To sustain growth — and hence reward equity owners — public company CEOs must exceed investor expectations each quarter.
In the last three years, rapidly changing headwinds and tailwinds have made that particularly challenging. Some companies — such as Zoom Video, Peloton, and Wayfair
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— enjoyed massive growth in demand as people worked from home.
What’s more, technology companies that enabled people to work from home also enjoyed a surge in demand because the war for scarce talent caused employers to let remote workers use whatever applications they wanted.
As the pandemic waned and the Federal Reserve began raising interest rates in March 2022, these consumer-focused pandemic darlings suffered a plunge in demand growth.
Meanwhile, enterprise technology has suffered a more subtle fate. As macroeconomic headwinds strengthen, companies buy more technology that helps them cut costs and hold onto revenue.
Purveyors of technology that does not offer companies such financial benefits must present compelling proof of value. If they cannot provide such proof, customers are likely to spend less on their products.
This comes to mind in considering Waltham, Mass.-based Dynatrace, a provider of tools that find and fix glitches in the vital cloud software companies use to interact with their customers.
In a May 18 interview following a strong first quarter financial report, CEO Rick McConnell made a clear case for the value of Dynatrace products to its enterprise customers and why it will continue to grow in the face of today’s macroeconomic headwinds.
(I have no financial interest in the securities mentioned in this post).
Dynatrace’s Strong First Quarter Report
Dynatrace’s latest earnings report exceeded most investor expectations for first quarter results and its forecast for the year.
Here are the highlights, according to Investor’s Business Daily:
- Revenue up 27% to $314 million — the second quarter of slightly faster sales gains — and $6.5 million above the analyst consensus.
- Adjusted earnings up 82% to 31 cents a share — nine cents per share more than the consensus.
- Annual recurring revenue increased 29% to $1.247 billion — $37 million more than estimates.
- Fiscal year revenue forecast increase of 21% to $1.397 billion $35 million above analysts estimates.
- Fiscal year earnings per share of $1 — three cents above consensus.
- Fiscal year ARR range midpoint of $1.48 billion $26 million more than estimates.
The one disappointment was the addition of 179 new corporate customers — which was 17% fewer than the previous quarter, according to an RBC Capital report.
Early contract renewals and significant tax payments also concerned RBC Capital. More specifically, $13 million in increased ARR came from early renewals and free cash flow in 2024 is expected to be $60 million lower due to tax payments, noted IBD.
Investors reacted positively to the report. Since May 16, the day before the earnings announcement, Dynatrace stock has increased 5% to $49.
Dynatrace’s Winding Road To $14.2 Billion Market Capitalization
Dynatrace has taken a long path to today’s $14.2 billion stock market capitalization. It was founded in Austria in 2006, backed by Bain Capital, acquired by Compuware, taken over by Thoma Bravo, spun out of Compuware, and brought public in 2019.
In February 2017, then-CEO John Van Siclen, a Princeton history major who previously ran Interwoven, an enterprise content management firm, told me Dynatrace was founded by Bernd Greifenederin in Linz, Austria and moved to Waltham in 2008 after Bain Capital backed it. In 2011, Compuware bought Dynatrace. Three years later, private equity firm Thoma Bravo acquired Compuware.
Thoma Bravo later spun out Dynatrace as a private portfolio company and worked its magic on the company. As Van Siclen told me, Thoma Bravo boosted cash flow by cutting costs in functions outside of product development, sales, and customer support. It hired enough sales people to meet bookings goals, created clear metrics, and optimized finance, IT, and human resources.
In August, 2019, Dynatrace went public and as of May 20, Thoma Bravo still owned 29% of Dynatrace stock.
However, in December 2021, McConnell took over as CEO after Van Siclen retired. As McConnell explained, “I was CEO of a startup that Cisco acquired in the early 2000s and ran Cisco’s unified communications business. After that I spent eight years at Akamai and ran products before becoming president. In 2021 Dynatrace needed a CEO. I was making a transition and most of the offers were easy to say ‘no’ to.”
The Stanford MBA tried but could not find a reason not to take the Dynatrace CEO job. “I was trying to find out what was wrong with Dynatrace and could not find a hole in its story. It was performing according to the rule of 50 — ARR growth plus cash flow margin was above 50%, it had a great product set, its customer relationships were bulletproof. In November 2021, I took it and haven’t looked back,” he told me.
Sadly for investors, since peaking in October 2021 at $22.8 billion, Dynatrace’s stock market capitalization has declined 38% during which time the NASDAQ
NDAQ
fell 20%.
How Dynatrace Keeps Creating Value For Customers
Dynatrace creates value for enterprises by identifying and fixing problems with their cloud-based software more quickly and effectively than competing products. It invents new products that solve new problems its customers face while rivals try to protect their old products. Finally, it holds people accountable for achieving ambitious goals.
Why Dynatrace customers keep buying despite macroeconomic headwinds
Companies have transitioned to running their operational software in the cloud which has increased the challenges of maintaining an excellent customer experience. As McConnell told me, “The problem we are solving is the massive explosion of data created by the proliferation of the cloud. AWS, Azure, and Google Cloud are driving a huge business with $175 billion in ARR. This creates an explosion of data and the complexity of software developed to run on the cloud must be bulletproof.”
People expect their interactions with a company to work perfectly, “Users expect the cloud to work all the time. It used to be that when software ran on mainframes it would be updated every six months. On the cloud software is updated far more frequently and it is hard to make the software work as well. Users expect it to work every time. The explosion of data and applications makes it harder to manage,” he said.
Dynatrace creates measurable value for its customers by improving the user experience to prevent lost revenue. “British Telecom started using Dynatrace a year ago. They issued a public report on our behalf. We helped them reduce the number of incident by 50%. This will enable them to save about $35 million over several years,” he said.
Nevertheless, Dynatrace is not immune to the prevailing macroeconomic headwinds. “We are not impervious to macroeconomic challenges. Enterprise budgets are tighter and the sales cycle is lengthening. We show clients how we create value for them — by helping your environment work better by saving money and improving the user experience. The last iPhone launch was flawless due to Dynatrace,” he said.
How Dynatrace wins and keeps customers buying
Dynatrace prevails against rivals because it identifies and solves problems with cloud software more effectively.
Specifically, Dynatrace saves customers time spent troubleshooting. Its competitors provide dashboards with relatively vague red, yellow, and green diagnosis of cloud application performance.
Dynatrace offers a decade old AI engine that provides automated responses to resolve problems more quickly. “We can pinpoint the problem to a server on Virginia or a specific slice of code,” McConnell noted.
Dynatrace keeps customer buying by adding new services. Its net retention — a measure of how much more its customers spent in the most recent year — is 190%. Dynatrace’s gross retention is about 95%. He told me that Dynatrace customers need to identify security vulnerabilities in software — so Dynatrace has added an application security service.
How Dynatrace stays ahead of the competition
Dynatrace stays ahead of rivals by viewing itself from the customer’s perpsective, setting clear objectives, holding people accountable, and reinventing itself as rivals defend their core products.
Dynatrace listens to the voice of the customer. “Our product strategy, pricing, and organization structure is aimed at delivering customer value. I meet with customers every month and we are helping them with the three or four most important applications that they use to run their business. It is super humbling,” said McConnell.
Dynatrace operates a flat organization and empowers people to meet its objectives. The company values people who are ethical, tenacious, humble and who always aim to be better. This approach enables Dynatrace to grow ARR at 29% and enjoy significant cash flow — resulting in 29% free cash flow margins.
Dynatrace has maintained its lead in the industry while rivals have fallen behind. As he told me, “Gartner Magic Quadrant and Forrester Wave report we are a leader in the industry. The companies that were leaders five years ago moved down and to the left.”
While rivals suffer from what I call cognitive lock-in, Dynatrace says it has “innovation DNA. We constantly look to reinvent and evolve as the market evolves. Our core market of observability is merging with log management — from companies like Splunk. We see the markets converging,” he explained.
By contrast, Dynatrace’s competitors protect their core business. “They are ahead for the first three quarters and they start playing defense because they’re leading. Why are you slowing down? They seem to have lost a vision of what they are trying to achieve and are not innovating in that direction,” he said.
A key Dynatrace advantage is its European R&D organization. “Our secret weapon is our 1,000 person R&D unit in Austria and central Europe. They are talented, loyal engineers focused on success. Our founder and chief technology officer is a passionate innovator,” McConnell concluded.
What’s Next For Dynatrace Stock?
Given the value that Dynatrace provides for customers, its stock seems underappreciated. According to CNNBusiness, 24 analysts set the company’s median 12 month price target at $53.50 — about 8.8% above its current price.
If Dynatrace can keep providing customers with a significant return in investment — as measured by cost reduction and revenue enhancement — its stock price could go up much more.
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