Cloud computing is a game changer in software technology. Businesses are able to get more efficient as they migrate their operations to the cloud, but in doing so, they are also faced with an explosion in digital data. This can yield new insights for the company -- if they have the right tools for the job.
That's why the cloud has opened the way for a big shake-up in the software industry. One such niche is data analytics. Splunk (SPLK) has been the market share leader in this department for many years, but it was late to make its own transition to the cloud. A number of cloud-native upstarts have been making headway, Dynatrace (DT -0.02%) among them. And Dynatrace just announced a disruptive new product that could further stir things up in data analytics.
It's all about automated observability
Dynatrace has been pioneering infrastructure software with its "observability" platform. IT teams work with increasingly complex amounts of data coming from the public cloud (like Amazon's AWS or Microsoft), a business's own data center, and legacy computing systems. Put simply, observability software is a type of tech infrastructure that gives these IT teams a visual look at what's working -- and more importantly, what might be broken.
A lot of analytics companies out there provide observability solutions, but Dynatrace specifically addresses the world's mega-organizations that have massive amounts of data and complex systems. It does so with artificial intelligence (AI), not just providing a glimpse into the cloud but also automating the collection of information and recommending fixes. Tech researcher Gartner has consistently ranked Dynatrace a top pick for monitoring and observation along with Datadog, although the latter has historically targeted smaller companies with its suite of software. Customer rankings on Gartner's "Peer Insights" page have Dynatrace listed as the top pick for what it does in the world of analytics.
But what of this brand-new product that could deliver a jolt to the industry? It's called Dynatrace Grail, a type of "data lakehouse." Put simply, a data lakehouse combines aspects of data warehousing with data lakes, the type of innovative information storage infrastructure Snowflake (SNOW 0.76%) provides. A data lakehouse builds on this, though, and provides a new analytics service for a specific use case. In this instance, it's cloud observation and security.
How Grail could shake up the industry
I mentioned Splunk at the outset because it has long been the market leader in analytics, and it has a lot of very large customers. For context, Splunk hauled in $3.04 billion in revenue over the last reported 12-month period, compared to $987 million for Dynatrace.
However, Splunk's basic functionality dates back to a simpler time in IT, a time when logs of unstructured data could be parsed through to yield insights on business operations. The world has changed, and a more unified and feature-rich set of automated tools designed for the cloud is now needed. Splunk has been busy getting itself upgraded, which has included a number of large acquisitions. But it's been a messy journey, one that many investors haven't had an easy time understanding. Splunk stock has fallen 65% from its all-time highs last seen all the way back in the summer of 2020.
Splunk is just now getting back to profitability (as measured by free cash flow), and revenue is on the rise again, too. But it's been an expensive endeavor. The company has $3.9 billion in debt and only $1.7 billion in cash and short-term investments. Long gone are the days when Splunk had a clean balance sheet. Splunk was late to innovate, and the cost of waiting was high.
Now, just as it's emerging from its efforts to catch up, Splunk could need to respond quickly. With Dynatrace introducing a brand-new analytics architecture built on modern data storage and computing technology, Splunk can't afford to make the mistake of falling behind yet again.
A financially nimble structure is key
This highlights a longtime debate software stock investors have had: What does it mean for a company to have a defensible moat? Few technology companies can boast the type of product depth of Microsoft or Alphabet's Google. Even Adobe, which many maintained had a highly defensible position in digital content creation, may have just indicated it isn't so impervious to upstart competition.
The technology sector almost implies there are no moats. In software in particular, companies need to constantly stay on the offense with innovation and (in my opinion) frequent acquisitions of tiny upstarts that might provide them with future growth opportunities. And along the way, they also need to remain financially nimble and highly profitable to stay on top. It's a tough balancing act, and most software companies aren't able to pull it off.
For now, it looks like Dynatrace has been doing a pretty good job. Since it reemerged from under the guidance of a private equity firm in 2019, it's been paying down debt and funneling cash into innovation (as made evident by the release of Grail). And it's profitable, both on a free cash flow basis and as measured by unadjusted earnings.
From a technological perspective, I think Grail could set a new standard for software analytics. This may not be a company with a deep moat that can sit on its new innovation without fear of someone else taking a swipe at it. However, paired with Dynatrace's financial performance, this software tech stock is worth paying serious attention to right now. Time will tell how things shake out in this important corner of the cloud industry.
