Datadog Inventory: Appears Like A Promote (NASDAQ: DDOG)

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Introduction and Thesis

Datadog (DDOG) has been one of many hottest shares within the inventory market. The corporate’s inventory worth has seen large progress all through 2021. Nevertheless, the optimistic pattern began to vary in the direction of the tip of the yr, and I consider this destructive worth motion pattern will persist all through all through 2022.

Datadog has been rewarded with share worth progress as a result of its sturdy fundamentals and monetary efficiency bringing extraordinarily excessive valuations. In a world the place using information is changing into a close to necessity, Datadog has continued to ship distinctive providers that drive each operational effectivity and income progress. All the things concerning the firm pointed to a brighter future prospect, aside from its valuation. As a consequence of large optimism for the way forward for the corporate, the valuation has reached an unreasonable degree, making the risk-return facet of the funding unfavorable. Moreover, because the Federal Reserve heads right into a contractionary coverage via 2022, I consider the present lofty valuation will see a correction. Due to this fact, I believe Datadog is a promote right now primarily as a result of its valuation metrics.

Fundamentals

Apart from Datadog’s valuation, the corporate’s funding thesis appears close to excellent. The underlying elementary thesis strengthens over time as the corporate’s progress exhibits sturdy steady sequential enchancment.

It is vital to notice that Datadog continues to be within the early levels of progress, which suggests the corporate is primarily targeted on progress reasonably than profitability and effectivity. Thus, the potential for dramatic enchancment in operational effectivity after this preliminary section of progress was measured by the online greenback retention charge and the variety of clients utilizing a number of merchandise. the the online greenback retention charge has exceeded 130% over the past 16 quarters whereas the uncooked retention charge has reached the center of 90%, which exhibits sturdy demand and product stickiness.

Gross retention rate TTM

https://buyers.datadoghq.com/static-files/e0597c76-5970-453b-88ee-b862d2f4a68a

[Source]

Moreover, via product growth, Datadog up-sell and cross-sell their product, unlocking extra potentials. By continued funding in R&D, Datadog has accelerated the event of latest merchandise, together with safety, log administration, and consumer expertise monitoring, as seen within the first picture beneath. In the end, the innovation led to a dramatic enhance within the variety of clients utilizing a mess of Datadog merchandise proving two issues. First, Datadog’s providers are in excessive demand. Second, as soon as Datadog begins to deal with profitability, working margins can be extraordinarily excessive as a result of potential operational efficiencies that may be achieved from the SaaS enterprise mannequin with a mess of product choices.

The Datadog Innovation Story

https://buyers.datadoghq.com/static-files/e0597c76-5970-453b-88ee-b862d2f4a68a

[Source]
Number of customers using more than one product

https://buyers.datadoghq.com/static-files/e0597c76-5970-453b-88ee-b862d2f4a68a

[Source]

finance

Datadog monetary efficiency is robust sufficient too. The corporate reported income progress of 75% to $270 million whereas working at near-break-even ranges. GAAP web loss was $4.9 million whereas non-GAAP web earnings was $44 million. The variance was primarily as a result of stock-based compensation, SBC, of ​​roughly $44 million. Nevertheless, outdoors of SBC, the corporate has proven sturdy income progress with continued operation near break-even.

The corporate’s steadiness sheet was additionally fairly sturdy. Datadog had whole money and short-term investments of roughly $1.47 billion with whole property of roughly $2.2 billion, and the corporate had whole liabilities of roughly $1.24 billion. billion, together with roughly $734 million in long-term debt. Given the overall liabilities to property (L/A) ratio of round 56.4% and manageable debt given near breakeven trades and an enormous pile of money, I believe well being the corporate’s monetary place is able to supporting the longer term operations and goals of the corporate.

Total, Datadog’s relevance is anticipated to develop as the necessity for this software program is simply anticipated to extend, which can be adopted by optimistic monetary efficiency.

Valuation and stock-based compensation

Behind this wall of optimistic components that bolster investor sentiment towards Datadog, questionable stock-based compensation (SBC) practices and valuation ranges make an funding in Datadog unfavorable right now.

CCS

Beginning with SBC, the brand new public corporations elevated SBC justifying its actions citing expertise retention. These tech corporations, together with Datadog, have diluted their shareholders to excessive ranges for progress causes, and I believe the rise in Datadog’s SBC, each comparatively and completely, is a priority.

In Q1 2021, Datadog’s SBC was $28.86 million. Then, within the second quarter of 2021, the SBC elevated by 20% sequentially to roughly $34.5 million, and within the third quarter of 2021, the SBC additional elevated by 27.5% sequentially to roughly $44 million. Relative to income, SBC accounted for 14.5% of income in Q1 2021, 14.7% in Q2 2021, and 16.3% in Q3 2021, exhibiting that SBC progress matches progress in enterprise earnings.

Expertise retention in right now’s market might be important, and tens of hundreds of thousands of {dollars} in SBCs relative to Datadog’s whole market cap might be low; nonetheless, I believe SBC rising quicker than earnings present is a transparent warning signal for buyers.

Analysis

The primary cause for my destructive views on Datadog comes from its excessive valuation. The corporate has a market ccapitalization of round $45 billion with a price-to-sales ratio of round 51x. To iterate, the corporate trades at 51x earnings whereasWe repeatedly anticipate near break-even operations. I simply suppose that this degree of valuation, regardless of future potential and present progress, is absurd. Even the two-year ahead P/E ratio sits at round 255x. The anticipated future return will merely be too low at this degree. For instance, assuming the corporate experiences income of $2.2 billion with gross margins round 30%, which is on the excessive finish of the estimate, for fiscal yr 2023 the corporate will commerce nonetheless at round 65 instances its earnings. Given present market situations, I believe it is solely a matter of time earlier than buyers notice that huge corporations can have dangerous shares.

The excessive valuation downside has worsened in current weeks because the Federal Reserve has begun to trace that it’s going to change course in its financial coverage. Because the begin of the pandemic, the Federal Reserve has been implementing an expansionary coverage with large quantitative easing and traditionally low rates of interest bringing M2 to an all-time excessive justifying some excessive valuation ranges. Merely, there was an excessive amount of cash in circulation with low rates of interest resulting in a focus of capital within the inventory market resulting in a better valuation. Nevertheless, the Federal Reserve is anticipated to finish the minimize by March and probably begin elevating charges as early as March to struggle inflation. The Federal Reserve went even additional by asserting that it supposed to shrink its steadiness sheets, warning that it might start to scale back the circulation of money that has pushed increased valuations. Due to this fact, given these macro situations, I believe Datadog’s inventory seeing a correction is simply a matter of time.

Dangers for the thesis

Datadog advantages from two large secular developments. A transfer to the cloud and demand for information utilization has pushed progress and robust fundamentals. Moreover, since SaaS corporations usually obtain a better valuation than their friends, Datadog’s inventory could by no means see a correction. The mixture of useful underlying developments and robust progress could also be sufficient to beat the excessive valuation.

Abstract

Datadog is undoubtedly a fantastic firm with big potential. The enterprise will solely turn into extra vital and related to companies. Nevertheless, valuation and SBC should be addressed. SBC by way of income continues to develop to dilute shareholder worth whereas the upcoming shift in macro metrics is anticipated to place stress on excessive worth corporations. Due to this fact, I believe Datadog is an ideal instance of an enormous firm and dangerous inventory. Regardless of wonderful and bettering fundamentals, I believe Datadog is a promote primarily as a result of its excessive valuation.

About Edith J.

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