Above, Dynatrace’s technology aids IT departments in monitoring the health of their networks.
Dynatrace provided this image.
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Keeping track of what’s going on inside your network is one of the problems of modern enterprise computing. Public clouds, private clouds, old-school data centers, third-party apps, edge computing, and mobile workers make up cutting-edge information-technology systems. Keeping track of what works—and what doesn’t—is a huge undertaking. For investors, the good news is that the result is a massive emerging market.
The market for this stuff used to be known as infrastructure management tools, but it now has a sexier, slightly Orwellian name: “observability.” Datadog is one of these companies (ticker: DDOG),
Dynatrace
(ESTC), and Elastic (DT).
Splunk
(SPLK) provides observability solutions to assist IT departments in monitoring the health of their networks. Observability players should benefit greatly when enterprise tech spending accelerates as a result of the pandemic. Last week, Citi software analyst Tyler Radke made a bullish case for the group as a whole—and for Datadog, Dynatrace, and Elastic in particular—in a research note. “We see a bright future for observability investment,” adds Radke, “with hints that it could reaccelerate when IT spending recovers and digitalization projects pick up.” While the concept of observability is a relatively recent buzzword, it has been around for decades. “The term observability has its roots in engineering and mathematics applications, and it dates back over six decades to 1960,” he explains. “Observability is described as a ‘measure of how well a system’s internal states can be deduced from knowledge of its exterior outputs.’” In other words, observability tools look for signs of network health in the same way that doctors look for symptoms that indicate internal problems when diagnosing illnesses. Infrastructure monitoring (why is the network so slow? ), application-performance management (what’s wrong with my apps? ), and log management and telemetry (why are we getting issues and service tickets? ), according to Radke. “Having visibility into these three components enables enterprises to identify service issues, isolate them, and repair them, whether they are infrastructure or application issues,” he adds. Radke said in an interview that he’s been getting queries from the buy side about whether the market is big enough to maintain the market’s astronomical growth rates. He believes the opportunity is significant, with a projected value of $55 billion in 2025, more than tripling Gartner’s forecast. He believes that certain projections place too much emphasis on revenue from traditional on-premise tool vendors, rather than expecting the increased usage of cloud-based apps.
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Datadog, a company that provides both infrastructure management and application performance monitoring tools, is one of Radke’s top overall business software stocks. The stock is not inexpensive. Datadog shares are valued at 28 times expected 2022 revenues, and profits are insufficient to make the price/earnings ratio significant. However, he anticipates “durable growth” driven by “continuing robust new customer additions and multiproduct strength,” and believes the premium value reflects a combination of premium growth, increasing profitability, and potential upside to consensus projections. Elastic’s combination of observability tools and search software appeals to him, as does Dynatrace’s position in application monitoring for large organizations. He’s less enthusiastic about Splunk, a company I’ve written about that is experiencing financial difficulties as a result of an ongoing business-model transformation. However, if IT investment follows the script and increases in the second half, all four will gain.
Apple
Last week, shares of Apple (AAPL) set a new high, bringing the company’s market capitalization to an all-time high of $2.4 trillion. It was the stock’s first new high since January, reflecting rising expectations for the June quarter’s financial results, which are due in two weeks, and the iPhone 13’s fall release. Hardware sales increased by 66 percent for iPhones, 70 percent for Macs, and 79 percent for iPads in the March quarter, outpacing a 27 percent increase in services. This division includes revenue from streaming services like Apple Music and Apple TV+, as well as commissions from the App Store, where it sells apps for iPhones and other devices.
Care for Apples
as well as iCloud Apple’s role as a gatekeeper and toll collector for app distribution is becoming increasingly risky. A collection of state attorneys general filed a lawsuit against Google last week over its ownership of the Android Play Store. Similar legal action against Apple appears to be unavoidable. New rules for app shops from the Federal Trade Commission, currently chaired by Lina Khan, are also probable, according to Cowen Washington Research Group analyst Paul Gallant. What is the level of risk? In the last six months, services accounted for 16 percent of total revenue. Apple recently announced that the “app store ecosystem” will produce $643 billion in income in 2020, with about 90% of that coming from sources outside than the store (booking rides on Uber, say, or buying goods on Amazon). This translates to $64 billion in sales through the store. If you utilize the maximum commission of 30%, that’s around $20 billion in income, or little over a third of the $57 billion in services revenue for calendar year 2020. According to app tracker Sensor Tower, Apple’s store revenue in 2020 is expected to be $21.7 billion. (It reads $11.6 billion for Google.) If the App Store is regulated, around 7% of Apple’s revenue could be jeopardized. However, since a lowered price appears to be the most likely situation, the underlying risk is likely to be lower. Apple has a vulnerability, but it is minor. Investors appear to be unconcerned. Eric J. Savitz can be reached at eric.savitz@barrons.com./n
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