Well it’s now up 21%. Today! Why be in Motley Fool if you feel that way? David Gardner has always said he wouldn’t buy a stock unless it was being attacked for being overvalued. Every stock in my portfolio is “overvalued” but the portfolio is up about 6 percentage points today. If you want “value” you can buy the IJS, S&P, Dow, Russell, Nasdaq, all of which are down today.
As someone just wrote, Datadog is obviously a “force of nature.”
You know, you can never make a quadruple on a stock if you sell it because it’s up 20%.
I have a small position in DDOG (1% only). I couldn’t add to it because it was too expensive. If it would grow 4x it would be a $45B company. Maybe that will happen. If we look at the Salesforce.com example (the poster child of a successful SaaS company that has grown into a dominant megacap: https://discussion.fool.com/crm-a-case-study-for-saas-companies-… )
then we can see the path that DDOG could take. Ultimately, DDOG will be valued on FCF and growth of FCF.
Starting with revenue growth and gross margins we might get to an estimate of FCF margin. Let’s do some math:
TTM revenue is $310M and the revenue growth rate is 88%. Revenue growth is still accelerating which is very nice. We need to make an assumption on future revenue growth to arrive at revenue. Let’s assume that DDOG can grow 85% (on average) for 5 years. You get TTM revenue of about $6.7B after 5 years. If they grow only 70%, 60%, and 50% on average then the TTM revenue after 5 years would be $4.4B, $3.25B, and $2.35B, respectively.
Gross margins are 76% and have been in the range of 73%-79% for the past 11 quarters (as long as data was available). So let’s assume gross margins are going to stay about the same at around 76%. By comparison, CRM has gross margins in the low 80%s (if I recall correctly). AYX has gross margins of 92%. Gross margin is will be an important determining factor in how high the FCF margin can be. 92% > 83% > 76%.
CRM has had a consistent (more or less) FCF margin of around 21% for many years. AYX is targeting FCF margin of 30-35% at scale. A question is where will DDOG end up at scale. Will it be lower than CRM because it has lower margins? Or will DDOG manage to be operationally more efficient than CRM at scale? With lower gross margins (76% versus 83%), I think it will be a real challenge for DDOG to have FCF margins above 20%. Perhaps someone can argue that DDOG can be more operationally efficient that CRM but I’d love to hear the reasons.
TTM FCF after 5 years:
5yrGr TTMrev FCFmar TTMFCF
85% $6.7B 20% $1.34B
70% $4.4B 20% $0.88B
60% $3.25B 20% $0.65B
50% $2.35B 20% $0.47B
So what multiple on FCF should a company at scale have? Well, if the revenue growth rate is higher then it deserves a higher multiple. Currently, CRM as a TTM FCF multiple of 43 and it’s growing revenue at 25%. The highest FCF multiple CRM ever had was 73 and it was a $4B TTM revenue company growing at around 35% per year. In the rosiest of rosy scenarios can we give DDOG a TTM FCF multiple of 100? It seems high to me but let’s say it manages to grow on average 85% per year for 5 years and then is still growing 60% after 5 years. Seems very high but let’s crunch the numbers:
5yrGr TTMrev FCFmar TTMFCF MktCap Shares Price CAGR FCFmult
85% $6.7B 20% $1.34B $134B 388M $345 54% 100
70% $4.4B 20% $0.88B $88B 388M $226 42% 100
60% $3.25B 20% $0.65B $65B 388M $168 34% 100
50% $2.35B 20% $0.47B $47B 388M $121 25% 100
In the above calculation I have assumed 6% per year share dilution starting with 295M shares today.
Personally, I am skeptical that DDOG will maintain an 85% growth rate average for 5 years. I think, though that 50-70% is a reasonable guess.
I think that FCF margin of 20% is possible.
I think (just my opinion) 100x TTM FCF after 5 years is too rich. Perhaps, if CRM has a 43 multiple and DDOG is still growing revenue twice as fast (around 50%) after 5 years then it might deserve a multiple of 85. This would result in a share price range from $103 to $192 and a CAGR between 21% and 37%.
So what did we learn from doing this exercise (I know there are a lot of assumptions)? Well, even a company like DDOG that is one of the most highly valued SaaS companies in our universe can still achieve an outstanding return going forward. This is not based on EV/Sales but on a multiple of cash flow.
So what are the ingredients for achieving the success that CRM achieved? Why is Saul so willing to pay up for DDOG and ZM? I think he sees their dominance as much more assured than ESTC’s dominance. I also think that he he sees their path to profitability and lots of FCF generation to be a lot more certain (because their already demonstrating it) than the certainly of profitability for ESTC which is still burning a ton of cash (and going in the wrong direction).
I know that I still like AYX the best. I haven’t been able to add to DDOG, but perhaps I need to do more thinking. I think that thinking will involve assessing my certainty of DDOG continuing it’s rapid growth for an extended period and continuing to show increasing operating leverage.
Chris