Dynatrace S-1 Analysis — Tracing a Transition

Dynatrace, which offers a software intelligence platform, recently priced its IPO range from $11-$13/share. At the mid-point of the range the business would raise $408M and be worth $3.5B. Dynatrace is best known for its Application Performance Monitoring (APM) solution and is transitioning from a software license to SaaS model. At the end of the last fiscal year, Dynatrace had 2.3K customers generating $431M in revenue. Founded in 2005, Dynatrace has ~2K employees and is headquartered in Waltham, MA.

The business was originally sold to Compuware for $256M in 2011 and then Thoma Bravo acquired it through its $2.4B acquisition of Compuware in 2014. Thoma Bravo spun out Dynatrace into a standalone company that has more than $1B of debt on its balance sheet. Post-IPO Thoma Bravo will continue to own 71.4% of the business.

Starting in 2014 Dynatrace began developing the Dynatrace Software Intelligence Platform, a software monitoring solution for dynamic, hybrid cloud applications and containers. The newer solution has four parts: 1) OneAgent, an automatic instrumentation technology, 2) SmartScape, a real-time dependency mapping system, 3) PurePath, transaction-centric code analysis technology, and 4) Davis, an AI-engine for instant answers to service degradations, anomalous behavior, and user impact. The Dynatrace Software Intelligence Platform has two form-factors: 1) SaaS and 2) Managed, which runs the software in customer-provisioned infrastructure. It has been commercially available since 2016 and is now the company’s primary offering.

The business argues its solution is superior to alternatives for a number of reasons. First, it can be installed as a single agent so it is easier to configure and maintain. Second, it combines Application Performance Monitoring (APM) with Cloud Infrastructure Monitoring, AIOps, and Digital Experience Management (DEM), in a single full-stack approach to decrease the number of tools and cost and increase productivity. Third, its AI engine dynamically baselines the performance across the entire stack for holistic intelligence and root cause determination. Finally, it can support web-scale with a flexible deployment architecture (SaaS and self-managed).

Dynatrace states its Total Addressable Market (TAM) is $18B. It targets 15K global enterprise accounts, which generally have annual revenues over $750M. There are numerous competitors in this market including Cisco AppDynamics, Broadcom, New Relic, Datadog, Nagios, Akamai, Catchpoint, Amazon Web Services (AWS), Microsoft Azure, and Google Cloud Platform (GCP).

Dynatrace is growing slightly. It achieved $431M in revenue in FY19 compared to $398M in FY18, 8% YoY growth. As a data point, New Relic achieved $479M in revenue over the same FY19 period and grew 35% YoY. In FY19 Dynatrace’s subscription revenue represented 81% of revenue while software license and professional services each represented 9%.

The customers’ geographic composition is diverse. Dynatrace’s customers are located in over 70 countries and non-U.S. customers represented 46% of revenue in the last fiscal year.

It achieved $403M total ARR in FY19 compared to $280M in FY18, 44% YoY growth. It is important to note that ARR is comprised of Classic $120M (30%) and Dynatrace $283M (70%). The business has stopped offering Classic products including AppMon, Classic Real User Monitoring (RUM), Network Application Monitoring (NAM), and Synthetic Classic to new customers.

The number of Dynatrace Software Intelligence Platform customers increased to 1,364 in FY19, up from 574 in FY18, 138% YoY growth. About 53% of these customers were added since April 1, 2017, and the remaining 47% were existing customers that either added or converted to the new solution. Dynatrace’s transition from licensing to SaaS is clearly underway.

Moving on to gross margin, which equals revenue minus the cost of goods sold that includes things like hosting costs and customer support. Dynatrace achieved an 75% gross margin in FY19, below New Relic’s 84% for the same period. Subscription gross margin was strong at was 84%.

Of each operating expense item, Dynatrace spends the most on sales and marketing at 42% of revenue. Dynatrace has a poor sales efficiency coefficient of 0.­­2, suggesting it needs to improve its GTM. As a reminder, the sales efficiency coefficient measures gross profit increase over a period divided by sales and marketing investment. The company has a weak magic number of 0.1. A magic number between 0–0.5 suggests the business doesn’t have a sustainable growth model.

In terms of net income margin, Dynatrace was -27% in FY19, which is below the 2% it achieved the equivalent period a year earlier. The net loss of $116M was in part due to a ~$70M increase in operating costs, drop in its income tax benefit, and unspecified expenses on the balance sheet.

Dynatrace’s IPO registration touches on a few trends. First, more companies that sell to DevOps teams are going public (see my PagerDuty S-1 here). Second, management teams are driven to be SaaS-first to achieve higher revenue multiples for bigger outcomes. Finally, observability companies can reach incredible scale in terms of revenue and valuation. Dynatrace could be worth $3.5B at $430M in revenue; New Relic is trading at ~$4.8B Enterprise Value (EV) at $480M in revenue (10x EV/LTM Rev); and Cisco acquired AppDynamics for $3.7B at ~$200M (17x EV/LTM Rev). The business should IPO shortly so it will be know soon how the stock perform.