Datadog (DDOG): A Software Industry Savior?

  Shares of Snowflake Inc. (SNOW), MongoDB Inc. (MDB), and Elastic N.V. (ESTC) rallied sharply in last Tuesday’s premarket trading after Datadog, Inc.’s (DDOG) stronger-than-expected third-quarter earnings report eased fears about consumption-based software companies for the most recent quarter.

SNOW’s shares surged more than 8%, shares of MDB were up nearly 6%, while ESTC shares climbed about 4%. DDOG’s stock surged more than 24% last Tuesday, marking its best day ever. Moreover, the stock has gained more than 22% over the past month and nearly 51% year-to-date.

Mizuho desk-based analyst Jordan Klein called DDOG “clearly one of the most shorted and over-sold names” in all software and among consumption-based players. After Datadog topped expectations with its latest results and outlook, “Other peers like SNOW, MDB and ESTC yet to report should bounce, but also a good sign for AWS and Azure demand trends in my view and broader software,” wrote Klien.

Let’s determine if DDOG is a solid buy now and what the stock’s upbeat earnings report means for other computer-based software companies.

Here are some of the factors that could impact DDOG’s performance in the near term:

Robust Financial Performance in The Last Reported Quarter

For the third quarter that ended September 30, 2023, DDOG, the monitoring and security platform for cloud applications, reported revenue of $547.54 million, beating analysts’ estimate of $524.20 million. This compared to the revenue of $436.53 million in the same quarter of 2022. Its non-GAAP gross profit grew 29.5% year-over-year to $450.87 million.

Datadog continued to grow its customer base and ended the quarter with 3,130 customers worth $100,000 in annual recurring revenue (ARR). This is an increase of 140 customers from the previous quarter and 530 more than the company had a year ago, at the end of September 2022.

The cloud company’s non-GAAP operating income came in at $130.76 million, an increase of 74.7% from the prior year’s quarter. Its non-GAAP net income rose 95.5% year-over-year to $158.46 million. It posted non-GAAP net income per share of $0.45, compared to the consensus estimate of $0.34, and up 95.7% year-over-year.

Furthermore, net cash provided by operating activities increased 82.7% year-over-year to $152.78 million. DDOG’s free cash flow stood at $138.19 million, up 105.9% from the same period last year.

Upbeat Full-Year Guidance

“We were pleased with our execution in the third quarter, with 25% year-over-year revenue growth, robust new logo bookings, and a continued focus on solving our customers' DevSecOps pain points,” said Olivier Pomel, co-founder and CEO of DDOG.

“Companies across all industries and sizes are building cloud applications and services to deliver positive business outcomes, including more users, higher revenue growth, improved productivity, and cost savings. With our unified, cloud-native, end-to-end observability and security platform, Datadog is uniquely positioned to help our customers reach their goals,” added Pomel.

After upbeat third-quarter earnings and confidence in continued business momentum, DDOG raised its revenue and profit view for the full fiscal year 2023. For the full year, the company expects its revenue to be between $2.103 billion and $2.107 billion. Its non-GAAP operating income and non-GAAP net income per share are expected to be in the range of $453-$457 million and $1.52-$1.54, respectively.

DDOG now expects fourth-quarter revenue between $564 million and $568 million. The company’s non-GAAP operating income is anticipated to be between $129 million and $133 million, while its non-GAAP net income per share to be between $0.42 and $0.44.

Impressive Historical Growth

Over the past three years, DDOG’s revenue grew at a CAGR of 55%. Its tangible book value and total assets increased at CAGRs of 16.5% and 25% over the same period, respectively. Also, the company’s levered free cash flow improved at 88% CAGR over the same timeframe.

Positive Recent Developments

On November 8, Datadog expanded a strategic partnership with Google Cloud, which allows Google Cloud customers to proactively observe and secure their cloud-native and hybrid applications within Datadog’s unified platform.

As a part of the extended partnership and integrations, DDOG is one of the first AI/ML observability solution partners for Vertex AI, enabling AI ops teams and developers to monitor, analyze, and optimize the performance of their ML models in production.

Also, on August 3, DDOG announced new AI observability capabilities that assist customers in deploying LLM-based applications to production with confidence and help them troubleshoot health, cost, and accuracy in real-time.

These capabilities include integrations for the end-to-end AI stack: AI Infrastructure and compute, embeddings and data management, model serving and deployment, model layer, and orchestration framework. Datadog’s LLM observability includes model catalog, model performance, and model drift.

Datadog’s CEO Olivier Pomel told analysts on a conference call that “AI-native customers” contributed 2.5% of the company’s annualized revenue during the last reported quarter.

Favorable Analyst Estimates

Analysts expect DDOG’s revenue for the fourth quarter (ending December 2023) to grow 21.1% year-over-year to $568.56 million. The consensus EPS estimate of $0.44 for the ongoing year indicates a 68.6% year-over-year increase. Moreover, the company has surpassed the consensus revenue and EPS estimates in each of the trailing four quarters, which is impressive.

For the fiscal year 2023, Street expects DDOG’s revenue and EPS to grow 25.4% and 56.4% year-over-year to $2.10 billion and $1.53, respectively. In addition, the company’s revenue and EPS for the fiscal year 2024 are expected to increase 22.7% and 14.8% from the previous year to $2.58 billion and $1.76, respectively.

Rating Upgrade

Mark Murphy, an analyst at JPMorgan Chase & Co., upgraded his rating of DDOG to “Overweight” from “Neutral”, stating that the “worst period” of declining revenue growth at the solution solutions group has most likely ended. Also, the analyst bumped up the share price target of the stock to $115 from $90.

What Do DDOG’s Upbeat Earnings Mean for Other Computer-Based Software Firms?

Datadog and other consumption-based software companies, including, Inc.’s (AMZN) AWS, Microsoft Corporation’s (MSFT) Azure, and SNOW, among others, have been grappling with a slowdown in cloud spending by inflation-hit customers.

After COVID-19 prompted companies, governments, and schools to switch to cloud services driven by the surge in work-from-home, several cloud-computing firms enjoyed robust demand. However, when inflation hit last year, the central bank hiked interest rates, and cloud stocks began tumbling as companies responded by scrutinizing their IT spending as they engaged in cost-reduction measures.

Inflation has declined sharply from its 2022 peak, with the Consumer Price Index (CPI) showing further signs of easing in October. The core CPI, excluding volatile food and energy prices, increased 0.2% for the month and 4% year-over-year, against the forecast of 0.3% and 4.1%, respectively. The annual level was the lowest in nearly two years and down from 4.1% in September.

With these positive developments, cloud infrastructure providers indicated last month that some organizations’ cost-cutting efforts have begun to wane. Datadog’s Pomel also validated this observation, saying optimization activity among the company’s clients could be easing.

“Overall, we continue to see impact from optimization in our business, but we believe that the intensity and breadth of optimization we’ve experienced in recent quarters is moderating,” he said.

DDOG’s significant surge last week, following its upbeat earnings and optimistic guidance, also buoyed other cloud-computing names, including SNOW, MDB, and ESTC.

As per the latest forecast from Gartner, global end-user spending on public cloud is expected to rise by 20.4% to a total of $678.80 billion in 2024, an increase from $563.60 billion in 2023. Growing business needs and emerging technologies like GenAI drive cloud model innovation.

Bottom Line

DDOG, the data analytics platform provider, beat third-quarter Wall Street’s expectations for earnings and revenue. Further, the cloud company raised its full fiscal year 2023 guidance on third-quarter upside and expected continued business momentum.

Due to reduced IT spending by inflation-hit clients, Datadog’s revenue growth slowed from 83% in early 2022 to 25% now. However, this slowdown will likely “moderate and level out,” driven by the recovery in companies’ cloud spending, benefitting DDOG significantly. The company is well-positioned to serve its customers effectively with its unified, cloud-native, end-to-end observability and security platform.

According to Alex Zukin of Wolfe Research, DDOG has the potential to become the “fastest-growing software company” amid the AI boom. Datadog’s platform can offer advanced predictive analytics and intelligent alerting by leveraging new AI and ML capabilities.

Given DDOG’s solid financials, accelerating profitability, and bright growth outlook, it could be wise to consider investing in this software stock.