Company Overview: Dynatrace Inc. (NYSE: DT) is a software intelligence company, engaged in delivering application performance management, and artificial intelligence for businesses, monitoring cloud infrastructure as well as digital experience management. The company’s software intelligence platform enables customers to modernize and automate IT operations, thereby improving overall user experiences for better business outcomes. As of 30 September 2020, the company has greater than 2,600 customers in more than 80 countries. The company has a diversified business model in industries such as banking, insurance, retail, manufacturing, travel, and software.

DT Details

Strong Demand for APM Solutions & Robust Product Adoption Aid DT: Dynatrace Inc. (NYSE: DT) has been a leader since the beginning of its operations, within the application performance monitoring space. In 2014, the company leveraged the expertise and capability of the same engineering team that founded DT to build a new platform, the Dynatrace Software Intelligence Platform, an AI-powered infrastructure to manage web-scale functions within multi-cloud platforms.

The company recently announced that it has been acknowledged as one of the highest 10 Top-Rated cloud computing companies to work for during the global uncertainties surrounded by COVID-19 crisis. This distinction positioned the company at number 10 on a list of 25 organizations. The company has also expanded its strategic alliance with SAP. The partnership will aid DT to prepare the world’s leading retailers for a flourishing Cyber Monday and beyond by making Dynatrace’s digital experience monitoring capabilities, available for SAP Commerce Cloud. Further, the customers can subscribe to the new service via the online SAP Store.

DT remains on track to benefit from robust demand for its Application Performance Module (APM) solutions and an increasing clientele base. Notably, DT’s target addressable market is worth greater than $32 billion and consists of the largest 15,000 global enterprise accounts with more than $1 billion in revenues. As digital transformation among worldwide enterprises has escalated, owing to coronavirus-led disruption, the company’s strong portfolio is expected to tap on this growing opportunity, which in turn will drive its top-line growth in the days ahead.

Furthermore, the addition of its Software Intelligence Platform to aid all services from Amazon Web Services and assimilation with ServiceNow’s Service Graph Connector Program has strengthened Dynatace’s portfolio, thereby facilitating it win new customers. Notably, the company added 133 new customers and ended 2QFY21 with 2,594 customers. It is worth mentioning that the net expansion rate was greater than 120% for the 10th successive quarter. Also, the company’s strong recurring-revenue base remains a key positive. Total annual recurring revenues (ARR) at the end of the 2QFY21 soared 35.5% from the prior corresponding period and came in at $638.1 million (on a constant currency basis). ARR per Dynatrace customer also rose 14% on pcp to $234K. The trend is likely to continue in the near future, thereby driving up subscription revenues. 

The company witnessed a CAGR of 10.3% and 11.1% in revenue and gross profit, respectively over the period of FY17-FY20. Subscription revenues also increased from $232.8 million in FY17 to $487.8 million in FY20, instilling investors’ confidence.

Key Past Performance (Source: Company Reports) 

2QFY21 Key Financial Highlights: During the quarter, the company reported adjusted earnings of 18 cents per share as compared to 7 cents reported in the year-ago quarter. Revenues during the quarter came in at $168.6 million, which increased a whopping 30.3% year over year. Revenues went up 30% on pcp at a constant currency basis. Notably, during the quarter, subscription revenues came in at $157.7 million, up 36.2% year over year. On a constant currency basis, subscription revenues soared 35% from the prior corresponding period. Nevertheless, service revenues and license revenues declined 3.3% and 83.9%, respectively, year over year. In 2QFY21, non-GAAP gross margin came in at 85% as compared to 83% in 2QFY20, driven by a higher subscription gross margin. Research & development (R&D) expenses, sales & marketing (S&M) expenses and general & administrative (G&A) expenses increased by 24.7%, 16.7% and 11.7%, respectively, year over year. Non-GAAP operating margin increased from 23% reported in the year-ago period to 32.7% in 2QFY21, owing to higher revenues and gross margin, along with operating efficacy.

Liquidity Details: The company ended the second quarter, with a cash balance of $248.4 million, and long-term debt amounting to $480.9 million. Notably, long-term debt decreased from $510.5 million reported at the end of 30 June 2020. A principal payment of $30 million was made by DT at the beginning of 2QFY21. In October 2020, DT also made a principal payment of $30 million, which further reduced its debt to $451 million. Free cash flow during the quarter stood at $40.5 million, up from $27.2 million reported in the year-ago period.

Cash Highlights (Source: Company Reports)

Top 10 Shareholders: The top 10 shareholders have been highlighted in the table, which together form around 61.06% of the total shareholding. Thoma Bravo, L.P. and The Vanguard Group, Inc. hold the maximum interests in the company at 33.7% and 5.76%, respectively.

Top 10 Shareholders (Source: Refinitiv, Thomson Reuters)

Key Metrics: The company reported a 2QFY21 gross margin at 81.8%, higher than the industry median of 77.3%. EBITDA and Operation Margins stood at 22.6% and 13.6%, respectively, in 2QFY21, higher than the industry median of 11.3% and 2.6%, respectively. ROE, in the same time span, stood at 1.7%, as compared to the industry median of -0.6%. 2QFY21 debt to equity ratio stood at 0.47x, lower than the year-ago figure of 0.64x, depicting an improvement in leverage position. The company remains on track to deleverage its balance sheet in the coming times.

Key Metrics (Source: Refinitiv, Thomson Reuters)

Risk Analysis: A leveraged balance sheet might weigh on the company’s financial performance, going forward. As of 30 September 2020, the company’s cash and cash equivalents were $248.4 million, while total long-term debt was $480.9 million. Additionally, the company’s business is exposed to market risk primarily as a result of fluctuations in foreign currency exchange rates and interest rates and inflation. Further, competition from peers, challenges of COVID-19, and the global threat environment remain the key concerns.

Outlook: For 3QFY21, the company anticipates top-line to be in the ambit of $171 million and $173 million, depicting a rise of 18-20% on pcp. DT expects subscription revenues to be in the range of $160.5 million and $162 million, suggesting a 24-25% growth year over year. Non-GAAP operating income for the coming quarter is expected to be within $43 million and $45 million, whereas non-GAAP earnings are likely to be in the range of 12 cents and 13 cents per share.

Coming to the FY21 outlook, revenues are expected to be in the range of $721 million and $727 million (up from the prior outlook range of $646-$656 million). The company now expects subscription revenues between $624-$630 million (prior guided range was $603- $612 million). Non-GAAP operating income is now expected to be $186 million and $191 million, compared with the previous guidance of $166-$175 million. Non-GAAP earnings are now expected between 55 to 57 cents per share as compared to the prior outlook of 46-49 cents per share. Additionally, unlevered free cash flow is now anticipated in the ambit of $192-$200 million, up from $187-$195 million guided previously.

Key Valuation Metrics (Source: Refinitiv, Thomson Reuters)

Valuation Methodology: EV/EBITDA Multiple Based Relative Valuation (Illustrative)

EV/EBITDA Multiple Based Valuation (Source: Refinitiv, Thomson Reuters)

Note: All forecasted figures and peers have been taken from Thomson Reuters, NTM-Next Twelve Months

Stock Recommendation: The stock of DT closed at $38.45 with a market capitalization of ~$10.85 billion. The stock made a 52-week low and high of $17.1 and $48.85, respectively, and is currently trading above the average of its 52-week trading range. On a technical analysis front, the stock has a support level of ~$38.04 and a resistance level of ~$43.29. The stock went down ~3.2% in the last three months period. The company’s results are likely to benefit from a robust product portfolio, which, in turn, will boost the top-line and support the overall growth. The company’s capability to enhance its customer base is expected to be a tailwind in the near-term. Considering the above factors, we have valued the stock using an EV/EBITDA multiple based illustrative relative valuation method and arrived at a target price with an upside of lower double-digit (in % terms). For the purpose, we have taken peers like Splunk Inc (NASDAQ: SPLK), Datadog Inc (NASDAQ: DDOG), Palo Alto Networks Inc (NYSE: PANW), to name a few. Hence, we recommend a “Buy” rating on the stock at the closing price of $38.45, down 1.64% on 14 December 2020. 

DT Daily Technical Chart (Source: Refinitiv, Thomson Reuters)

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