Following its initial public offering (IPO) on Thursday, Sumo Logic (SUMO) grabbed much less attention than another IPO phenomenon debuting the day before, Snowflake. Yet Sumo Logic, a data monitoring and analytics specialist, has been generating strong revenue growth over the last several years thanks to its cloud-native disruptive solutions that address vast markets.
Should you consider buying Sumo Logic stock, which is currently trading slightly above its IPO price?
What does Sumo Logic do?
Over the last decade, enterprises have been moving some of their infrastructure and applications from their data centers to the cloud to be able to quickly scale computing resources as needed. But these companies still need to monitor those cloud-based resources to prevent and troubleshoot issues.
Sumo Logic was founded in 2010 to address that new opportunity. It initially proposed a cloud-based solution for the monitoring and troubleshooting of applications and computing infrastructures.
Image source: Getty Images.
Then, the company leveraged its platform and developed extra monitoring and analytics capabilities for business, security, IT, and development teams.
Management estimates the company's addressable market opportunity at $49.3 billion. As always, you should take these forecasts with a grain of salt as they sometimes include optimistic assumptions. In any case, given its modest trailing-12-month revenue of $181.4 million, Sumo Logic is exposed to significant growth opportunities driven by the adoption of cloud computing.
High revenue growth, but intensifying competition
Thanks to its expanding offerings, the company has been generating strong revenue growth over the last several years. Yet despite Sumo Logic's modest scale, that growth is decelerating. Also, Datadog (DDOG 0.50%), which offers similar cloud-native monitoring and analytics capabilities, has been posting stronger results.
Granted, some differences exist between both companies' solutions. For instance, Sumo Logic recently focused on business analytics while Datadog developed user experience monitoring capabilities. But Datadog, which was also founded in 2010, attracted more customers and grew faster than Sumo Logic thanks to its easy-to-use platform. At the end of June, Datadog had accumulated about 12,100 customers, dwarfing Sumo Logic's customer base of only 2,130 companies at the end of July.
| Company | Trailing-12-Month Revenue | Fiscal 2018 YOY Revenue Growth | Fiscal 2019 YOY Revenue Growth | Fiscal First-Half 2020 YOY Revenue Growth |
|---|---|---|---|---|
| Sumo Logic | $181.4 million | 53% | 50% | 38% |
| Datadog | $480.8 million | 97% | 88% | 77% |
Data sources: Sumo Logic and Datadog. YOY = year-over-year.
Besides, Sumo Logic will be facing intensifying competition at the high end of its market. The legacy competitor, Splunk (SPLK), which addresses mostly large enterprises, has yet to finalize its transition from its on-premises offerings to a cloud-native multi-tenant platform. That means that, in contrast with Sumo Logic and Datadog, Splunk can't host multiple customers on a shared cloud-native solution yet. Management didn't provide a timeline for the platform to be ready, but once that happens, Splunk will become a stronger competitor in the cloud.
The risk of pricing pressure has also recently materialized. Another competitor, New Relic (NEWR), announced in August a new pricing model that includes perpetual free offerings that should attract small businesses. The impact of such a move remains to be seen, but it certainly represents an extra hurdle for Sumo Logic to attract those types of customers.
Given these competitive and pricing pressures, Sumo Logic's revenue growth could keep decelerating over the next several quarters.
Strong growth expectations
Despite its 26.7% increase from its IPO price of $22 in its first day of trading, Sumo Logic stock still trades at a modest valuation ratio compared to its cloud-native peer Datadog because of the company's lower and decelerating revenue growth in the context of intensifying competition. Sumo Logic's trailing-12-month enterprise-value-to-revenue ratio is a much more manageable 11.4 compared to Datadog's 53.3 ratio.
Yet Sumo Logic's valuation still corresponds to strong growth expectations over the long term. In addition, given its investments to fuel its growth, the company is still far from reaching scale and becoming profitable. Its losses worsened to $35.4 million during the last two quarters, compared to a loss of $28.6 million one year before.
Before considering buying this tech stock, investors should check to see whether Sumo Logic can sustain its revenue growth against intensifying competition over the next several quarters.
