If you are CEO of a public company, you face the same challenge each quarter: Can you beat investor expectations? If you do, your stock price goes up; if you miss, the stock falls.
The answer is not always clear cut. Sometimes, a company beats expectations for the previous quarter yet is not sure about whether to raise expectations. In that case, the CEO is better off leaving the forecast as is, and take the hit when investors punish the stock for not boosting guidance.
This is what happened to Dynatrace, the Waltham, Mass.-based security technology company, when it reported its first quarter 2024 results.
Despite a 25% increase in revenue for the quarter, the company’s shares have fallen 13.6% since August 1 — the day before its earnings report — and August 3.
Does this represent a buying opportunity? The answer depends on how much additional revenue Dynatrace generates from its growth investments. My August 2 interview with CEO Rick McConnell shed some light on this.
Dynatrace Q1 FY 2024 Performance And Prospects
Dynatrace exceeded expectations in the quarter while maintaining its guidance. Here are the key numbers, according to MarketWatch:
- Revenue: $333 million. This was up 25% from the year before and $6 million more than the analyst consensus.
- Earnings per share: 13 cents. This was 13 times more than the year before and nine cents ahead of the consensus.
- FY 2024 total revenue guidance: $1.41 billion. This is an $11 million increase and represents growth of about 20.5% — one percentage point above the company’s prior guidance, according to Dynatrace’s Fiscal Q1 2024 earnings call transcript.
- FY 2024 annual recurring revenue guidance unchanged at a midpoint of $1.48 billion. This is 18.5% more than the year before, according to the company’s earnings call transcript. CFO Jim Benson said the company “declined to raise guidance for annual subscription revenue because it is early in the year,” MarketWatch reported.
Dynatrace is proud of its performance and optimistic about its future. As McConnell said, “Dynatrace’s first quarter results exceeded guidance across all our key metrics, demonstrating the powerful combination of growth and profitability. Observability and application security are becoming critical to the success of organizations around the world,” according to a company statement.
Dynatrace stock fell after the announcement. In an August 2 interview. McConnell told me, “Investors reacted to the results ‘Great quarter, good — but not good enough — guidance.’ Our guidance was prudent and fiscally responsible. We had 25% ARR growth, 28% operating margins, 26% free cash flow as a percent of revenue, and 27% subscription revenue growth. Our fiscal first quarter is seasonally weakest. We will win over the long haul.”
Dynatrace’s Long And Winding Road
Dynatrace has followed a long and winding road to its current $14 billion market capitalization. As I wrote in May 2023, the company was founded in Austria in 2006, backed by Bain Capital, acquired by Compuware, taken over by private equity firm Thoma Bravo, spun out of Compuware, and taken 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 he ran Dynatrace after Thoma Bravo spun it out of Compuware. The private equity firm boosted Dynatrace’s cash flow and in August 2019, Dynatrace went public.
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. McConnell said he “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 see 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,” he told me.
Sadly for investors, since peaking in October 2021 at $22.8 billion, Dynatrace’s stock market capitalization has declined 39%.
Dynatrace’s Growth Investments
Dynatrace is investing in future sources of growth. As McConnell said in a statement, “Our rapid pace of continuous innovation has made Dynatrace an industry leader for more than a decade. We believe hypermodal AI and developer observability will be catalysts for incremental future growth as they are expected to extend our reach to a wider range of users and accelerate the creation of even more workloads.”
He sees these investments playing out on two horizons — Dynatrace’s core business and its next waves. As he told me August 2, “We get most of our revenue from observability. Our next waves are application security — from which we will generate an additional $100 million in revenue in the next three years and log management which will also bring in $100 million in revenue over the next few years.”
While he declined to specify how much revenue hypermodal AI will add to for Dynatrace, he said, “material investment will yield material returns.”
Hypermodal AI will make Dynatrace’s services accessible to more users. As he said, “Hypermodal AI combines two services Dynatrace currently offers — causal and predictive AI — with Generative AI. As Gartner in its 2023 Magic Quadrant report, we lead the industry in the first two and when we combine it with GAI’s natural language interface, we will make these tools easier for more people to use.”
More broadly, McConnell sees two ways GAI will increase Dynatrace’s revenue. “First, more data leads to higher volume and more workloads which means more observability. Hypermodal AI means more end users — which increases the capabilities of Dynatrace’s platform,” McConnell concluded.
Where Will Dynatrace Stock Go Next?
Analysts have mixed views about Dynatrace. According to TipRanks, Goldman Sachs’ Kash Rangan and Robert W. Baird’s William Power issued Buy ratings on August 2 for Dynatrace. “However, on July 25, Barclays assigned a Hold rating.”
The consensus, according to Fintel, as of August 2 is Dynatrace trades below its 12-month price target — which is $55.53. As of August 3, that gave the stock 16.4% upside.
Rangan’s report set a much higher price target of $59. As he wrote, “Dynatrace has built a durable and balanced business model which we forecast has the ability to generate subscription revenue growth at 20%+ over the long term, in our view, with potential for FCF margins at 25%+, well above the average Rule of 40. We believe this is attainable given the company’s current ~$1bn in revenue scale vs addressing a $50bn+ market ($20bn APM/infrastructure + parts of security + parts of digital engagement).”
Rangan’s report details the following risks:
- Increased competition in observability and monitoring from “hyperscale cloud providers such as Microsoft” and “point providers such as Datadog
DDOG
- Slower than expected customer adoption of new modules,
- Sales and marketing execution risk,
- Risk of “increased churn from customer renewals,” and
- Slower than expected addition of “new logos.”
Time will tell whether Dyntrace’s conservative forecast will enable the company to beat and raise when it reports Q2 results. If that happens and the company’s growth investments pay off, its shares should rise.
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