DigitalOcean: Taking The Next Step To Cloud Darlinghood

DigitalOcean: Taking The Next Step To Cloud Darlinghood

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DOCN just released their 3Q earnings. On the face of it, this was a beat, and a relatively strong quarter from a pretty consistent business.

NDR increased to 116%, ARPU strengthened, and the company managed to further accelerate revenue growth to 37% y/y.

Thematically, we like DOCN as it is a real player in a massive market with a relatively unique product. Moving to PaaS and FaaS will help DOCN scale in time.

DOCN may eventually face the TWLO dilemma however. We are worried over the potential commoditization of core IaaS as large competitors move down-market and small competitors nibble underneath at market share. Broadening to PaaS and FaaS services will likely help to differentiate however.

Downgrading DOCN from Buy to Hold, increasing PT from $77 to $106. Bear case target set at $52. Bull case target set at $135. r/r skews downward, hence the downgrade.

da-kuk/E+ via Getty Images 3Q Recap – Firing On All Cylinders

DigitalOcean (NYSE: DOCN ) reported third quarter earnings this past Thursday, and the results were fairly solid. Let’s briefly recap: Reality Cons. Expectation +Beat/-Miss Revenue (in $m) $111 $108.17 +2.6% EPS $0.12 $0.07 +71.4% ARPU $61.97 $59.82 +3.6% NRR 116% 114% +200bps Gross Margin (non-GAAP) % 80.2 78.9 +130bps Customer Count 598,000 611,556 -2.2% 4Q Revenue Guide (in $m) $118 $117.28 +0.6% 4Q EBITDA Margin Guide % 30.5 29.9 +60bps As can be seen here, the company delivered solid results and guidance, with highlights including strong EPS, net retention rates, gross margins, ARPU, and revenue. Points of concern could include the substantial miss on customers, and the relatively in-line guide for 4Q revenues. Both concerns will be addressed in this note. Now that we have the data from the print, let’s dive into management’s conference call to get all the qualitative details. Conference Call Notes: Added Color on Customer Issues, GTM Strategy, Competition & More

As a result, we are increasing our outlook for the balance of 2021 and reiterate our confidence in sustaining 30% or better growth in 2022. The transformation of DigitalOcean is well underway and we remain laser-focused on achieving our first $1 billion of revenue in 2024. – Yancey Spruill, CEO Management has reiterated longer-term targets/informal guides for next year and 2024. Management is confident that the business can sustain 30%+ revenue growth into next year, and eventually hit their $1 billion revenue goal by 2024. It is good to see management reiterate its confidence in their goals. Relative to Q3 of 2020, top line growth improved nearly 1,300 basis points and accelerated more than 200 basis points from the prior quarter. – Yancey Spruill, CEO What is so fascinating about DigitalOcean is that we are just now seeing their initiatives pay dividends. In 3Q of 2020, revenues only grew about ~24%, but as a result of the leadership and strategy of Yancey & Co., the business has seen a re-acceleration in growth on both a y/y and sequential basis. Investors often ask whether we would be willing to invest even more into the business to grow even faster. The answer is we are doing so today. In fact, our margins could have been higher in Q3 but we see opportunities to invest that will enhance our growth in 2022 and are more than happy to hold back on current adjusted EBITDA margins in order to give us a head start on product innovation and go-to-market initiatives, driving growth acceleration into 2022. – Yancey Spruill, CEO This should be a very comforting passage for anyone invested on the long side of DigitalOcean. One of the underlying concerns I had developed with DigitalOcean was that a move away from a founder-led (Uretsky brothers) vision and towards an experienced steward would change strategy. Essentially, pushing for growth would be sacrificed in order to attain short-term shareholder returns, cash flow, and margins. The greatest companies in the world are the ones who invest in their businesses now along the S-curve rather than sit on their heels and return capital. I am glad to see that Yancey & Co. are investing in the business while also maintaining solid margins. As counterintuitive as it may seem to ‘value’ investors, investing in the business now at the expense of margins is a ‘green flag’ for me as it shows the dedication and prioritization of growth. In spite of DigitalOcean’s eye-popping low 30s EBITDA margin this quarter, it was actually suppressed by investments in GTM and product development. These investments are expected […]

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