DOCU (12.6% allocation; Q2FY22 2Sep earnings date)
DOCU was the last portfolio company to report its quarterly results. My thoughts about their 30Apr quarter were summarized in my 4Jun Portfolio Update:
DOCU now has another quarter under its belt, but my overall sentiment on the Company is largely unchanged. I like my growth companies to have four characteristics which I described in a recent blog post:
Let’s go through them again for DOCU.
Dominant company within its markets: DOCU is far and away the dominant company in its market with >50% market share in its eSignature business. It’s not even a contest.
Profitable: Many hyper growth firms aspire to one day become profitable. DOCU is already there. Free cash flow (FCF) hit a record $162M in the quarter; FCF margin also hit a record 32%. DOCU continues to throw off increasing amounts of cash all while investing substantial amounts into R&D and other expansions efforts.
Durable competitive advantage: DOCU is leveraging its market leadership position in eSignature to expand into adjacent markets such as CLM and Notary. Notary has now been rolled out into 18 U.S. states with more on the way. Furthermore, DOCU continues to utilize its financial strength to expand on its lead by pushing into new geographies and introducing new product features and enhancements. Thus, by building on its considerable lead, DOCU is erecting a larger and larger barrier to entry which further increases its competitive advantage.
Continued future growth: DOCU’s subscription revenue grew at 52% y/y. While this is higher growth than the year ago quarter, growth was higher during the pandemic (three quarters prior to the most recent quarter). Management expected growth to dip lower after the pandemic, and we are seeing this now. It’s likely that DOCU’s growth will settle in the high 40%s in the coming quarters. So why is it acceptable to keep DOCU in the portfolio when there are higher growth opportunities available? Sticking with growth for a moment, DOCU has only penetrated a small fraction of its addressable market (see slides 10-11 in the latest investor presentation: https://s22.q4cdn.com/408980645/files/doc_presentations/2021… ). DOCU has years of growth ahead in eSignature and its newer products. In addition, DOCU has room to grow internationally; international revenue comprises only 22% but it is growing faster (71%) than overall revenue (50%). Thus, the growth boost from the international business should continue for a while.
So let’s go back to the question of the relatively low growth of DOCU. Why is it ok for the portfolio to hold a position that’s expected to grow less than 50%. First, growth will likely remain high for a very long time. Second, the other three characteristics are incredibly strong which means that the certainty of DOCU being the top company in its markets is virtually assured; the possibility that DOCU will be disrupted is pretty much off the table, maybe more so than any of the other companies in the portfolio. Last, DOCU has and continues to lay the groundwork for its new and upcoming products to succeed. eSignature is the prerequisite for the next products in the Agreement Cloud. In short, DOCU’s strategy and product roadmap is extremely powerful and and continues to be brilliantly executed.