On Wednesday, Datto Holding Corp. (NYSE:MSP) pulled off its initial public offering. At first there was a nice jump in the stock price but then things would start to fizzle. By the end of the day, Datto stock was trading up less than 1%.
Now the Datto IPO did price at the high end of the range, as the company raised close to $600 million. But the deal came on a day when the markets were volatile. It’s also important to note that Wall Street has seen a flood of IPOs lately. In other words, there may be some fatigue. For example, there was muted interest with the IPO of McAfee (NASDAQ:MCFE), whose shares fell by more than 6%.
Regardless, Datto stock does look interesting right now. So let’s learn more about the company.
Back in 2007, software developer Austin McChord founded Datto. At first, he created and sold a backup service. But it was a struggle to get traction. It did not help that – in 2010 – a new software release crashed his customers’ systems! Yet McChord did not give up and quickly created a completely new piece of software and provided it for free.
But the key inflection point for the company came a year later. This is when Datto helped local hospitals retrieve their lost data because of a tragic tornado in Joplin, Missouri. After this, sales really started to get into gear.
However, the success for Datto was not just about the product. The distribution model was also important. That is, the company sold software through partnerships with managed service providers (MSPs), which are organizations that handle IT processes for companies. For the most part, the focus on MSPs has been a great way to quickly build up revenue.
Consider that Datto is on track for annual recurring revenue, or ARR, of $507 million. The company is also profitable. For the first half of this year, the net income was $10.1 million.
In terms of the network of MSPs, there are about 17,000 and they serve more than a million small and medium size businesses. Consider that more than 1,000 contribute over $100,000 in ARR.
Then why do MSPs want to partner with Datto? Basically, the company provides substantial software assets and marketing support. Here’s a look at the main offerings:
- Unified continuity. This is a suite of cloud products for security, virtualization, cloud replication and disaster recovery. These tools are available for both the cloud an on-premise environments.
- Networking solutions. These include systems for integration of WiFi access points and network connections. This allows for remote monitoring and alerts.
- Business management solutions. This is software for improving operations and workflows for IT environments. These tools are completely managed through a cloud portal.
MSPs have proven to be essential for small and medium size businesses. After all, these businesses generally do not have the financial resources or technical talent for managing the complexities of modern IT. Yet these companies still need to be much more digital if they want to effectively compete in the marketplace. As a result, an outsourced model makes a lot of sense.
And yes, the market opportunity is large, which is certainly a big positive for Datto stock. According to Gartner, the spending on SMB IT hit $1.2 trillion in 2019 and is growing at about 4.6% per year. It looks like the novel coronavirus pandemic may have accelerated things, as there is more urgency for digital transformation.
Bottom Line on Datto Stock
There are notable risks for Datto stock. First of all, the growth has trailed off. Note that revenue is increasing at about 16%. True, Wall Street has been willing to pay premiums for software companies. But then again, if things go sideways, a company like Datto could easily go out of favor.
Next, there is lots of competition, especially in the different categories that the company targets. Some of the rivals include Barracuda, Acronis, Veeam, Cisco’s (NASDAQ:CSCO) Meraki, Ubiquiti (NYSE:UI), ConnectWise, Kaseya and Solarwinds.
But then again, the valuation is reasonable and seems to be accounting for the risk factors. Note that the shares are trading at about 8.5 times revenue. What’s more, Datto stock could be an interesting long-term play. After all, it is positioned nicely to benefit from a major trend of SMBs who are looking for cost-effective ways for digital transformation.
On the date of publication, Tom Taulli did not have (either directly or indirectly) any positions in any of the securities mentioned in this article.
Tom Taulli (@ttaulli) is an advisor/board member for startups and author of various books and online courses about technology, including Artificial Intelligence Basics, The Robotic Process Automation Handbook and Learn Python Super Fast. He is also the founder of WebIPO, which was one of the first platforms for public offerings during the 1990s.