Dynatrace (NYSE: DT) is coming public this week. They are in the application performance (APM) space which has been around forever but becomes ever more complex as technology advances and more pieces are added into the computing mix. The challenge scales in a non-linear fashion so every so often brand new tools are needed.

In a nutshell, APM helps companies identify where the root cause of a problem is. For example, let’s say my rental car booking fails while I’m using the app on my cell phone. There are at least dozens and probably scores of systems and networks that sit between the user and the ultimate application server at the car rental company. A solution from a company like DT involves having “agents” placed at various points along the way so that performance issues can be identified and resolved. In many cases IT staff can set up the agents to provide alerts so that they don’t need to wait for end-users to experience failures. Here’s a picture of that world.

One of the first companies to come public in this area was New Relic (NEWR) which debuted on December 2014 at $23/share. The stock spent a couple of years growing into their IPO valuation and then took off with the rest of the “New Enterprise SaaS” stocks in 2017. They now change hands at $93 which is a market capitalization of $5.4B on TTM revenues of $480M.

At the very beginning of 2017 and on the eve of their IPO AppDynamics was acquired by Cisco (CSCO/APPD) for $3.7B. At the time this seemed like a decent premium to the proposed IPO valuation but with the benefit of hindsight we now know that AppDynamics would have been worth much more had they stuck with the IPO. But few predicted we would have the valuations we have today for enterprise SaaS players.

At the mid-point of the increased filing range of $13-15, the market cap of DT will be $4B on $430M of trailing revenue or about 9.3x. Based on current growth the shares will be just under 7x forward revenues. Both NEWR and SPLK are trading at just over 7x forward revenues. More on valuation below.

Dynatrace Lineage & Positioning

Dynatrace has grown out of a bunch of older products and services that were acquired, aggregated and revamped by technology-specialist PE firm Thoma Bravo. The compiling started with the acquisition of Keynote Systems in 2013 for $395M. Then in 2014 Thoma Bravo acquired Compuware for $2.5B. Compuware was a long-t

ime leader in mainframe-based software management tools and Keynote systems were known for more distributed, internet-friendly software monitoring tools.

Going way back to 2005 a forerunner of the modern Dynatrace was offering their software prior to Compuware buying it. Between them, Compuware and Keynote acquired a fairly long list of smaller companies in the software management space. Ultimately elements from these companies were combined to form what is being put forwar

d as the modern Dynatrace. This is what is being spun out into the public markets today. After the IPO Thoma Bravo will still be the majority shareholder in the public company.

Despite their long history in the space the current Dynatrace product set only dates back to 2016 so it is indeed “modern” and can take handle the broad range of enterprise-based technologies and the more edgy cloud services provided by AWS, Azure, and others.

Dynatrace will proudly show anyone who cares their leadership position in the Gartner “magic quadrant” where they sit along with both AppDynamics (now Cisco) and New Relic (NEWR). Luckily for DT, there is some natural differentiation happening in the market between these three leaders.

Cisco is understandably taking AppDynamics in a more infrastructure-focused direction. Cisco has to care about the layers underneath the application layer so it makes sense that to extend AppDynamics deeper into networking. New Relic came up from the bottom of the APM space with a focus on new applications and developers. Since then New Relic has scaled up relentlessly, first into SMB customers and now into the enterprise.

In summary, the way these three leaders break out is Cisco/APPD leans towards infrastructure, New Relic leans more developer/cloud and Dynatrace is more enterprise IT/operational support. Thus this is a good market for all three. We know that both NEWR and DT are growing at ~35% and have high gross margins. It’s interesting that NEWR is still not profitable on the operating margin line despite growing from less than $100M in revenues at the time of the IPO to a $500M level today.

Customer reviews of DT are generally very positive. Most of the complaints are suggestive of young software which demands frequent updates as the company races to add features and eliminate defects. These updates have not always gone smoothly and it’s something many customers complain about. Still, they balance that with high praise for how quickly they can deploy and how helpful the software is in their environment.

 

Valuation & Stock Conclusion

Our PFV model suggests the shares can trade at 2x the IPO price given the very low discount rate the market is implying these days. Although at the IPO price DT would be trading in line with their most direct compare of NEWR the group is at a much higher multiple. In aggegate, the New Enterprise SaaS group is at 13.4x forward revenues. Looking at the individual names the median is 13.8x and the average is 15.1x forward revenues.

Both the PFV and the comparables suggest that DT should trade at about $28/share in the aftermarket. With so many banks on the cover, we know we can expect maximum hype and pressure on institutions to buy aggressively in the aftermarket.

One sobering thought is that when the lockup provisions come off we could see quite a bit of stock for sale from Thoma Bravo. This is something to look at again in four or five months before it’s upon us. Stay tuned for more in this space!

 

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