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Digital Ocean $DOCN Stock Analysis – A Future Winner?
Company Background
DigitalOcean Holdings, Inc (Ticker symbol: DOCN) is a cloud computing platform offering on-demand platform tools and infrastructure specifically for software developers, start-ups, and small and medium-sized businesses, or SMBs.
DigitalOcean was founded in 2012 with the sole purpose of creating and providing simple solutions that developers love.
With a mission, “to simplify cloud computing so developers and businesses can spend more time creating software that changes the world.”
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It currently has 570,000+ customers across 187 countries spanning North America, Europe, Asia, and internationally.
They provide a range of on-demand infrastructure, capabilities, and platform tools for developers, start-ups, and small micro-businesses (SMBs) which includes:-
- compute;
- network; and
- storage infrastructure; as well as
- software-managed services from building to testing; deploying; and scaling customer serving applications, thereby enabling customers to rapidly innovate and increase their productivity and agility in an ever-competitive environment.
DigitalOcean tailors its platform and offerings to developers, start-ups, small and medium-sized businesses thereby abstracting a lot of complexities making it the perfect place for them to start, build products, solutions and gain much-needed traction to grow and scale their businesses.
Industry Background
Technology is transforming every part of our daily lives from artificial intelligence, IoT, blockchain, metaverse to the day-to-day digital products we use.
This global phenomenon of technology-powered transformation and growth requires every company and business to focus their efforts on leveraging the advantages provided through cloud services.
Cloud computing has become the benchmark IT infrastructure as companies and businesses seeks to take advantage of:-
- the speed;
- flexibility;
- scalability; and
- reliability the cloud tends to provide.
In today’s digital-first world, cloud computing has become the foundation for the effective delivery of the daily services we use as well as an alternative to the traditional enterprise IT infrastructure.
According to IDC, the total worldwide spending on cloud services will surpass 1.3 trillion by 2025 at a compound annual growth rate (CAGR) of 16.9%.
As Infrastructure-as-a-Service (IaaS), Platform-as-a-Service (PaaS), and Software-as-a-Service (SaaS) will see a compound annual growth rate of over 21% through 2025.
Primarily the combined IaaS and PaaS markets are expected to grow at a 27% compound annual growth rate.
The IaaS model covers:-
- primary storage;
- compute;
- disaster recovery;
- backup, etc.
The PaaS model is segmented into application development and testing, data analytics and management, etc.
All of these represent core areas of DigitalOcean’s offerings and products.
So, business continuity and outcome in today’s digital-first world are dependent on the ability to leverage and put to good use the innovative technologies and services as such provided by DigitalOcean.
Investment Thesis
The cloud computing world is dominated by giants like:-
- Amazon Web Services (AWS)(NASDAQ: AMZN);
- Google Cloud (NASDAQ: GOOGL);
- Microsoft Azure (NASDAQ: MSFT); and;
- IBM cloud (NYSE: IBM).
These companies hold a larger portion of the total market share of the cloud computing industry but the majority of their products are tailored to larger enterprises’ needs.
DigitalOcean competes with these giants with similar offerings which are more specifically targeted at individual developers, start-ups, small and medium-sized businesses.
With more than 32 million SMBs in the united states alone according to the world bank, and more SMBs springing up each year this creates an attractive business opportunity.
DigitalOcean (NYSE: DOCN) went public in March 2021 and rose to an all-time high of $133 per share in the second half of 2021 which is 3x its Initial public offering (IPO) share price of $47 per share.
It seems the excitement and the enthusiasm among investors for the cloud company has all but disappeared over the past few months.
With its stock now trading at about $50 – $50 which is just a few dollars above its IPO price, it is nothing but a drastic decline from its all-time high price.
Some of this decline could be attributed to the recent sell-off in tech-focused investment assets including stocks and cryptocurrency.
The technological sector has plummeted in recent weeks with major indexes down from their recent highs.
This could be primarily attributed to the Federal Reserve announcement indicating that interest rate hikes are on the way, resulting in a mass exodus from growth investing towards value investing in the market.
Notwithstanding DigitalOcean (DOCN) remains one to keep an eye on for the reasons discussed below.
Outstanding Growth
In terms of financial performance, DigitalOcean is growing rapidly with revenue steadily at a rate of at least 25% yearly with analysts expecting a 30%+ revenue CAGR through at least 2026.
DigitalOcean most recently announced results for its third quarter ended September 30, 2021. Yancey Spruill, CEO of DigitalOcean said:-
“We are building the foundation for durable 30%+ revenue growth with strong free cash flow generation driven by investments in product innovation to support our customers’ needs and sales and marketing initiatives to further penetrate our massive market opportunity.”
Its third-quarter 2021 financial highlights include:-
- Revenue of $111.4 million, which represents an increase of 37% year-over-year;
- GAAP Gross Profit of $67.9 million i.e. 61% of the revenue;
- The total cash, cash equivalents, and restricted cash were $592.0 million with zero debt as of September 30, 2021;
- Its cash flow from operations was $40.2 million representing 36% of revenue as compared to $23.3million (29% of revenue) in the prior-year period;
- Total capital expenditures were $26.7 million (24% of revenue) as compared to $26.1 million (32% of revenue) in the prior-year period.
Growing Customer Base
With its low-friction, self-service cloud platform combined with a highly-efficient self-service marketing model DigitalOcean is able and well-positioned to increase the number of customers using its cloud computing platform, especially among SMB customers.
If the projected fast growth rate for SMBs is accurate this would create a greater pool of customers for DigitalOcean leading to a faster revenue growth rate.
There are 100 million small and medium-sized businesses in the world and 14 million new businesses are started each year.
Also by 2030, there are supposed to be about 45 million developers in the world. That’s up from 19 million in 2019.
The opportunity to expand its customer base is substantial.
Net Dollar Retention Rate
DigitalOcean’s ability to sustain long-term revenue growth and achieve profitability is dependent on its ability to retain and grow revenue from our existing customers.
DigitalOcean reported a net retention rate of 116% for the third quarter of 2021. Meaning the average customer spent 16% more than in the prior year.
DigitalOcean has a customer base of more than 585,000 customers, this represents a significant opportunity for further consumption of its services within its customer base.
The ability to increase the usage of its platform by existing customers is dependent on a number of factors, including customers’ satisfaction, product offerings, competition, and pricing.
Enhanced Platform and Product Offerings
The market opportunity for serving developers, start-ups and SMBs is substantial and transcends providing the core IaaS services of storage, compute, and networking.
Its ability to invest significantly in, developing and delivering innovative products, features aimed at it core customer base will go a long way in increasing adoption and usage.
Also as the company’s customer base grows, the number of products in the marketplace should grow too which creates immense value for all of DigitalOcean’s customers thus driving up usage.
Multi-cloud adoption
According to HashiCorp’s inaugural State of cloud strategy survey, 76% of 3,205 responses said they already work in multi-cloud environments.
Though multi-cloud adoption tends heavily to larger enterprises.
It also found that 60% of small businesses with less than 100 employees are also operating multiple clouds.
With multi-cloud adoption on the rise, this represents an opportunity to also increase its customer base among larger and smaller enterprises.
Risk Factors
DigitalOcean operates in a very competitive and rapidly changing environment. New risks and uncertainties may emerge from time to time, and it is not possible for us to predict all risks and uncertainties but some of the notable risk factors are:-
- The company is not profitable because of operating losses;
- The cloud computing market is highly competitive this could affect the operating standard and financial conditions thus affecting the stock price and the value of your investment;
- A security breach or unauthorized access to customer data and the platform by unauthorized parties may incur significant liabilities thereby affecting the business which may ultimately impact the stock price.
Conclusion
Digital Ocean $DOCN Stock Analysis – A Future Winner?
Although DigitalOcean competes with some of the biggest companies in the world, its stock offers prime exposure to the core benefits of the cloud computing industry.
DOCN stock offers a unique investment opportunity because major competitor stocks (AMZN, MSFT, GOOGL) are all diversified across other industries with slow growth which may impact their stock performance.
The company has steady revenue growth, quality margins, strong free cash flow generation, and a solid balance sheet all of which indicate that DigitalOcean could achieve profitability in the near future.
With DigitalOcean stock trading at $48 – $55 which is a discount to its all-time high of $135, it represents an attractive investment opportunity for long-term investors.
Cloud computing offers significant opportunities as it will be the bedrock of the delivery of some of the most beneficial innovations and products (A.I, Metaverse, etc.) will use in the future.
Thus, DOCN stock offers a remarkable chance of a stellar return in the near future.
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