Investing in Cybersecurity Provider Datadog

Maxim Manturov, Head of Investment Research at Freedom Finance Europe, assesses the viability of cybersecurity company Datadog as a lucrative investment within a growing sector

The cybersecurity sector is expanding to match the digitalisation of companies across the globe. These new technological advancements bring an increased risk of criminal activity which needs to be combated. With this increase in demand for robust cybersecurity solutions, investors should seize the opportunity to diversify their portfolios with stocks in this area to benefit from market demands. Cybersecurity firm Datadog (DDOG.US) is one company that has proven significant value for money and going forward, should be on investors’ radars.Datadog offers its customers a platform for monitoring and securing cloud applications under the Software as a Service (SaaS) model. The company generates revenue from monthly or annual subscriptions, products such as customizable metrics kits, and anomaly detection kits. Datadog uses a Land-and-Expand business model, which involves offering easily deployable products to appeal to a large range of customers, thereby expanding its reach with additional applications.

Datadog’s expansion

With an increased demand for its products due to the general digitalisation of potential customers, Datadog may benefit from business migration to the cloud and an increase in the number of users adopting next-generation DevOps. Gartner estimates that cloud spending as a proportion of total IT spending will increase from around 10% at the end of 2022 to around 17% in 2026. Furthermore, Datadog, which cites Gartner research, predicts the total target market for its key Datadog Observability product will increase from $41 billion (£33 billion) to $62 billion (£50 billion) over the 2022-2026 horizon. This increase is a good opportunity for Datadog to expand its market share, which should have a positive effect on both the company’s financial results and stock price.

Datadog has also been making new acquisitions, On November 3, 2022, they announced the takeover of Cloudcraft, a visualisation service for cloud and systems architects that enables the creation of real-time diagrams of cloud infrastructures. Such a toolkit is highly relevant as users move to the cloud, as it allows them to intelligently model their infrastructure, enabling automatic updates to the diagram, and reducing the need for manual documentation updates.

Along with this new acquisition, Datadog announced updates on multiple products on October 19, 2022. These products will also be accompanied by a further 11 currently in the beta test stage of development, we expect them to contribute to improved financial results after their full release.

In addition to Datadog’s product offering and development, its focus and commitment to research investment convey an additional bonus from an analyst’s view. Their volume has been growing for the past five years and 2022 was no exception. This greater investment in research increases the company’s chances of creating an innovative product that can help expand market share.

The company’s efficient customer service also helps to grow revenue: the proportion of customers using more than two, four and six products simultaneously, has been growing steadily since 2018. At the end of Q3 2022, 80% of the company’s customers were using more than two products, 40% were using more than four products, and 16% were using more than six products. The growth in these figures indicates that Datadog has been successful in cross-selling, an important quality for expanding businesses. We expect that further product launches by the company will contribute to the continued growth of these figures.

Financial growth

Datadog’s financial indicators also point towards future growth in shares. The company’s revenue over the last 12 months is up from $880.1 million (£712.6 million) to $1531.9 million (£1240.3 million), operating profit is up from -$36.5 million to -$15.6 million, and net profit up from $-44.1 million (£-35.7 million) to $-14 million (£-11 million).

Datadog has delivered excellent performance over the past 12 months, given the high base and negative market sentiment in 2022. In our opinion, the decline in profitability in Q3 is temporary and the increase in sales force costs will be recouped by a further increase in the number of products used by customers.

The future

There are obviously risks as there are with any investment, with Datadog these risks are:

• significant investment in R&D could weaken a company’s financial stability in the event of a recession.
• expensive valuation by multiples implies greater volatility in case of negative events (e.g. cybersecurity incidents).
• against the backdrop of a potential recession, the company may lower its forecasts for next year, which could eventually lead to a significant sell-off in the company’s stock.

The minimum price target set by Macquarie is $85 (£69) per share. Sanford C. Bernstein, in turn, set a target price of $172 (£139) per share. According to the consensus, the fair value of the stock is $118 (£95) per share, which implies a 51% upside potential.