Shifting To End-to-End Observability And Cloud Management Fuels Revenue And Earnings Surge

Key Takeaways

• Shift towards end-to-end observability and effective cloud environment management could significantly increase demand for Dynatrace's services.
  
• Strengthening partnerships and revising the partner economic model aims to boost deal origination and ARR from both new and existing customers.
  
• Market uncertainties and strategic transitions pose risks to revenue and ARR growth, alongside potential financial impacts from delayed decision-making and partner reliance.

Catalysts

Provides a security platform for multicloud environments in North America, Europe, the Middle East, Africa, the Asia Pacific, and Latin America.

• The shift towards end-to-end observability and the need for organizations to manage cloud environments effectively could drive increased demand for Dynatrace's services, impacting revenue growth.
  
• Focus on strategic enterprise accounts, especially within the Global 500, aims to enhance sales force productivity and drive higher potential ARR, potentially boosting revenue and earnings.
  
• Investments in customer success and segmentation mapping could enhance customer retention and expansion rates, positively impacting net retention rate (NRR) and contributing to revenue growth.
  
• Expansion of the DPS licensing model, which now represents a significant portion of the customer base and ARR, could lead to an increase in platform consumption and up-sell opportunities, driving revenue growth.
  
• Strengthening partnerships and revising the partner economic model to encourage closer collaboration and ease of market entry with partners could lead to more deal origination and increased ARR from new and existing customers.

Assumptions

• Analysts are assuming Dynatrace's revenue will grow by 16.8% annually over the next 3 years.
• Analysts assume that profit margins will increase from 10.8% today to 12.2% in 3 years time.
• Analysts expect earnings to reach $276.8 million (and earnings per share of $0.92) by about August 2027, up from $154.6 million today. The analysts are largely in agreement about this estimate.
• In order for the above numbers to justify the analysts price target, the company would need to trade at a PE ratio of 78.0x on those 2027 earnings, down from 89.6x today. This future PE is greater than the current PE for the US Software industry at 37.0x.
• Analysts expect the number of shares outstanding to grow by 1.68% per year for the next 3 years.
• To value all of this in today's dollars, we will use a discount rate of 6.59%, as per the Simply Wall St company report.

Risks

• The dynamic macro environment and current market choppiness introduce risks of slower or delayed decision-making by potential and existing clients, potentially affecting revenue and ARR growth.
  
• The transition and maturation of the recent go-to-market strategy alterations could result in short-term disruptions or slower than anticipated improvements in sales execution, potentially impacting quarterly ARR and revenue growth.
  
• With a significant portion of annual recurring revenue (ARR) being booked in the second half of the fiscal year, any unforeseen market or operational challenges in later quarters could disproportionately impact annual financial results, including revenue, net margins, and earnings.
  
• The noted increase in deals requiring higher levels of approval suggests potential for elongated sales cycles, which could postpone revenue recognition and affect quarterly and annual financial performance.
  
• Dependency on partner-based deal origination, influenced by overhauled partner economic models and strategic focusing on global 15,000 organizations, carries inherent risks if partner engagement does not meet expectations, potentially impacting deal flow and ARR growth.

Valuation

• The analysts have a consensus price target of $56.96 for Dynatrace based on their expectations of its future earnings growth, profit margins and other risk factors. However, there is a degree of disagreement amongst analysts, with the most bullish reporting a price target of $68.0, and the most bearish reporting a price target of just $45.0.
  
• In order for you to agree with the analyst's consensus, you'd need to believe that by 2027, revenues will be $2.3 billion, earnings will come to $276.8 million, and it would be trading on a PE ratio of 78.0x, assuming you use a discount rate of 6.6%.
  
• Given the current share price of $46.44, the analyst's price target of $56.96 is 18.5% higher.
  
• We always encourage you to reach your own conclusions though. So sense check these analyst numbers against your own assumptions and expectations based on your understanding of the business and what you believe is probable.