Despite better-than-expected third-quarter results and raised full-year guidance, Datadog (NASDAQ:DDOG) stock has kept dropping. The market now values the high-growth cloud monitoring specialist at a more than 25% discount to its October all-time highs. Yet the company remains exposed to the secular strong growth of its vast cloud computing market. So should you buy the dip?
Strong short-term results
Even with the threat of pricing pressures given the recent generous free offerings from the cloud monitoring competitor New Relic, Datadog posted quarterly results above guidance. Revenue increased 61.3% to $154.7 million, way above the forecast revenue range of $143 million to $145 million.
The company's land-and-expand strategy, which consists of attracting new customers that will increase their consumption of Datadog's services over time, fueled that growth. And CEO Olivier Pomel indicated during the earnings call the coronavirus-induced uncertainties that led to rationalized cloud usage in the second quarter didn't materialize in the third.
As a result, the dollar-based net retention rate exceeded 130% for the 13th consecutive quarter, which means existing customers spent more than 30% more than last year as the company leveraged cross-selling opportunities between its different modules. During Q3, 71% of customers used at least two products, up from 50% in the prior-year quarter.
In addition, Datadog attracted approximately 1,000 new customers during last quarter, bringing the total number of customers to 13,100, up from 9,500 one year ago -- another indicator of the strength of the company's offering.
With the various modules it developed over time, Datadog now offers a comprehensive observability platform. "Observability" is a new buzzword, but it corresponds to real demand. Enterprises need to manage their cloud infrastructures and applications with end-to-end and easy-to-use solutions that help them optimize performance, plan resources, and troubleshoot issues.
And given the flexible consumption of resources cloud computing allows, enterprises should keep moving some of their computing infrastructures and applications to the cloud over the next many years. As a result, the global cloud computing market should grow at a compound annual rate (CAGR) of 17.5% by 2025, according to research outfit Research and Markets.
Given these attractive prospects, competition is intensifying. For instance, many monitoring specialists, such as Splunk and New Relic, have been expanding their offerings to propose similar cloud observability capabilities. Even tech giant Oracle revealed a new cloud observability and management platform in October.
The impact of such moves remains to be seen, but with so many players ramping up their efforts to address the cloud observability area, competitive pressures should intensify going forward.
In any case, Datadog should keep thriving with its cloud-native portfolio by capitalizing on its strengths. Pomel indicated during the earnings call that he will still prioritize top-line growth over profitability with aggressive investments in research and development and sales and marketing efforts. As an illustration, a year ago, the company expanded its footprint into the growing cybersecurity area, which will provide extra cross-selling opportunities with its core offerings.
In addition, Datadog is developing various partnerships with the three major public cloud vendors: Amazon, Microsoft, and Alphabet's Google to fuel its long-term growth. For instance, the integration with Microsoft's cloud infrastructure (Azure) console will significantly reduce the friction to use Datadog's services for the tech giant's customers.
Buy the dip?
Despite the company's attractive long-term potential and strong Q3 results, the stock price remains well below its October all-time highs. Yet the market cap at 46 times the midpoint of management's full-year revenue guidance range of $566 million to $572 million still corresponds to phenomenal long-term expectations.
With scale, sustaining spectacular revenue growth will become more and more challenging. As an illustration, the midpoint of the fourth-quarter revenue guidance range represents 43% year-over-year growth. Many companies would dream of that outlook, but it represents a strong deceleration compared to Datadog's previous quarters of top-line growth way above 60%.
Thus, even though Datadog's stock price dropped by more than 25% below its recent all-time highs, investors should consider waiting for a deeper pullback to participate in the company's long-term growth story.