What happened
Shares of cloud-based software-as-a-service (SaaS) companies Datadog (DDOG 4.95%), Zscaler (ZS 1.28%), and C3.ai (AI 3.02%) were in rally mode on Tuesday, up 5.3%, 4.8%, and 6%, respectively, as of 12:50 p.m. ET.
Both Datadog and Zscaler were upgraded today by Wall Street analysts, and the two separate upgrades contained optimism not only for the specific companies, but also for the return of enterprise spending in general. That seemed to light a fire under their enterprise-software peers as well, including the controversial C3.ai.
So what
On Tuesday, Wolfe Research upgraded its rating on Datadog from "perform" to "outperform," while raising its price target to $140 versus a $111 share price at the start of the day.
What was especially encouraging about Wolfe's upgrade was that it was based on channel checks that revealed stronger fundamentals for the business and not multiple expansion. In fact, Datadog's valuation is already rather high, at almost 20 times sales. Therefore, the market expects a lot of growth from Datadog not only this year but for years to come.
Fortunately, the analysts at Wolfe see growth getting better, as the "optimization period" for enterprise spending, in which corporations pulled back and consolidated their software spend in their digital transformation over the past year, appears to be ending. The optimization period came as inflation took off, the Federal Reserve hiked interest rates, and fears of recession loomed. That caused an across-the-board pullback in enterprise spend that affected even the highest-quality and best-positioned software companies like Datadog.
Whereas Wolfe initially rated Datadog "perform" on the large deceleration from 63% growth in 2022 to 25% in 2023, analysts now see a reacceleration in 2024 and 2025, forecasting 28% and 32% growth in those years, respectively, as generative AI boosts spending on digital infrastructure.
Image source: Getty Images.
Zscaler got similar love today as well, as it was upgraded by research firm BTIG. The BTIG analysts also conducted channel checks into companies offering secure-service edge cybersecurity software and found the situation has "sustainably improved," with projects that were put on hold now moving forward. Zscaler is one of the newer-age, cloud-cybersecurity vendors, and BTIG believes Zscaler should maintain its leadership and market share in the secure-edge sub-sector.
Putting these two upgrades together makes it seem clear that the harsh slowdown and pause in digital-transformation spending seen over the past 12 to 18 months may be coming to an end. Inflation is decelerating, and the Federal Reserve could be close to finished hiking interest rates, so it appears companies are now moving forward with their investment. The advent of generative AI and increased cyber threats from China noted a couple weeks ago may also be playing a part in getting enterprises moving again.
That sectorwide optimism could also be boosting C3.ai today, which has exploded higher this year largely on hype around its engagements with customers and optimism those would eventually bear fruit in terms of revenue. C3.ai engages customers early and then builds out company-specific AI software for them, but that takes time. Last quarter, the company basically didn't grow revenue at all, so it is dependent on large-scale projects moving forward. While there is still uncertainty around C3.ai's ability to win, the positive news on other SaaS stocks likely spurred optimism and short-covering, with C3.ai's short interest at a sky-high 31% of shares outstanding as of June 30.
Now what
It was a good day for software names and technology in general. Digital transformation is a long-term trend that was turbocharged during the pandemic, which lifted all tech stocks from software, to cloud infrastructure, to semiconductors. But that trend ground to a halt amid the post-pandemic inflationary period. Fortunately, it appears long-term digital transformation is now back on track, which will hopefully result in steady, above-GDP growth for all involved.
