Datadog's (DDOG 7.79%) first earnings report after its initial public offering in September didn't disappoint investors, to say the least. The cloud-based monitoring and analytics vendor released third-quarter results last week that were above ambitious expectations, and it's likely to outperform its market over the medium term.
Given these positive developments, the company's market capitalization increased by more than $1.9 billion overnight, which suggests investors expect Datadog to deliver stellar results over the long term without pricing any risk.
Impressive third-quarter results
During the third quarter, Datadog posted revenue of $95.9 million, up 87.8% year over year and way above analysts' expectations of $87.73 million. This performance represents a solid acceleration compared to the first-half strong revenue growth of 79.5%.
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Taking into account the midpoint of next-quarter revenue guidance, the company's lower year-over-year expected revenue growth of 65.6% remains outstanding compared to the forecasted growth of its markets.
For instance, a study estimates the market for application performance management (granular monitoring of applications) will grow annually by 11.84% over the next several years. And the IT infrastructure monitoring market, which consists of monitoring and analyzing IT infrastructure components such as servers and network devices, is forecasted to grow annually by 6.6%, according to another study.
During the earnings call, Datadog CEO Olivier Pomel explained that the company's outperformance was mostly due to the opportunities the growing cloud computing market represents:
So the business is still mostly greenfield and it's mostly net new and it's mostly cloud environments, which by definition are new for our customers. ... When you talk about large customers and large enterprise customers, they have existing solutions for their legacy environments, but they make new decisions for the cloud environment. We do see also a few competitive displacement, but that's not the majority of what we do.
Also, Datadog's offering differentiates from other cloud-based monitoring and analytics vendors that could profit from that tailwind. For instance, Datadog competitor New Relic (NEWR +0.00%) offers flexible and programmable monitoring and analytics capabilities. But, in contrast with Datadog's simpler solutions, New Relics' advanced features involve a steeper learning curve and require consultancy or professional services, which may explain a part of the much slower 26.9% revenue growth New Relic posted during its latest quarter.
Medium-term tailwinds
Management gave its guidance for the next quarter only, but I expect Datadog's strong performance to continue over the medium term. Besides the tailwind from the growing cloud computing market, a couple of positive developments should support the company's revenue growth over the next several quarters.
During the earnings call, Pomel mentioned Datadog wasn't yet charging its customers for using the new products it announced at its Dash conference in July this year. These new features include server-less and mobile monitoring capabilities, for instance. And given the company's high retention rate above 130%, which indicates existing customers have been increasing their consumption of Datadog's products, cross-selling opportunities are likely to contribute to the revenue growth when the company decides to charge for its new products.
Also, the CEO confirmed the process of achieving FedRAMP certification, which would expand the company's addressable market to U.S. federal departments and agencies. The $10 billion Department of Defense's cloud contract shows the large potential market these U.S. federal entities represent when they consider using more cloud-based services.
Investors don't price any risk
Given its impressive revenue growth and its strong potential over the medium term, the company's market capitalization increased by more than $1.9 billion (from $10.1 billion to $12.0 billion), which represents 34.2 times the midpoint of its full-year revenue guidance of $351 million. Besides, management forecasted non-GAAP (adjusted) losses in the range of $18 million to $20 million in 2019. Such a lofty valuation indicates investors expect the company to deliver stellar results over the long term.
Given its tailwinds, Datadog isn't likely to disappoint investors during the next several quarters. But with its increasing revenue base, sustaining a high revenue growth rate over the long term will become challenging. Also, Datadog reduced its losses during the third quarter, but the intensifying competition could have a negative impact on its margins.
Thus, Datadog's solid performance makes it an attractive tech stock, but prudent investors should keep in mind the company's sky-high valuation corresponds to a flawless execution over the long term.
