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The last couple of years in the market have seen some significant volatility. It started with the COVID crash in March 2020, which whipsawed into an insane rally through the end of that year to seemingly punish anyone too fearful to buy the dip. Now, those investors who benefitted most from the high growth rally at the end of 2020 have taken a beating in early 2022. A few names worth mentioning are Zoom (NYSE:ZM)(80% off highs), Roku (ROKU) (68% off highs), and Fastly (FSLY) (87% off highs). The baby has been thrown out with the metaphorical bathwater in the high growth space, much in the same way that the rising tide lifted all boats regardless of the validity of the investment thesis in 2020.

Datadog

One of the best-in-class cloud operators I want to take a look at today is Datadog (NYSE:DDOG). The best analogy I've seen to explain what the company does is that they operate a cloud version of the Windows Task Manager but for the entire technology stack of a company.

That's dumbed down, and the company continues to buy/build new features for its clients, but it's good enough to understand it at a basic level. The company operates a monitoring and security platform for company's cloud applications, which is used for event-tracking of enterprise services. The software is compatible across nearly every cloud service and in on-premises servers, and continues to expand its offering to be an all-in-one solution.

Like many other cloud companies, Datadog is looking to ease the transition for companies as they conduct their digital transformation. In this case, companies may have multiple different pieces of software or some home-grown monitoring that doesn't communicate across the enterprise when there are issues. Datadog seeks to solve that by "breaking down silos" and not only enhancing visibility but also predicting issues using commonalities across the customer base like on-premises shared hardware, third-party software, etc.

An interesting case study discussed by Datadog management was Seven.One Entertainment, a Germany company which was able to lower its monitoring costs by 78% after onboarding Datadog software.

Datadog Investor Presentation

Datadog Investor Presentation

Another interesting metric is that 78% of customers now use at least 2 products, up from 72% YOY, 43% use at least four products, up from 22%, and 10% use six or more products, which is up from 3%.

Add that to a >130% net revenue retention rate for 18 straight quarters and those metrics set the stage for an incredibly successful SaaS business.

Datadog Investor Presentation

If you haven't been paying much attention to the market, cloud software has been a huge story, and for good reason. Between high margins, easy onboarding, and the necessity of digitization made abundantly clear by a global pandemic, you couldn't lose investing in the cloud space in 2020. I think this year has shown the importance of digging a little deeper and finding the best-in-class operators, but either way it's a rapidly growing market opportunity. Gartner Peer Insights projects just IT operations management to be a $25B opportunity in 2025.

Datadog Investor Presentation

Generally speaking, these software/tech companies tend to compete with different companies across the business lines. Datadog is no exception, as there is no perfect parallel, but Splunk (NYSE:SPLK) and Dynatrace (NYSE:DT) are decent proxies.

Gartner Peer Insights

Looking above, Datadog has been well reviewed within its industry on Gartner Peer Insights, and carries a similar rating to its competitors mentioned above. Datadog typically competes with Splunk in log management and Dynatrace in application performance monitoring. However, when discussing competition on the most recent earnings call, Co-Founder and CEO Olivier Pomel had this to say:

So, first off all, we don't actually see the competition all that much. So I don't wake up every morning asking myself how are we going to win or whether we're winning. We mostly compete against customers building it themselves or being under-tooled and starting in the cloud without the clear idea what's going on. We do see a few big replacements in every quarter. We've mentioned a few on the call. When that's the case, we - I mean, the ones we mentioned are typically the ones that are upmarket. The reason why we win in those situations is we offer integrated platforms where others don't. We're cloud native where others aren't. And most importantly, we have a lot more usage and adoption from the teams on the ground around our product. So, that's the deployed everywhere, used by everyone saying that I repeat at every call, and that really is what makes us win in the end with customers. And that applies upmarket, that applies down-market, that applies everywhere.

[W]e build a product and a company that serves the whole market, like the whole gamut of potential customers. We think that developers at small companies behave, especially in the cloud, like they behave very much the way as developers in very large enterprises. They have the same tool box. They work the same way largely. And so, we build a product that serves everyone. We do expect to have very large counts of customers in the end. But to your second question, we also see right now a lot of that demand, a lot of the growth is coming from midmarket and large enterprises and also the higher end of the market. And we feel good about that part of the market, like we see it successfully standardize on Datadog. We see it successfully land and expand with us. I think we're growing faster - we're in equivalent size and growing faster than anybody else in the market for that specific part of the market. So, I think we feel good about it. That's a big part of what we do.

That's really the best-case scenario. Looking at it as a green-field opportunity, you don't have to worry as an investor about some of the pricing pain and potentially slower growth that can come with intensely competitive industries. There appears to be plenty of room and Datadog is growing into the field quickly.

Speaking of which, the company's recent results were pretty fantastic. Q4 revenues of $326M were up 84% yoy, the company was GAAP profitable, and drove $250.5M of free cash flow in 2021. Net revenue retention rate remained above 130% and the company is carrying $1.6B on its balance sheet. It's starting to make sense why the company is so expensive. Management has guided for FY2022 for $1.51-1.53B in revenue for 48% growth with high 70's% gross margins and net income of $0.45-0.51 per share.

The company is obviously growing at a blistering pace, but the fact that management is keeping its expenses in check while continuing to maintain a best-in-class net revenue retention rate for existing customers sets it apart. Of course, keep an eye on everyone's favorite technology metric, share-based compensation. The share count rose 3% YOY, with share-based compensation up to $163M in 2021 from $74M in 2020. It's basically a fact of life at this point in the tech space, but it's still worth monitoring.

One additional takeaway from the most recent quarter is the win the company had on the federal government side, which could yield some highly lucrative and sticky contracts.

The goal is really to be able to sell to fully go-to market on the federal side. With the FedRAMP law we had before, we were limited in the number of agencies we could target and we also were limited in number of use cases. We basically could only target Infrastructure Monitoring use cases. We couldn't send logs, APM, things like that. With FedRAMP medium, what we can do is we can sell all of our products and we can pretty much sell to every single civilian agency in the federal government as well as a number of other government agencies that are - local agencies but that take the same or use FedRAMP as the same guidelines for security and compliance. So it really opens up the market. We've seen already some success to-date. We already have as of last quarter a $1 million-plus customer on the federal side on our FedRAMP on OSCAL offer. So we're optimistic, but we still have a lot of building to do on the go-to market there, like it's not necessarily exactly the same go-to market that we're used to.

I just wanted to highlight this as one of many growth vectors the company is pursuing.

Clouded Judgement Substack

Clouded Judgement Substack

Looking below, the market has not punished Datadog like much of the rest of the tech sector. After a significant run-up (the company IPO'ed in 2019 at $26 a share), the company is really treading water, a mere 27% off of its highs.

Finviz

I do own shares of Datadog, and I have continued to buy the company over time. I don't think it's a bargain today, but I don't like to wait anymore for the best companies to become bargains to own them. Quite a bit of the froth has come out of the market, and amid the selloff, Datadog appears to me to be a best-in-class operator trading at a deserved premium that is already profitable and will reward shareholders for many years to come.

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Datadog: Sorting Through The Rubble - Seeking Alpha