Dynatrace: Strong Momentum, But Fully Priced (NYSE:DT)


Investment Thesis

Dynatrace (DT) is very well positioned in a rapidly expanding market. However, the stock already trades for 17x forward sales multiple, which puts its stock at a premium to some of its peers.

Having said that, Dynatrace is a very high-profit margin business, which goes a long way to support its large multiple.

However, given its 20% fiscal 2021 guidance, I struggle to see enough upside potential here at this valuation.

Revenue Growth Rates are Highly Stable, Even if Trending Slightly Lower

Source: Investor Presentation

Dynatrace is an application monitoring and analytics solution platform. Dynatrace is aimed at improving the experience of its customers’ users.

Given the digital acceleration the world has embraced during the post-COVID environment, you can see that this is an incredibly hot area right now.

Moreover, as you can see from the table above, Dynatrace competes against the likes of Datadog (DDOG) and Splunk (SPLK) — both these companies are stock market darlings, and Dynatrace is no way as exuberantly priced as these two.

Indeed, it’s easy to understand why there’s a lot of competition in this space, given its $20 billion plus total addressable market size.

Source: Investor Presentation 2020 (Total Addressable Market)

Moving on, despite this space’s rapid expansion, it doesn’t appear that Dynatrace is growing quite as fast as some of its peers.

Source: author’s calculations; revenues as reported, *high-end Q2 2021 guidance; **high-end fiscal 2021 guidance

As we can see above, Dynatrace is not a high growth company.

Last year, when the economy was strong it mostly hovered in the high 20s up to 30 percent range. For fiscal year 2021, Dynatrace appears to be decelerating its revenue growth rates.

Even if we take the high-end of its guided revenue growth rates, Dynatrace’s second half of fiscal 2021 is presently expected to drag down its full-year revenue growth rates so that fiscal 2021 ends up at 20% y/y. Most likely this implies sub 20 percent revenue growth rates for either Q3 or Q4.

In fact, analysts following the company are expecting a fairly dramatic slow down to start in Q3 2020.

Source: SA Premium Tools

Even if we assume that the analysts are wrong and that Dynatrace beats the consensus, Dynatrace would still, most likely, be reporting sub-20s revenue growth rates fairly imminently.

This may not be a huge problem if its revenue rates are now largely expected to be in the sub20s region, however, I believe we can safely conclude that Dynatrace is not a high growth company. On the other hand, it’s not all bad, and there’s a lot to like from Dynatrace.

Very High Level of ARR

For fiscal 2021, at the high-end of its constant currency revenue guidance, Dynatrace’s ARR (Annual Recurring Revenue) is aiming towards 27%. This is an important figure and worthwhile unpacking.

Here we should note that Dynatrace’s ARR growth rate is higher than its total 2021 revenue growth rate. This implies that its low margin Service revenue stream, which is made up of consulting and training services, is becoming a smaller contributor to Dynatrace’s consolidated revenue stream.

In other words, Dynatrace’s revenue stream is becoming mostly made up of a high margin revenue stream.

Indeed, for Q2 2021 guidance, more than 93% of Dynatrace’s is subscription-based. Once more, this positively reinforces a higher multiple for a couple of reasons:

  • Firstly, Dynatrace’s total revenue is becoming mostly composed of a high margin revenue stream, which validates the company trading at a higher multiple.
  • Secondly, on a GAAP basis (including stock-based compensation), Dynatrace’s Subscription gross profit margins as of Q2 2021 reached slightly over 88%. This makes Dynatrace’s subscription revenues incredibly alluring.
  • Thirdly, the steadier and more recurring Dynatrace’s revenue stream, the fewer negative surprises its results are likely to have, and the higher the multiple investors can be justified for paying for Dynatrace’s stock.

Valuation — Most Likely Fairly Valued

As a brief aside, while not a huge detraction, but compared with many other SaaS companies, Dynatrace does carry some debt:

Source: Q1 2021 Press Statement

Nonetheless, Dynatrace also has approximately $250 million in cash, which offsets its debt, leaving its balance sheet slightly leveraged at 1.6x. In sum, this is clearly not overly restrictive, and investors are unlikely to put too heavy a consideration on its balance sheet when valuing Dynatrace.

However, the reason I’ve drilled down on its balance sheet is that Dynatrace often makes references to its high unleveraged free cash flow, as having reached 24% in Q2 2020. On the other hand, a more realistic and ”clean” free cash flow calculation margin puts Q2 2021 at 21%.

Thus, we should observe that Dynatrace trades at slightly more than 17x forward revenues. But for a company which is largely expected to grow its revenues at 20%, this puts Dynatrace at a meaningful premium to other Saas stocks.

For example, Salesforce (CRM) is guided to grow with a CAGR of 20% too and offers investors high visibility well into next year, however, Salesforce is priced at 11x forward sales.

Also, PagerDuty (PD) is expected to grow its revenues at close to 22% to 25%, and that stock is also priced at 11x. What’s more, PagerDuty has very little meaningful competition.

Closer peer Elastic (ESTC) also trade for 17x forward sales, but Elastic is still aiming to grow its revenues at close to 30%.

Source: author’s work

In sum, it’s difficult to argue that Dynatrace is particularly cheaply valued and trading at a discount to intrinsic value.

The Bottom Line

There’s a lot to like from Dynatrace and its prospects. As far as SaaS businesses go, very few are generating as strong free cash flow as Dynatrace.

Having said that, given that it already trades for 17x forward sales, together with its middle of the road revenue growth rates, it’s difficult to argue that it’s dramatically undervalued.

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Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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