The past six months have been rough for the stock market, and the Fed’s decision to raise interest rates has convinced more investors to flee. But this random sale led to some tempting deals. One such company that sells at a good price at the moment is Digital Ocean (DOCN 9.14%).
The cloud computing company caters specifically to small and medium-sized businesses, but ignoring DigitalOcean due to its size may be a missed opportunity for investors in the long run. Let’s see why.
Strong Business Essentials
Cloud computing has been pivotal to digital transformation. With the cloud, companies can build and scale their operations faster than ever before. AmazonAWS, MicrosoftAzure and the alphabetGoogle Cloud are all platforms that provide cloud-based services to huge companies, but these platforms are often too expensive for small developer teams to afford.
DigitalOcean addresses this gap, simplifying cloud computing for small businesses. With its extensive knowledge resources, convenient setup, relatively easy-to-implement products, and reasonable pricing, young beginners with limited resources are excited to partner with DigitalOcean.
During the company’s first-quarter earnings call on May 4, DigitalOcean reported that its total customer base grew to 623,000, up 6.5% year over year. The highest-value group, which consists of customers paying more than $50 per month, grew faster, improving 20% year-over-year to over 102,000.
Average revenue per customer jumped 28% to $68.90. Strong cadence with customers led to a 36% increase in quarterly revenue, generating more than $127 million, representing the fourth consecutive quarter of 35% revenue growth. DigitalOcean generated $5 million in free cash flow, which was 4% of revenue.
The time horizon is important
Altogether, DigitalOcean had a very good first quarter of the year, although that likely isn’t an immediate impression if one looks only at the company’s stock price. Shares tumbled after the earnings announcement, dropping more than 16% in a single day. This sent the company’s stock price down 76% from its all-time high of about $130 in November 2021.
What likely caused the post-earnings selloff is that DigitalOcean missed average analyst expectations on certain metrics. Although the company beat analysts’ earnings estimates, it missed on an earnings per share (EPS) basis, coming in at $0.07 per share, compared to analysts’ expectations of $0.12. But missing analysts’ estimates of a fourth It really is not an event. It seems to me that the sell-off is the product of short-term investor concerns about the broader market and macroeconomic headwinds rather than the fundamentals of DigitalOcean’s business.
Management expects $566 million in revenue for all of 2022, which would represent 32% year-over-year growth. DigitalOcean also expects to expand its free cash flow margin from 6% in 2021 to 9% in 2022, another indication of the company’s strong business momentum. For long-term investors, the reaction to DigitalOcean’s stock price is just a blip on the radar.
Do all the right moves
Historically, DigitalOcean’s primary means of customer acquisition has been the self-service sales model, where potential customers visit the DigitalOcean website and sign up for its services. Because of this, increasing web traffic is key. The company has been successful in this regard, increasing traffic among unique visitors by a whopping 70% year-over-year during the first quarter.
This increase came before DigitalOcean acquired CSS Tricks, an educational site with 6,500 articles, videos, guides, and other content focused on web and cloud development. Adding this valuable content will help boost your potential customer pipeline even more.
The company is also complementing the self-service sales model by building a sales team to attract larger clients. These larger customers will have spending starting at $5,000 to $6,000, as opposed to self-service customers, who start at $15-20 per month.
Finally, the company is expanding its product range and serving more and more needs of its customers. This will allow for a steady increase in the average spending of existing customers, which is currently around $827 per year. However, an existing client spends up to $2 million annually with the company. Even a relatively modest increase in spending per customer can significantly expand the revenue potential of an existing customer base. The growth of its products increases the chances of the company to take advantage of this growth opportunity.
Adults at an early age
DigitalOcean’s strategy is to attract and grow a large world of early stage developers and companies without worrying about low customer spending at the start. As these companies thrive using DigitalOcean’s services, the platform will reap rewards in the long run. Successful implementation of this strategy is already leading to steady growth of the company.
But DigitalOcean is committed to a high standard and wants to grow responsibly. It’s steadfastly focused on improving free cash flow, or the amount of cash left after paying its bills. The company has made cash flow positive in 2021 and expects to improve its free cash flow margin from 6% in 2021 to 9% in 2022.
It also strives to ensure that shareholders’ equity is not impaired. DigitalOcean repurchased $150 million of its stock in the first quarter. It expects to buy the same amount over the remainder of 2022 to offset equity granted to executives and employees, ultimately avoiding dilution for shareholders.
It is very rare to see the financially responsible behavior of a company at such a young age. This should give investors confidence that the company is in good hands.
gather it all together
DigitalOcean’s stock may remain volatile. However, the company is working smart to weather the overall headwinds and drive profitable growth. According to DigitalOcean, SMB spending on cloud computing is expected to double from $72 billion in 2022 to $145 billion in 2025. With just $566 million in revenue projected for 2022, the company has a long way to go.
Looking at the company’s prospects, its current price-to-sales valuation of 7.3, as of this writing, doesn’t look very rich. For patient investors, now could be a great opportunity to take on a junior position at DigitalOcean.