Chief Financial Officer: Yeah. Nothing that we’re pointing out on this call. So nothing that we wanted to point out.

There is something vague about this answer, and perhaps there could be an impact from the loss of some key customers that we haven’t counted in. While I do think Datadog will beat its guidance, I don’t believe it’ll be a big beat. I hope I’m wrong.

“I’ve learned to see a sustained high valuation as a perceived certainty, by the market, of a company’s dominance” (gmcnatt)

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.

You’ll note that Datadog’s revenue is usually very predictable, but in the Q2 earnings call management admitted that there was a lot of ‘noise’ and uncertainty.

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. Equally, I’m not encouraging anyone to sell, I just want to provide a balanced view.

Thinking past Q3

"Given macro uncertainty, we saw these larger customers look to conserve cash where they still could and therefore, optimize the consumption of cloud infrastructure. We see large 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 biggest reliance we are placing on management’s comments is that their usage recovery is genuine. I have faith in that, compared to the April-June period, as this was the height of the outbreak. I can’t see a deceleration in usage from that point, which their guidance implies, which is why I think they’ll beat it. But what happens after?

I have no doubt in my mind that Datadog is an excellent company and an excellent proposition. But what we need to scrutinise is whether this ‘optimisation’ that caused the Q2 slowdown (in other words ‘cost cutting’) is really a one-off. It is ‘unusual’ in comparison to prior quarters, because there was no pandemic in prior quarters.

My concern is that if Datadog was an expendable proposition to its customers at the beginning of Covid, then why would it not be expendable as pressure on cost cutting continues - and it will. I think very, very few companies will be protected completely from this pressure (we had even seen something similar with Fastly in Q2, and many others). How can we place faith that this really was a one-time ‘optimisation’? I am giving Datadog the benefit of the doubt for now, but it is something I will keep an eye on closely for Q3.

Why do I think that? For context I work in finance selling IoT solutions within the ‘Enterprise’ division, spending much of my day trending run rates, churn, new logo/pipeline and usage. We achieve revenue through data usage via a platform, and during the first months of Covid (and lockdown) usage dropped off a cliff and has since recovered to almost the prior year exit rate. Albeit, we are NOT a Datadog. But we are well behind budget and struggling to accelerate usage & new logo due to the macro enviroment. And being behind budget means pressure to cut costs. I am fully ready to admit that my own experience may have skewed my perception here, and to judge Datadog on its own merits. I would welcome that reassurance.

To be quite honest, I would rather not to have to interpret management’s good faith. It seemed obvious Zoom would blow-out Q2 earnings due to having 3 months of positive Covid impact as opposed to 1 month in their blow-out Q1. We would all prefer not to have to second guess a Covid headwind instead. But that’s the reality we are in.

I think Datadog will be just fine long term. I just wanted to provide a more rounded and realistic view here, as in my opinion I don’t think many companies will be unaffected one way or another from Covid. I don’t want my post on Datadog’s Q3 guidance to be interpreted that the growth will reaccelerate to new highs in Q3 and then fly off into the sunset. I don’t think that’s realistic, and that we might need to reassess what Datadog’s ‘high growth’ looks like going forward.

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My concern is that if Datadog was an expendable proposition to its customers at the beginning of Covid, then why would it not be expendable as pressure on cost cutting continues - and it will.

I thought this was in reference to companies identifying servers they were monitoring that they could shutdown and replace the functionality on other servers. Since you pay to observe servers with DataDog, reducing your own infrastructure allows you to reduce what you monitor. I don’t see this as DataDog being expendable, but rather their customers’ infrastructure was optimized and right-sized in a hurry as the pandemic was making things really uncertain in Q2. Getting rid of servers and all associated maintenance doesn’t seem to be a comment on DataDog nor its utility@price.

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Getting rid of servers and all associated maintenance doesn’t seem to be a comment on DataDog nor its utility@price.

Thanks for clarifying on the optimisation. My broader point is more around whether the optimisation and the references to customers ‘short term savings’ or ‘cost cutting’ would be one off in nature, or if continued pressure to cut costs down the line will impact it - for example customers to get rid of more servers that are considered expendable and which impact on Datadog usage.

I think Datadog’s value as a proposition is clear from its growth to date, and that it will do excellently long term. My concern is more around the coming quarters.

I will watch the Q3 earnings very interestedly. For me, anything above 15% sequential growth (+68% YoY) will signal a significant re-acceleration of its usage, and I would likely add in that scenario regardless of how the market reacts. This is where the faith in management comments comes in.

Maybe we have become a bit spoiled with Datadog growing 80-90’s% YoY, and perhaps we should now expect to see it growing in the 50-60’s% for a few quarters at least. This is still very high growth, and the key for me will be to view its growth rate sequentially over this period, to understand its underlying usage impact and to look out for more signs of ‘optimisation’ or customer cost saving. I am certainly hopeful that a company with such panache for beating expectations will have no trouble to beat my own.

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Well, a return to 15% QoQ growth would be amazing. That puts them right on the $162MM mark, too? If they were headed there when they did the call, I think they’d not have lowballed the 50% mark?

I thought this was in reference to companies identifying servers they were monitoring that they could shutdown and replace the functionality on other servers. Since you pay to observe servers with DataDog, reducing your own infrastructure allows you to reduce what you monitor. I don’t see this as DataDog being expendable, but rather their customers’ infrastructure was optimized and right-sized in a hurry as the pandemic was making things really uncertain in Q2. Getting rid of servers and all associated maintenance doesn’t seem to be a comment on DataDog nor its utility@price.

Hi rtichy,
I read it exactly the same way you did.
Saul

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Well, a return to 15% QoQ growth would be amazing. That puts them right on the $162MM mark, too? If they were headed there when they did the call, I think they’d not have lowballed the 50% mark?

I would generally agree with you, and am confident in the range $150-160m, presupposing deceleration of new logo does not offset assumed re-acceleration of usage.

Re lowballing their guidance, I can’t answer that. But perhaps there is a clue in Datadog’s ‘beats’ in previous quarters:

Datadog revenue beat vs management guidance:


Q319 **+13%!!!**
Q419 **+12%!!!**
Q120 **+11%!!!**
Q220 +4%

For a ‘best case’ +15% quarter on quarter revenue growth, we are asking for an +18% beat vs guidance. They have beaten guidance every quarter since IPO, this would be the biggest beat of all. A +12% beat vs guidance which they had consistently done in prior quarters, would fall in the middle of my range (+62% YoY).

Bear in mind, these 12% beats came when Datadog’s revenue was (as management has admitted) very predictable. If Datadog management ‘lowballed’ consistently while their revenue was predictable, why could they not be lowballing now too. Food for thought.

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Bear in mind, these 12% beats came when Datadog’s revenue was (as management has admitted) very predictable. If Datadog management ‘lowballed’ consistently while their revenue was predictable, why could they not be lowballing now too. Food for thought.

‘lowballing’ implies quoting a number lower than they know they will achieve.

I do not think this is the case. Instead DDOG, like several other companies is restricting guidance to what they can see, i.e the business they know is there. However in the transcripts of these companies it is stated or strongly implied that business is improving , getting back to “normal” or better but that given the uncertainties attendant upon Covid CEOs are unwilling to provide guidance concerning the implications of apparently improving conditions because there is no clarity or certainty.

Nevertheless IMHO optimism is barely concealed if not overt. So I surmise there will be a strong beat. Given the circumstances of pent up demand as well as an apparent acceleration of adoption rates for software and cloud services the beat could be significantly stronger than anticipated. But we need to wait and see.

cheers

arnie

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