Elastic Is a Leader in Enterprise Search With Strong Offerings in Security and Observability

Analyst

Malik Ahmed Khan

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We are positive on Elastic's prospects in the full-stack monitoring, security, and search markets. The firm's solutions benefit from secular tailwinds driving an accelerating increase in data for enterprises to secure, search through, and monitor. In our opinion, the firm's sticky product portfolio, broad swath of products that enable clients to conduct a variety of mission-critical tasks, and increased penetration in the enterprise market have enabled Elastic to form a narrow economic moat around its business.

As the volume of data increases, so does its impact on an enterprise's decisions. More data brings greater complexity, nefarious activity, and search-oriented use cases. This increase in data, and the corresponding complexity, is driven by an uptick in cloud migrations and digital transformations. We believe these secular trends enable a long runway for growth for Elastic. We also believe that Elastic's products are critical for its clients as they allow them to gather insights, detect and triage nefarious activity, and improve their IT stack efficiency. 

While Elastic is well entrenched in search, we see full-stack monitoring and analysis and security as key growth verticals for the firm. We believe Elastic has plenty of greenfield opportunities to exploit in these two verticals in the near to medium term. To this end, the firm has been investing heavily in its sales and research divisions, a strategy that we view as sound. In addition, with different use cases enabled by its three end markets, we believe Elastic has a big cross-selling opportunity ahead of it. 

As Elastic lands and expands its customer base, we see the benefits of the cross-selling opportunity at play. As a client adopts a multiproduct offering, Elastic's entrenchment in that client's ecosystem increases. This entrenchment subsequently results in a higher client lifetime value. In our opinion, the firm's strong net retention rate—close to 130%—is evidence of the upselling strategy's success. With the ability to consistently add new customers and subsequently upsell them, Elastic has strong long-term growth prospects, in our opinion.

Business Strategy & Outlook

We believe Elastic merits a narrow moat rating owing to strong customer switching costs associated with its products. Its platform utilizes the firm's best-in-class search capabilities to offer its clients products spanning security, full-stack monitoring, and enterprise search. With a sticky suite of products ranging from front to back end and increased adoption in the enterprise market, the value of Elastic's platform can be seen by its impressive dollar-based retention metrics and strong customer growth. With secular tailwinds behind its back and a competitive suite of inherently sticky product offerings, Elastic is more than likely to generate excess returns over the next 10 years, in our view.

We consider Elastic to be a competitor in three subsectors: search via its enterprise search offering, security via its SIEM and endpoint security offerings, and full-stack monitoring and analytics, or FSMA, via its observability products.

As a company, Elastic is best known for is its search engine. We believe that security and FSMA are adjacencies that Elastic has penetrated using its search engine as both verticals require ingestion, indexing, and analysis of copious amounts of data to glean insights or highlight/respond to nefarious activity.

In search, Elastic primarily focuses on enterprise search with solutions that allow businesses to have internal and external search products. Internally, an organization may deploy Elastic as a search tool for all internal content (models, spreadsheets, documents, and so on). Externally, a firm may use Elastic as an add-on to its websites/applications to allow external users to quickly locate what they're looking for (whether it is a support-related question or finding a specific product to purchase). For example, on the internal front, Elastic powers the search on widely used communication app Slack. Whenever a user searches for a document within their organization's Slack, Elastic's enterprise search is powering the document lookup. Likewise, Instacart uses Elastic to power its search tool, so whenever a customer is looking for a specific product or store to purchase from, Elastic is at the back end enabling that search.

We think enterprise search, as a subsector, is naturally conducive to high switching costs and network effects. As Elastic powers the search for a company, whether internal or external, its search engine iteratively improves itself. This improvement allows for better search results for future searches. As the firm's product improves, it does a better job of retaining existing customers and attracting new customers to its product.

If a client were to switch away from Elastic's enterprise search offering, they'd have customer switching costs associated with forgoing the improvements in search quality and starting from scratch with a new vendor. On the other hand, as Elastic's product improves by analyzing more queries, the firm can attract more clients to its search offering, leading to more queries, leading to a better product. We see this snowball effect as evidence of a network effect associated with Elastic's enterprise search offering.

Further, we think search offers Elastic a valuable cross-selling tool, allowing it to initially land customers and then cross-selling its security and FSMA offerings to customers currently only using search.

On the security front, Elastic's core security products are SIEM— security information and event management—and endpoint security. SIEM companies typically ingest high volumes of machine-generated data (typically in the form of log files) and produce real-time analysis of a company's security infrastructure. Think of SIEM as a well-serviced alert system: Whenever any irregular activity is detected, the SIEM software will put out an alert, warning the IT team (ideally in real time). Elastic's SIEM offering is coupled with its endpoint security offering, which allows clients to detect, isolate, and prevent attacks on their ecosystems from one unified platform. 

The SIEM space is naturally conducive to the presence of economic moats. SIEM products can swiftly become essential to business operations and security, thereby making the switch to another vendor difficult. Further, the switch to another vendor may entail data loss or a security lapse, possibilities that further increase customer switching costs.

Lastly, Elastic is also a strong player in the full-stack monitoring and analytics space. The FSMA subsector is nascent, springing into existence as a method of unifying and coalescing disparate parts of an enterprise's monitoring framework. FSMA providers seek to give enterprises a one-stop shop to monitor their entire IT stack, ranging from application performance to the end-user experience. An essential criterion in the FSMA space is a provider's ability to ingest large amounts of data, consolidate it, and then make meaningful inferences from it, leading to better business outcomes. The status quo before the emergence of FSMA was various providers focusing on specific parts of the IT stack. For example, an enterprise may have had one company monitor its application performance while another monitored its logs. Naturally, this division of labor led to inefficiencies as IT professionals coalesced the outputs manually to construct a meaningful picture of the overall infrastructure's health and performance. FSMA providers are now offering customers the ability to remove these data silos and monitor the entire IT stack from one consolidated platform.

The two key secular trends driving the robust growth in the full-stack monitoring space are cloud migrations and digital transformations. Both lead to exponentially more data for the companies undergoing these changes. Often, this additional data is machine-generated in the form of metrics, logs, and traces that have to be monitored and observed. Enter FSMA vendors, which allow firms to monitor their IT stacks and glean meaningful insights from them to provide better business outcomes. 

After a company adopts an FSMA vendor, it is vital to understand the costs of ripping and replacing that vendor. First, firms often use an FSMA vendor to "standardize" their monitoring frameworks. This standardization includes deep integration of the vendor's product into its IT stack. This integration, which ranges from incorporating the vendor's code into the company's applications to developer training, leads to increased switching costs for the FSMA vendor's platform. While single sourcing can create obvious vendor lock-ins, we believe that by doing so, companies can capture efficiencies by allowing their developers to focus on mastering one vendor's product portfolio. 

Second, we believe IT decisions in a company are driven by its engineers, not its accountants. We do not think that companies nickel and dime their way to picking an FSMA vendor; typically, they will select the product based on the features most relevant to them. As a result, if an FSMA vendor can demonstrate its portfolio's value to a firm's developers and get them accustomed to its platform by incorporating itself into their day-to-day workflows, its platform can be very sticky within an organization thereafter. 

Third, ripping and replacing an FSMA vendor can lead to data loss and security lapses. This risk is a genuine concern for firms using a vendor to monitor their entire IT stack. While competitors may offer a parallel migration that allows these concerns to be somewhat allayed, we do not see companies switching away from their FSMA vendors due to the risk of exposing or losing mission-critical data. 

Elastic, as an FSMA vendor, provides value by monitoring a business' entire IT stack. By offering a host of products that tackle various segments such as application performance, log management, and metrics, Elastic's value proposition centers on the ability to capture efficiencies in a firm's IT operations and save IT labor hours. 

All three verticals that Elastic plays in are naturally conducive to economic moats. As Elastic lands and expands customers, its entrenchment in the client's IT and search infrastructure deepens, leading to high switching costs. Further, the longer Elastic monitors, secures, and powers a client's search operations, the better its products get. This improvement leads to an upselling motion, reflected in Elastic's strong net retention rate of 130%. 

We also believe that there is plenty of opportunity for Elastic to continue cross-selling its products. We think this cross-selling motion is made easier by Elastic's single resource-based pricing model. If a company wants to utilize Elastic's security, FSMA, or search products, the price charged by Elastic is determined by the amount of underlying server resources the client uses. As a result, if a customer wishes to try out Elastic's adjacent products while only currently using another, the motion is not made cumbersome by having to negotiate additional modules. 

Overall, we think the firm is still in the early innings in terms of customer penetration. While this low penetration provides Elastic with a long runway for growth, we suspect that the firm will run into competition against the likes of Splunk and Datadog in the FSMA space, its largest vertical. At the same time, we think that a sizable chunk of the market is still greenfield. This opportunity can allow Elastic to land larger clients without having to displace existing well-entrenched FSMA/security vendors. Overall, we think that the competitive landscape is broad enough to accommodate multiple winners, leading to multiple narrow-moat companies in the space.

Narrow

Economic Moat

Elastic N.V

Elastic NV engages in the provision of open-source search and analytics engine services. It offers Elastic Stack, a set of software products that ingest and store data from various sources and formats, as well as perform search, analysis, and visualization. The firms Elastic Stack product comprises Elasticsearch, a distributed, real-time search and analytics engine, and data store for various types of data, including textual, numerical, geospatial, structured, and unstructured, Kibana, a user interface, management, and configuration interface for the Elastic Stack, Beats, a single-purpose data shippers for sending data from edge machines to Elasticsearch or Logstash, and Logstash, a data processing pipeline for ingesting data into Elasticsearch or other storage systems. It also provides software solutions on the Elastic Stack that address cases, including app search, site search, enterprise search, logging, metrics, application performance management, business analytics, and security analytics. Its products are used by individual developers and organizations of a range of industries. The company was founded by Shay Banon, Uri Boness, Steven Schuurman, and Simon Willnauer on February 9, 2012, and is headquartered in Mountain View, CA.

Earnings data Q1 2024

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Elastic NV is a data analytics company, which engages in the provision of open-source search and analytics engine services. It operates through the United States, the Netherlands, United Kingdom, India, and Rest of World geographical segments. The company was founded by Shay Banon, Uri Boness, Steven Schuurman, and Simon Willnauer on February 9, 2012 and is headquartered in Mountain View, CA.

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