Generative AI Could Drive Dynatrace’s Growth by Over 25%

Since August 2023, Dynatrace, the Waltham-based provider of software observability services, has seen its stock rise by 8%, trailing the Nasdaq’s 14.5% gain. Despite a strong 23% increase in revenue for the quarter ending December 2023, the company’s stock performance has been lackluster. Investors often favor companies that exceed expectations, and while Dynatrace beat revenue expectations and provided solid revenue guidance, the stock was punished after slightly lowering its guidance for annual recurring revenue (ARR). CEO Rick McConnell’s cautious approach to forecasts contrasts with his optimism about Generative AI driving demand for the company’s services. This optimism raises questions about whether Dynatrace will surpass investor expectations in its next earnings report.

Dynatrace’s fourth-quarter 2023 performance exceeded expectations, with revenue reaching $365 million, up 23% from the previous year. Earnings per share were 32 cents, a 28% increase, and ARR reached $1.425 billion, surpassing expectations by $150 million. Q1 2024 revenue guidance of $374.5 million fell in the middle of the forecast range, slightly above analysts’ consensus.

The company slightly lowered its March quarter ARR guidance, disappointing analysts. McConnell emphasized the company’s ability to execute successfully in a dynamic market, noting its balanced growth, profitability, and free cash flow.

Generative AI, particularly in customer service applications, is a key focus for Dynatrace. McConnell highlighted the importance of training AI models with high-quality data and accessing accurate and up-to-date customer data for effective customer service. Dynatrace has been using AI for over a decade, starting with causal and predictive AI. The addition of Generative AI through Davis CoPilot democratizes data access, allowing users to query data with natural language questions.

Hypermodal AI is expected to drive business transformation, enabling companies to grow faster and reduce costs. For example, Dynatrace can help e-commerce companies improve conversion rates by identifying and resolving performance issues. One Asian digital bank aims to win against established rivals by delivering the best software experience, relying on Dynatrace for reliability and issue resolution speed.

Analysts have mixed views on Dynatrace’s stock, with a focus on short-term ARR guidance. While management attributes the ARR guidance reduction to prudence related to deal closure timing, analysts are cautious about the impact of mix and close rates on ARR growth. Despite these concerns, market forecasters see an upside, with Dynatrace stock potentially rising about 25% to reach an average price target of $64.83 per share, according to TipRanks.