Docusign - Bert's comments after call with I

Investment Analysis Clubs Saul’s Investing Discussions
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A few days ago, I wrote about Docusign and stated that I’d arranged a call with the company’s IR department to better understand its business/moat.

Since I am the most non-techie person around (although I do understand numbers), I arranged for Bert Hochfeld to speak with Annie at Docusign.

Bert just concluded his call a couple of hours ago and he has sent me a glowing email!

Docusign has a 70% market share in its space and its real moat lies not in its e sign functionality but rather in its workflow automation and documentation process which it provides to enterprises.

Docusign’s central focus is in its ‘System of Agreements’ and the company is a clear leader in this area.

Bert is impressed by this business and he is planning to do a write up for his subscribers soon.

Docusign’s stock is up a fair bit since I invested a few weeks ago but this is likely to be a multi year growth story.

Hope this has been helpful.

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Bert has sent me another email and stated that Docusign’s System of Agreement (workflows and contract automation offering) will probably become the industry’s gold standard a la Microsoft Office or Adobe PDF.

He reckons Docusign will continue to grow rapidly over the next few years and that this underappreciated story is only in its first inning.

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GM,

Thank you!

Since they already have a 70% market share, I gather the growth story lies in the growth of the TAM. Is that your understanding?

Rich

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Bert has sent me another email and stated that Docusign’s System of Agreement (workflows and contract automation offering) will probably become the industry’s gold standard a la Microsoft Office or Adobe PDF.

Great stuff GM, thank you!!!

Matt

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Great update GM. Thank you for sharing.

Over last few weeks, I am becoming more confident (and more invested) into Docu.
The challenge with DOCU is that it’s dominance is / may remain so highly visible that one may not get bargain price point for a long time.
So it will continue to grow, just the level of upside may not match to what NTNX offers next few quarter… (and what ZUO May offer in 2020/21).

To me, it’s not just the best business, it’s the hidden growth stories bought at more opportune time that create highest returns…

Nilvest
(Mid size position in DOCU)

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Rich,

Docu has a 70% market share in e signatures but its real moat lies in its workflows and contract automation process solution “System of Agreement”.

As I understand, the e signature tool will eventually become commoditized, but nobody else is working on the contract/document automation process.

Docu has obtained regulatory approval, its solution offers security, reliability and compliance AND the company stores heaps of meta data for audit purposes.

The adoption of the ‘System of Agreement’ is still in the first inning so this is where the opportunity lies.

Currently, business contracts are prepared manually, they are printed off, emailed/sent to the other party, manually printed off/signed, scanned, emailed and sent back by courier - this antiquated system is what Docusign is attempting to automate.

I am not a techie, so dont really understand the nitty gritty but do know this automation makes sense (better security, cost and time savings etc).

Hope this has been helpful.

GM

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You are welcome Matt.

I have learnt a lot from this board so happy to give back, so we can all profit from the opportunities.

GM

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Since they already have a 70% market share, I gather the growth story lies in the growth of the TAM.

Do not confuse market share with market penetration. This business is nowhere near 70% market penetration (of TAM). DocuSign has 70% of the current revenue.

Denny Schlesinger

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Let’s make a correction here, and there are other companies working on the system of agreements. The market is large enough that Forrester did a report on it in 2018. There are at least 3 larger companies than the one that Docusign bought for $200 million. There are 4 or 5 in the leader’s sector (with the company that Docusign bought the smallest of the leaders (Spring), but near the back of that leader pack in the leader area).

What Docusign bought is the most modern and cloud native of the leader companies with the least legacy issues to deal with (in fact near zero legacy issues). The product is not as mature as some of the other larger players. But the reason for Docusign buying this smallest of the leaders is because they are (1) the most modern, and (2) DocuSign believes they can sell it into their enormous installed base, whereas Spring was otherwise handicapped in the market being a smaller player.

So it is not a brand new market that never existed before. It exists and there are established players, and at least 2 or 3 leaders that are larger than Spring.

None of the companies in this market however have a company like Docusign to push the product into an incredibly large customer base.

TBD as to how well it sells. Docusing paid $200 million for Spring. At a just 4x revenues (which is light these days) that means Spring had only $50 million in revenues or less. Thus, this is not a huge market for anyone yet, but most particularly not for Spring. Docusign will need to do a lot of evangelizing to (1) grow the market and (2) convince the market that Spring is the answer (this is probably the easier aspect of the two.

I am sure Bert did not have access to the Forrester report in regard. Nevertheless, there is no doubt that Docusign, if focused, will geometrically increase Spring’s ability to diffuse itself into the market than Spring alone was able to accomplish.

Tinker

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I don’t have a DOCU position, but I do have an anecdote.

I have been on the receiving end of DocuSign onboarding workflows and involved in hiring workflows for a 4 years or so. It seems to have quickly become ubiquitous in certain tech company circles (like WDAY, which is surprisingly never brought up here, but may be the moat-iest of cloud SaaS providers).

Recently I set it up and did a document end to end with a signing / countersigning workflow, and it was insanely easy. It was as simple as dragging a document onto their site to import it, set up the parties (name and email), dropping form fields onto the document (name, date, signature fields) for each party, and sending. It worked flawlessly and saves time (timed it end-to-end at about 2 minutes from new document to multi-party signed). I am a fan of the product, if not the valuation.

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I am a fan of the product, if not the valuation.

This is counterintuitive but we have discussed it many times on the NPI board and David Gardner makes it one of his prime criteria for Rule Breakers, and this is if the stock is cheap (in the textbook sense) run away from it as fast as possible. That simple.

When it comes to disruptive innovation any company worth investing in once they go public will not be textbook cheap. In fact we could barely find an exception to the rule. The cheap get cheaper.

That does not mean you do not look out for bubbles, but at least for me, if Docusign are not an expensive stock from textbook valuations I would not even want to look at it.

But each to their own. I would be interested to know who has bought “cheap” stocks and done well with them.

Recent issues are Talend (cheaper than peers by about 50%), NVDA got real cheap, even textbook cheap, Pure with an incredibly cheap price to sale and it kept getting cheaper, Cloudera… Of the many we looked at Nutanix was the only one that recovered from a too cheap price to sale.

At some point Nvidia will probably grow its multiple again, but it is the exception to the rule in my experience.

This aside, excellent to hear about how well Docusign’s system of agreement software is working. I am just experimenting with the simple eSignatures for my business. Quite fun just working with that.

Tinker

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When it comes to disruptive innovation any company worth investing in once they go public will not be textbook cheap. In fact we could barely find an exception to the rule. The cheap get cheaper.

I agree with you. But let me show you my thought process. I am procrastinating on other things, so I whipped up a 20 year DCF table for DOCU based on https://finance.yahoo.com/quote/DOCU/analysis?p=DOCU (consensus 2019 and 2020 analyst estimates for revenue and earning are the basis for the first two rows, then extrapolated). I used a 10% discount rate because of the risk. I hardcoded some growth rate and expense rate values to make it clearer (and tracked net margin to prove it was staying in reasonable ranges).


revenue         growth	expense	        growth  shares	margin  eps	dcf term	
700.00		        690.00		        165.00	0.01	0.06	0.06	
860.00	        18.60	820.00	        15.85	173.25	0.05	0.23	0.19	
1,075.00	25.00	1,000.40	22.00	181.91	0.07	0.41	0.31	
1,343.75	25.00	1,220.49	22.00	191.01	0.09	0.65	0.44	
1,679.69	25.00	1,464.59	20.00	200.56	0.13	1.07	0.67	
2,015.63	20.00	1,728.21	18.00	206.58	0.14	1.39	0.79	
2,418.75	20.00	2,004.72	16.00	212.77	0.17	1.95	1.00	
2,781.56	15.00	2,245.29	12.00	219.16	0.19	2.45	1.14	
3,198.80	15.00	2,514.73	12.00	225.73	0.21	3.03	1.29	
3,518.68	10.00	2,690.76	7.00	232.50	0.24	3.56	1.37	
3,870.54	10.00	2,879.11	7.00	239.48	0.26	4.14	1.45	
4,141.48	7.00	3,023.07	5.00	246.66	0.27	4.53	1.44	
4,431.39	7.00	3,174.22	5.00	254.06	0.28	4.95	1.43	
4,741.58	7.00	3,332.93	5.00	261.68	0.30	5.38	1.42	
4,978.66	5.00	3,432.92	3.00	269.53	0.31	5.73	1.37	
5,227.60	5.00	3,535.91	3.00	277.62	0.32	6.09	1.33	
5,488.98	5.00	3,641.98	3.00	285.95	0.34	6.46	1.28	
5,763.42	5.00	3,751.24	3.00	294.53	0.35	6.83	1.23	
6,051.60	5.00	3,863.78	3.00	303.36	0.36	7.21	1.18	sum
6,354.17	5.00	3,979.69	3.00	312.46	0.37	7.60	1.13	20.51

So this admittedly flawed and extremely simplified model comes out to ~$20 present value for DOCU. But as a spitballing exercise shows me it’s roughly fairly valued or a little overvalued. You can say “hey, the discounted term in year 20 still shows a lot of juice, you are leaving out a ton of tail valuation”. I tried running it out to 68 years (luck of the drag in my spreadsheet), capping them at 41% net margins (pegged rev and expense growth to 4% in year 23 forward), ensured the discounted earnings in year 68 were trivial ($.02), and the result was $34/share. Still fairly valued to slightly overvalued.

If I had some better analyst reports I might try looking at the projected TAM and DOCU’s market share in year N to see if the “model” agreed.

I tried to be conservative in the revenue growth. I am pessimistic about large company budgeting discipline, but perhaps they can cut expense growth even more rapidly. I am pessimistic about tech company dilution, and given float/fully diluted shares I probably was not conservative in share count.

But anyway, as a spitball exercise, it still comes out to a P/S of 5-9 depending on if you use the $20 or $34 value. That’s not cheap.

If you accept that valuation, though, maybe they’ll get acquired for a premium. They are already almost $8B with a P/S of 12. It’s one thing when a $3B acquisition happens at 20 P/S, but they are already relatively large. NetSuite isn’t a total comparable but they were 11 x TTM revenue. Maybe ORCL and SAP could get in a bidding war. Maybe ADBE or CRM would do a cash/stock offer. But I’m not sure it’s a double in 5 years.

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When it comes to investing I am a lot like Han Solo, “don’t ever tell me the odds,” or the DCF. That is textbook analysis and frankly there is not a single investment that Saul has, or I have had over {well ever} that has satisfied a textbook DCF analysis. I mean, run Twilio or Mongo or TTD through one of those. TTD is the only one with even a prayer of coming out even in hemisphere of what the textbook DCF says it should be worth.

YOY from 2018 to 2017, sales and admin expenses rose 15% while revenues rose 35%. That is called scaling and leveraging a business even while spending everything you have to sell, sell, sell, sell. A lot like Zs who became profitable, unexpectedly and without any intent, a year ahead of time.

I once had a DCF model used only inside the largest i-Banks. One of those prize little tools that you get at an elite MBA school (I did not actually belong there but I do pretty well on my GMATs, so I went). That tool actually worked reasonably well. Unfortunately, over the years, I lost it from computer to computer prior to Dropbox or Evernote.

CAP is one of the foundational elements of valuation that no DCF ever includes. Look at ISRG, despite only now growing in the low teens it still has a multiple of enterprise value to sales similar to Abiomed that is growing 2.5x faster.

Look at VEEV, growing in the low 20 but still with a multiple of 11x or more. That is called CAP.

Who is competing against DOCU? Well Adobe at 1/4 the size. The narrative from the last conference call is very instructive as to the competitive environment Docusign faces. The multiple is too low given a CAP like that, and given unanticipated upside to come such as if they are successful in push the systems of agreement, when the Federal government starts making eSignatures and systems of agreements part and parcel of their standard practices, as Trump, if memory serves, did sign the eSigning bill for the Federal government. The bill actually requires the Federal government to start using eSigning. So who will they predominantly use…{input your answer}.

Better yet, find a single company that has had extraordinary returns that actually comes out not extremely overvalued on a proposed DCF…good luck. It will not be easy. Perhaps Nvidia can now qualify as reasonable within a DCF model.

Tinker

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DCF had its day in the sum applied to commodity makers growing at vegetative rates like P&G and utilities. DCF was never precise but it is even more imprecise with fast growing, asset light, knowledge based companies. Some years ago I tried using DCF with my portfolio and never got reasonable results.

One has to use tools appropriate to the day and age. When Graham and Dodd wrote the first edition of Security Analysis they didn’t consider stocks investing but speculation. In time they changed their tune. Back then most if not all businesses were governed by the economic law of Decreasing Returns. Most if not all of Saul’s companies are governed by the economic law of Increasing Returns, a relatively new concept. To give an example, the cost to produce a ton of steel says fairy constant. The first copy of software is mightily expensive, the second one is practically free. When I was selling my software in Silicon Valley 30 years ago I had quite an expense in materials used, disks, labels, manuals, boxes, and shipping. Downloading the stuff on the WWW is practically for free.

Growth no longer costs what it used to cost.

Denny Schlesinger

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