DigitalOcean: Does Post-IPO Weakness Present A Compelling Opportunity?

DigitalOcean Holdings (DOCN), which operates a platform for hosting cloud systems, priced its IPO at $47 a share on March 24. This was at the high end of the proposed range of $44 to $47. The company issued about 16.5 million shares and the lead underwriters included Morgan Stanley, Goldman Sachs, J.P. Morgan, BofA Securities, Barclays, and KeyBanc Capital Markets.

However, the debut on Wall Street was quite rocky. On the first day of trading, shares fell by 7%. Of course, the markets were fairly bearish as well, especially for high-growth tech stocks. 

So then, might now be a good time to consider snapping up DigitalOcean stock? Well, let’s take a look.

Background

Ben and Moisey Uretsky started a web hosting business in 2003, with a focus on smaller businesses. No doubt, this provided valuable experience in understanding the market, and the founders would leverage this with their next startup, DigitalOcean, which was founded in 2011 (other cofounders included Mitch Wainer, Jeff Carr, and Alec Hartman). The goal was to make it much easier for a business to adopt cloud technologies.  

DigitalOcean was able to get initial backing from the Techstars incubator (in Boulder, Colorado). This helped to refine the business as well as get customer traction. By the end of the program, DigitalOcean had 400 customers, reflecting a clear indication of the product-market fit.

It should be noted that the focus was on more sophisticated cloud systems, such as containers and Kubernetes. However, DigitalOcean used an intuitive system called a droplet for the deployment. This wound up being a key factor in driving the growth of the company. 

Over time, the senior management team would be replaced by industry veterans.  For example, the current CEO is Yancey Spruill, who was previously the CFO of SendGrid, which has since been sold to Twilio (TWLO) for $2 billion.

Currently, DigitalOcean has about 570,000 customers that span 185 countries and regions. Over the past year, ARR (annual recurring revenues) rose by 25% to $357 million. Additionally, about 69% of customers come from outside of the U.S.

The company has been savvy with a grass-roots approach to marketing, as the MAUs (monthly active users) are 5 million. The result is that DigitalOcean spends only about 10% of revenues on sales and marketing. In fact, the EBITDA margin for 2020 was an impressive 30%. 

Another key to the success of the company has been its transparent pricing (it starts at $5 per month). On top of this, there are no long-term commitments and the fees are based on a usage model, which is especially important for smaller businesses. 

DigitalOcean has also been delivering increases in ARPU (average annual revenue per user), with the figure moving from $35.97 in 2018 to $47.78 in 2020. 

And as for the customer experience, it is impressive. Consider that the Net Promoter Score (NPS) is 65, which is in line with some of the world’s top brands like Apple (AAPL) and Netflix (NFLX).

Conclusion

There are several major tailwinds for DigitalOcean. One is the secular trend towards cloud computing, with the company estimating the opportunity to be $115 billion. In addition, the SMB (small and medium-sized business) category is underserved but large (there are about 100 million businesses across the globe).  And finally, customers want a multi-cloud approach in order to have less lock-in. 

That said, despite all of this, investors may still want to be cautious. The recent volatility in the markets seems to be pointing to a rotation away from growth plays. So, it might be a good idea to be patient on DigitalOcean stock. (See DigitalOcean stock analysis on TipRanks)

Disclosure: On the date of publication, Tom Taulli did not have (either directly or indirectly) any positions in the securities mentioned in this article.

Disclaimer: The information contained herein is for informational purposes only. Nothing in this article should be taken as a solicitation to purchase or sell securities.