Description

Based in The Netherlands and with principal executive offices in San Francisco, CA, Elastic N.V. (“Elastic” or "ESTC") is a software company specializing in enterprise search and security.  Co-founded by Shay Banon, the company’s visionary and Chief Technology Officer who personally owns nearly $1 billion worth of company stock, Elastic has three principal, search-powered service offerings:

· Enterprise Search:  Elastic's flagship product, Elasticsearch, is a powerful search and analytics engine.  It enables businesses to create customized search experiences for their websites, applications, and internal data.  Further, the Elasticsearch Relevance Engine (“ESRE”) leverages Elastic’s leading vector search capabilities and is designed to power artificial intelligence-based search applications.  Vector search, a fundamental technology for artificial intelligence applications and large language models, converts unstructured data into points within a spatial graph. In this arrangement, each axis corresponds to a unique attribute, and the proximity of two points reflects the similarity of the data they represent. The closer two points are in the graph, the more similar the data they represent.

· Observability:  The Elastic Observability solution provides a unified platform for monitoring and managing logs, metrics, and application performance data.  This helps organizations identify and troubleshoot issues in real time, ensuring the smooth operation of their IT infrastructure.

· Security:  Elastic Security combines threat detection, security information and event management, and endpoint security into a single platform.  This enables organizations to protect their data and infrastructure from cyberattacks.

With approximately 21,000 customers worldwide, Elastic’s competitive position is strong.  A few weeks ago, Elastic was recognized as the Winner of the 2024 Microsoft U.S. Partner of the Year award.  Microsoft commented, “Elastic is at the forefront of developing AI solutions on Microsoft Azure, harnessing the power of Azure OpenAI to redefine customer experiences. This partnership is more than just a collaboration; it's a feedback loop of innovation, benefiting customers, Elastic, and Microsoft while empowering the broader partner ecosystem. We are delighted to recognize Elastic as the Microsoft Partner of the Year for the United States.”

I enjoy watching founders talk about their companies, especially in an unscripted environment.  This gives me an opportunity to judge for myself how optimistic, engaged, excited and honest they appear.  In the case of Shay Banon, he is unique in that he is not a hired executive or a salesman, but a passionate software developer, having personally built the Elasticsearch platform and founded the company itself.  For a time, Banon had been Elastic’s CEO, but in January 2022 he decided to return to the lead platform development role (CTO) and promote Ash Kulkarni, the company’s head of product, to CEO. 

One particular video clip of Banon caught my attention.  On December 22nd, Banon spoke to Elastic community members in Bangalore, smiled continuously and said, “By the way this is just one of the big things that is happening at Elastic.  There's a lot of progress, you know, this is one of the most exciting times that I've had a chance to see that is happening in Elasticsearch and in Elastic the product line in general.  ES|QL [Elasticsearch Query Language], go and check it out.  This concurrency thing, I just mentioned it offhand but we've been working on it for the last seven months, both in Apache Lucene and in Elasticsearch so, like, there's tons of exciting things happening.  Gen A.I., dense vectors, quantization.  Tons of exciting things, so follow up, it's an exciting space and we're moving fast.” 

ESTC presently trades for ~7.9x calendar 2025 consensus EV/GP.  This is a meaningful discount to partially comparable company Datadog, which trades for ~14x.  Consensus revenue growth for Elastic is ~16% and for Datadog is ~23%.  However, there is a noteworthy dynamic at work here, as ESTC just completed its latest fiscal year in April, and may have set conservative expectations for the new fiscal year in its guide.  ESTC’s important partner AWS reported that growth accelerated from 17.2% in 1q24 to 18.8% in 2q24, driven by AI demand.  I believe there’s a chance that ESTC accelerates its growth, as well.  Should this play out over the next 16-18 months, ESTC might generate calendar 2025 gross profit in the neighborhood of $1.4 billion.  At a DDOG-comparable valuation multiple, we could see a stock price around $200, or roughly 2x the current value.  

From a downside perspective, the business has >$1 billion of cash on hand and a broad, sticky customer base and is cash flow positive with an adjusted EBIT margin of ~12%.  Like most enterprise software businesses, the company was, and is, investing heavily in research, development and sales/marketing to capture market share.  Naturally, these expenses run through the income statement, depressing this mid-70s gross margin business’ current reported earnings and cash flow.  There are likely several potential strategic buyers for ESTC, particularly in the wake of Cisco’s $28 billion acquisition of cybersecurity company Splunk in March.

Disclaimer:  The author of this idea presently has a long position in securities of this issuer and may trade in and out of these positions without notice.  The data contained herein are prepared by the author from publicly available sources and the author's research and estimates.  No representation or warranty is made as to the accuracy of the data or opinions contained herein.  Please do your own research.

Catalyst

- Investor awareness
- Potential re-acceleration of growth
- Strategic sale