Investors have seen time and again how some platforms can turn small businesses into big profits. Shopify (NYSE:SHOP) was a pioneer in helping small businesses establish themselves online, and its stock has soared more than 3,000% over the last five years. Square (NYSE:SQ) cut its teeth by empowering small business with payment systems and services. Now meet Datto (NYSE:MSP), which went public on Oct. 21 with a mission to bring big IT solutions to small and medium businesses (SMBs). Unlike many recent IPOs, the company just turned profitable . Here are three key indicators that could give investors confidence that Datto's story and stock has a bright future.
1. Landing more MSPs
Datto's ticker, MSP, is an homage to its unique strategy. SMBs often can't manage their own information technology needs. Imagine you own a local chain of bakeries, or a dentistry practice. You want to access and protect your and your customers' data easily, but you didn't acquire networking and cybersecurity skills at culinary or dental school. Additionally, your business may not be big enough to invest in your own IT department, with multiple contracts from multiple vendors.
For these reasons, many small businesses turn to "managed service providers," or MSPs, essentially one-stop shops that provide IT solutions. The total addressable market here is very big and growing. According to Datto's S-1 filing, SMBs spend $159 billion on IT annually. We can reasonably expect that figure to keep growing, since all businesses need software, data storage, and security. 125,000 MSPs currently manage about 10% of that market .
Datto offers a data storage and security platform to MSPs, which they in turn can offer their customers. This model allows Datto's customers more efficiency, since they can consolidate much of their work onto Datto's platform. It also allows MSPs to focus more of their time on growing their business relationships, rather than getting bogged down troubleshooting: They have Datto for that. Essentially, Datto is the MSP for MSPs.
This strategy seems to be paying off. Datto currently has 17,000 MSP customers. That's a nice diverse customer base and healthy 14% of the market. A growing market also invites growing competition. If Datto is going to be a multibagger from its current $4.4 billion market cap, it needs to not only keep market share, but also grow its market share
2. Expanding with MSPs
Datto has shown its ability to grow relationships so far. Its S-1 filing shows a dollar-based net retention rate of 115% for the 12 months ending June 30, 2020 and 119% in the previous fiscal year. For comparison, the more enterprise-focused cloud storage company, Box, recently reported a 106% net retention rate for the year ending July 31, 2020. . Datto has a three-pronged approach to growing revenues with existing MSP partners.
The first involves helping MSPs get Datto services to even more SMB customers. Datto invests heavily into this initiative. If offers a wide variety of tools, from books to videos, that help MSPs with marketing, pricing, customer service, and even hiring. Datto prices its technology to MSPs in tiers, and as the MSPs expand or bring new business into the Datto ecosystem, it can push them into higher pricing tiers . More on this later.
The second opportunity is to offer more solutions to the MSP business. One key product here is Datto's "Autotask Professional Services Automation," (PSA) -- essentially, software that helps MSPs triage, assign, and track workflow. There is plenty of competition in this arena as well. Datto has a bit of network effect going for it: If an MSP is already tied into the Datto platform for its customers, it might be more likely to use Datto's PSA software as well.
The third growth driver lies in expanding Datto's solutions for SMBs. The company's current focus is backup and recovery service, helping that imaginary dental office access your records even when their systems crash. That's a smart place to start, since different businesses all share that same need. For Datto to grow into a megacap cloud king, investors should look for new successful products and services for SMBs, additional business solutions for MSPs, and that net retention rate to stay above 100% for the foreseeable future.
3. Top line, bottom line
Since 94% of Datto's revenue comes from subscriptions, the company tends to highlight its annual run-rate revenue, the yearly value of all its current subscriptions . Whether investors chose to use that metric or the slightly more inclusive net revenue, they should hope for some acceleration in top-line growth. Datto grew its year-over-year subscription revenue nearly 20% for the six months ending June 30.
That kind of revenue growth is great ... unless you're a cloud software company. Other companies in the broader industry are posting revenue growth rates of 65% and even 121% . Granted, those companies, JFrog and Snowflake, come at much higher premiums. Nonetheless, if Datto is going to grow to be the dominant cloud services provider for SMBs through their network of MSPs, it may need get those network effects compounding and grow revenue above 19%.
Datto has not garnered as much media attention as other IPOs. That might work in investors' favor. Small companies will continue to need more and more technology solutions to compete. Most small businesses will look to their local MSP partners. If Datto emerges as the top dog in this space in the long term, its potential could easily turn this $4 billion company into a 10-bagger.