The New York Stock Exchange
The New York Stock Exchange. Image Credit: Bloomberg

Many of us have been fixated on WeWork’s struggle to go public and the disastrous post-IPO stock performance of high-profile start-ups Uber and Lyft. But as has often been true in the last few years, the tale is different for the unglamorous tech companies that are running circles around their cool peers.

The latest example is Datadog Inc., which helps companies monitor the health of their apps and computing infrastructure; it sold its first batch of public stock late Wednesday. If you fell asleep reading the description, let me wake you up by saying that the company’s latest pre-IPO investors have a nearly 1,100 per cent gain on their shares in less than four years. The earliest Datadog stock buyers from 2011 have a nearly 50,000 per cent gain.

Unsung stars

In a non-systematic look at more than a dozen other tech companies that have gone public in the past couple of years, the stock gain for Datadog’s pre-IPO investors is at or near the top of the leader board. Repeatedly, the less-buzzy start-ups like Datadog that sell cloud-subscription software to businesses have been the ones that deliver the goods for early backers. There have been exceptions, but companies like Zoom Video Communications Inc. and Slack Technologies Inc. have tended to produce strong returns for pre-IPO investors, and their public shares have typically done well, too.

Certainty of growth

Investors, both public and private, love these software-as-a-service companies. Generally their technology is better than anything that came before, and once businesses use the software and stitch it together with email, calendars, information databases and other corporate systems, it can be tough to ditch. If they’re managed properly, these business software companies can grow fast and predictably.

Among the tech companies that have gone public on US stock exchanges since the beginning of 2018, nine of the top 10 by stock gains from their IPO price are software companies that sell to businesses.

None of the hype

What are the lessons here? Well, not surprisingly, it may be that the consumer-oriented tech companies with lots of attention as start-ups may be great companies but not necessarily great investments if the hype leads to overvaluation. That’s particularly true — as in the cases of Uber, Lyft and WeWork — when public company investors are far more dubious than private investors about companies with unproven business models and unsteady financial metrics. The other lesson may be that you’re in luck if you founded a company in a sector like business software that, at least for now, is the apple of investors’ eyes. I have my doubts about how long these software-as-a-service companies can stay viable.

When there is an economic downturn and companies take a hard look at what they’re spending on technology, there are going to be software bills they can live without. That swings the advantage to the big software supermarkets like Oracle, Microsoft and Amazon, which can offer companies discounts on a range of technologies.

Splurging

Some young business software companies are also spending big to grow in a way that may not be sustainable, and their corners of the market may not be as big as optimists expect. These young cloud software companies are also priced for growth to the point where they are vulnerable to any hiccup in customer acquisition numbers or revenue gains. That has happened recently, when companies like Zscaler, Alteryx Inc., PagerDuty Inc., CrowdStrike Holdings Inc. and New Relic Inc. reported wobbly financial results, changes in management or were just infected by worries from other companies in their sector. Still, Datadog shows the benefit of being the right kind of business at the right time. Cisco Systems Inc. approached Datadog recently with a takeover offer significantly higher than the $7 billion valuation it had been shooting for in an IPO.

Datadog was apparently confident enough in its prospects to turn that down and opt to go public. The uncool companies truly are that cool.