Digital Ocean Q1 2023 Results

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:-

  1. 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

  2. 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…

  1. 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
  2. Their churn has been flat and the consumption optimisation has come from lower expansion of existing customers
  3. 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
  4. 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.
  5. 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
  6. 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


A couple other observations on DOCN. I own a small amount ~ 1% holding, which for me is about a half-size position.

I could be mistaken, but I do not see any insider selling by the CEO since they went public - and he has over 3MM shares according to this site - So, even when DOCN was over $100 he was not selling. (Maybe he sold some as part of the IPO and those don’t show up? I am not sure where to look for things like that.) But, even if he sold some at the IPO price around $40 - he did not sell any during the big spike up to $130.

In addition, there is very little insider selling at all.

On a different topic - DOCN raised $1.3 billion at just about the absolute peak in the stock price. They raised it as a “Convertible Senior Notes Offering” - with 0% interest. Yes, that is what the news reports says - 0%. The notes mature December 1, 2026. Quote from the news release - “The initial conversion rate is 5.6018 shares of common stock per $1,000 principal amount of notes, which represents an initial conversion price of approximately $178.51 per share of common stock. The initial conversion price represents a premium of 50.0% over the last reported sale price of $119.01 per share of DigitalOcean’s common stock on November 15, 2021. The conversion rate and conversion price will be subject to adjustment upon the occurrence of certain events.”

So, if you rode this down from $120 - it could have been worse. The people who loaned this money effectively paid the equivalent of $178 per share.

Now, DOCN is using that money to repurchase shares at what seems like it might be bargain basement prices.

  • In 2022 - Returned $600 million to shareholders by repurchasing 13.6 million shares.
  • In the most recent quarter they Repurchased 7,759,973 shares for $266 million under the share repurchase program.
  • In February 2023 they announced that they were increasing their share buyback program by up to $500M.

Seems like pretty good management of finances to me.

Short % of shares outstanding is 17%! That is the one thing that scares/confuses me. I can not find an explanation for why there is that much short interest on this - other than some kind of stock manipulation. It makes me wonder if I am missing something - but it also probably keeps a lot of people from considering buying - which might be what the manipulators want. (conspiracy theory).

Time will tell. Keeping my position small-ish, but I have doubled it since their ER.


AnalogKid70 - yep I agree that their financials have been managed extremely well. It was a shame that the previous CFO stepped down to retire.

One other point on financials…

"On January 27, 2023, the Board of Directors of the Company approved a restructuring plan to adjust its cost structure and accelerate its timeline to achieve greater than 20% free cash flow margins. The Restructuring Plan includes both the elimination of positions across the Company as well as the shifting of additional positions across a broader geographical footprint over the next several months. As a result of these headcount actions, the Company’s total employee base will be reduced by approximately 11%.

The Company estimates it will incur approximately $25 to $27 million in non-recurring charges in connection with the Restructuring Plan, predominantly related to cash expenditures for employee transition and severance payments, employee benefits, and stock-based compensation. The restructuring will result in an annualized run-rate savings of $60 million. The Company expects most charges to be recognized by June 30, 2023."

By the looks of it about $22m has been expended from this charge so not much left to go in Q2. Had it not been for this charge in Q1 the YoY GAAP profitability progress would have been very strong and further narrowed the negative GAAP earnings position. (I estimate it would have narrowed from -$18m to -$12m YoY).


Thanks for pointing this out, @anthonyms! Sure, they’re slowing down, but they’re generating meaningful (and growing) profits, and they’re priced for very little (if any) growth, whereas I think they’ll continue to grow incrementally with their customers. And at a market cap just over $3 billion, it feels like the upside outweighs the downside.

One negative I guess is that they have more debt than cash…but the debt is 0% convertible notes, and with strongly positive FCF they’ll be able to pay it back easily. The cash is down because they’ve spent it buying back shares. Can’t argue with that use of cash.

Not a super exciting company, and growth won’t be hyper, but I think it’s a bit undervalued. I’m in for a ~1% position and I’ll follow them for a bit.