Passing On Datadog And Dynatrace

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Today there are a couple of stocks we're going to "pass" on adding to the Watch List.

It's been said before, but it is important to remember that just because they get a "pass", doesn't mean these are not good companies! All Green Screen stocks are growing companies generating solid cash flows, and I expect in aggregate the stocks in the screen should outperform the market over the longer term.

These two are very similar companies and close competitors: Datadog (DDOG) and Dynatrace (DT).

Both of these firms offer cloud-based application and system analytics platforms that allow customers to troubleshoot problems, monitor uptime and system performance, target potential improvements, track customer behavior, and get a holistic overview of systems, as opposed to piecemeal monitoring through a variety of "point" tools. Large companies rely on a huge number of software applications, both internal and customer-facing, and having a single platform to monitor their status is key to keeping them running efficiently.

There is definitely some serious growth here. Datadog's 3-year average growth rate is over 70%, Dynatrace 29%. The full-stack monitoring and analysis (FSMA) space is estimated to be worth $16 billion by 2028, currently growing at 12% annually. That's a lot of revenue upside from Datadog's current $1.5 billion and Dynatrace's $1 billion. Since both of these platforms are cloud-based, revenues are based on subscriptions - a reliable, recurring model.

Everything looks pretty good so far, so why pass on these?

My big concern with the monitoring and analysis space, in general, is competition. There is a phalanx of competent competitors. Take a look at this list - and this is only the larger firms!

Datadog (DDOG)
New Relic (NEWR)
Splunk (SPLK)
Elastic (ESTC)
SolarWinds (SWI)
Instana, owned by IBM (IBM)
AppDynamics (private)
ManageEngine (private)
Grafana (private)

In addition to all of these, there are the built-in monitoring capabilities of major cloud platforms AWS (AMZN), Azure (MSFT), and GCP (GOOG)!

Compounding the competitive concern is the relative lack of economic moats in the industry. Sure, there are some switching costs, as there are for all enterprise software. But changing monitoring platforms is less onerous than, say, a customer relationship management vendor, or HR system.

Why? Because monitoring data is machine-generated and has a limited useful lifespan, as opposed to human-entered data that is valuable to a company for decades.

Over the long term, these 2 factors could limit the pricing power for all competitors in the space. In the scheme of enterprise software at large, $15 billion is a small-to-medium size pie. With so many competitors fighting over it, pricing is going to be a tool to win and/or keep business.

Given that, I don't have high confidence in continued great growth performance, long-term, from any of the names in this space. Again, that's not to say they are bad companies (or investments)! Both Datadog and Dynatrace have performed excellently and could end up being good investments from here. We're just looking for stocks that have a bit better competitive edge in less crowded and larger markets.


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