A few of us have been in Digital Ocean for a while (MovedOn, Disco Gater and Upsidedowntwice from memory) and whilst the growth rates continue to moderate I thought that it was worth bringing this back to the board since MovedOn introduced it a while back (Why I bought Digital Ocean (DOCN)) and others covered it in portfolio reviews, for a couple of reasons:-
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There seems to be a greater appetite to consider a tradeoff in high growth SaaS versus superior profitability and cash flow plays with a level of value
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As AI reaches peak hype, the search for investible AI plays continues from pure play top down king pins to bottom up picks and shovels operators
Yes Digital Ocean still offers one of the only AWS/Azure like pure play Cloud investment opportunities and that hasn’t changed, however with these other considerations then Digital Ocean could be of interest for a greater number of reasons.
Q1 2023 Results
- Q1 Non-GAAP EPS of $0.28 misses by $0.01 (but up from $0.09 in Q1 2022).
- Revenue of $165.13M (+29.7% Y/Y) beats by $1M.
- Annual Run-Rate Revenue ended the quarter at $669.1 million, representing 28% year-over-year growth.
- Gross profit of $93.3 million or 56% of revenue.
- Adjusted EBITDA was $56.2 million (up from $37.2m in Q1 2022) and adjusted EBITDA margin was 34% (up from 29% in Q1 2022).
- Cash, cash equivalents, and marketable securities was $613 million as of March 31, 2023.
- Net Dollar Retention Rate was 107% as compared to 117% in the first quarter 2022.
- Average Revenue Per Customer was $88.35, an increase of 16% over the first quarter 2022.
- Builders and Scalers, those customers spending more than $50 per month, increased 43% from the first quarter 2022 and their revenue grew 32% year-over-year.
- Repurchased 7,759,973 shares for $266 million under the share repurchase program.
Q2 Outlook:
- Total revenue of $169.5 to $170.5 million.
- Adjusted EBITDA margin of 37% to 38%.
- Non-GAAP diluted net income per share of $0.40 to $0.41.
- Fully diluted weighted average shares outstanding of approximately 103 million shares.
2023 Outlook:
- Total revenue of $700 to $720 million.
- Adjusted EBITDA margin of 38% to 39%.
- Adjusted free cash flow margin in the range of 21% to 22% of revenue.
- Non-GAAP diluted net income per share of $1.70 to $1.73.
- Fully diluted weighted average shares outstanding of approximately 103 to 105 million shares
So where does that leave us?
Well, on the revenue front Digital Ocean are at a $669m ARR level scale of business having turned in $165m for Q1 revenues.
On the revenue growth side of the equation at 30% for Q1 Digital Ocean is still growing faster than the IaaS/PaaS market and out growing Azure and AWS and is forecasted to grow 23% for the full year - and that includes a year of cloud optimisation, (they have a consumption based revenue model).
On the profitability and cash flow side they guide operating at 60% Gross Margin and 38% EBITDA Margin and 21.5% Cash Flow for 2023, with Capex falling to 15% of revenues this year. Net income growth was even stronger than revenue growth at 141% for 2022 and forecasted net income growth for 2023 at 70% thanks to leverage and on a per share basis at 80% in 2023 due to share buy backs and declining share count (-20% from end of 2022).
On the value side Digital Ocean, whilst not the highest growth play in town, is sporting a forward P/S of 4.12 and… wait for it… a forward P/E of 19.1 and for those that remember this good old fashioned metric… a PEG of less than 1 at 0.24! (1 year forward PEG).
All of this can be had for a company with a market cap of only $2.9bn playing in a $98bn total addressable market ($62bn IaaS and $36bn PaaS) expected to grow by a 26% CAGR over the next 3 years to $195bn in 2026.
From the earnings call which has plenty to digest…
- Their SMB customer base are firmly AI users and a lot of their compute capacity serves AI modelling and AI tools which they see as a tail wind
- Their churn has been flat and the consumption optimisation has come from lower expansion of existing customers
- They are introducing a pricing increase for their 2022 acquisition - the Cloudways hosting business, from April (the first for 5 years) which apparently has gone down well
- Their new Chief Revenue Officer is Chris Merritt (ex Cloudflare who took Cloudflare from 0 to $1bn in revenues). Not sure what to make of that given the 100 day findings of their new revenue officer. Although maybe a bottom up SMB style sales organisation might suit Chris better and Digital Ocean has an extremely self serve orientation in its sales.
- Their operating costs (and GM) have been weighed down in recent quarters with the build out of their Sydney Data Center which is now completed
- Analysts congratulated them on “stability and efficiency”
Financial Metrics and KPI Table…
| Q1’21 | Q2’21 | Q3’21 | Q4’21 | Q1’22 | Q2’22 | Q3’22 | Q4’22 | Q1’23 | |
|---|---|---|---|---|---|---|---|---|---|
| Revenue (M) | $93.7 | $103.8 | $111.4 | $119.7 | $127.3 | $133.9 | $152.1 | $163.0 | $165.1 |
| Revenue Growth | 29% | 35% | 37% | 37% | 36% | 29% | 37% | 36% | 30% |
| ARR (M) | $388 | $426 | $455 | $490 | $524 | $544 | $641 | $659 | $669 |
| ARR Increase (M) | $31 | $38 | $28 | $35 | $34 | $20 | $97 | $18 | $10 |
| Adj. EBITDA (M)1 | $31.1 | $31.2 | $36.6 | $37.8 | $37.2 | $45.5 | $61.5 | $54.2 | $56.2 |
| Net Dollar Retention Rate (NDR) | 107% | 113% | 116% | 116% | 117% | 112% | 118% | 112% | 107% |
| Average Revenue Per Customer (ARPU)2 | $59.32 | $63.93 | $67.65 | $72.01 | $76.45 | $79.74 | $86.54 | $87.52 | $88.35 |
| Builders and Scalers (Customers that spend more than $50 per month) | 85.2k | 90.7k | 94.6k | 99.4k | 102.5k | 105.4K | 142.1K | 144.2k | 146.5k |
| Builders and Scalers % of total company revenue | 81% | 82% | 83% | 84% | 84% | 85% | 86% | 86% | 86% |
| Capex as % of Revenue | 25% | 25% | 24% | 27% | 20% | 24% | 21% | 19% | 15% |
Q1 2023 Results Announcement
Q1 2023 Results Presentation
Q1 2023 Transcript