DocuSign vs. Cloudflare

Both companies have now announced Q4 earnings and both companies saw a pretty big drop in share price due to valuation and “soft” guidance. I’d like to better understand the board’s thoughts on these two stocks since I’m still not fully understanding why there’s so much love for Cloudflare vs. DocuSign.

DocuSign is guiding for $1.97 B in revenue for this year which is 35.8% YoY growth and Q1 guidance is $436 M on the high end which is 46.8% YoY, but only 1.18% sequentially. Assuming they beat annual guidance like they normally do which is around 5-8%, DocuSign will finish the year around 43-48% YoY growth.

Cloudflare is guiding for $593 M in revenue for this year which is 37.6% YoY growth and Q1 guidance is $131 M on the high end which is 43.6% YoY, and 4.05% sequentially. Assuming they beat annual guidance like they normally do which is around 6-9%, Cloudflare will finish the year around 45-50% YoY growth

DocuSign has an NRR of 123%
Cloudflare has an NRR of 119%

DocuSign’s FCF margin for the 2020 year was 14.8% up from 4.5%
Cloudflare FCF margin for the 2020 year was -21.6% up from -33.5%

DocuSign has 892k customers with 51.4% growth and 8.5% sequentially (12.2%, 13.3%, 9.8% and now 8.5%)
Cloudflare has 111k customers with 32% growth and 10% sequentially (6%, 7.8%, 5% and now 10.1%)

DocuSign has 599 greater than $300k customers, a 10.5% growth sequentially (up from 4.23%) (didn’t see the YoY)
Cloudflare has 828 greater than $100k customers, a 12.5% growth sequentially (down from 15.5%) and 57.4% YOY

DocuSign has 80.4% Non-GAAP GM up from 78.8%
Cloudflare has 78.07% Non-GAAP GM slightly down from 78.7%

DocuSign has a market cap of $39.2 B and a TTM EV/S of 26.8
Cloudflare has a market cap of $23.6 B and a TTM EV/S of 53.4

Based on all the financials above, it seems DocuSign and Cloudflare are pretty on par with one another from a financials perspective. I agree DocuSign seems to be slowing down more dramatically from a Q1 guidance perspective (though DocuSign’s Q1 is historically slightly softer than other quarters sequentially), but both companies are offering comparable annual guidance with mid-high single digit beats generally.

DocuSign though has significantly stronger FCF margins than Cloudflare (yes, they are a significantly bigger company revenue wise, but not so much from a valuation perspective) and showing some solid operating margins. DocuSign also has improving margins and a higher NRR.

Cloudflare has a lot going for them and their sequential customer growth is impressive and they are also showing improving operating margin too.

Ultimately though, Cloudflare is being valued from a TTM EV/S perspective, twice as much than DocuSign, and even if you use a forward EV/S view, since both companies have revenue growth rates that are comparable, it’s still basically the same forward EV/S.

Yes, Cloudflare’s tech is pretty impressive and is likely a lot more “cool” than e-signature solutions, but DocuSign still has a lot of growth drivers, per their CC they still have a ton of opportunity to expand internationally and they are finally building some pipeline in their CLM product though it’s likely not going to be a material add in FY '22, but it’s something that will likely be a growth driver in the future which will be ON TOP of their already impressive growth rate given the size of the company.

I know many people have different opinions on this, but I am of the mindset that valuation still matters to a degree on share appreciation and given Cloudflare’s already steep valuation, it just seems DocuSign has more “upside” given their comparable revenue growth rate and strong FCF margins which likely will provide a floor to some degree on their share price.

Finally, I will definitely concede that Cloudflare will likely outperform DocuSign from a revenue growth perspective this year, but 40-45% vs. 45-50% doesn’t seem to be a significant difference, especially since DocuSign has slightly higher gross margins. Does Cloudflare’s tech, TAM and slightly higher revenue growth rate really warrant 2x the valuation?

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I didn’t mean to start a Cloudflare vs. Docusign war, but it looks like you’ve doubled down on this Franklin29! I like the way you wrote up the compares though and just trying to stick to the numbers.

I, like you, though not a valuation snob do look at valuation in a similar manner that you do, and I’d be lying if that wasn’t a small part of my decision making.

I don’t think anyone is going to claim with a straight face that Docusign’s revenue growth in 2021 and beyond is going to consistently outpace Cloudflare’s revenue growth, but like you said they are still pretty close and obviously Docusign outperformed on a relative basis rather significantly in 2020 (fully acknowledging the COVID pull forward) while at more than 3x the revenue base.

At some point as an investor I guess you just have to decide how much all these other factors like margin expansion (both operating and profit), earnings expansion, customer expansion, free cash flow expansion, retention rate expansion, etc. matter to you relative to revenue growth. If the growth rate continues to decline into the 30’s and point lower than it may still be a “good” investment if they are killing it in other areas, but not appropriate for this board. At this point I don’t think anyone is close to concluding that for either of these companies based on following the actual results to-date.

FWIW, I sold out of my small position in Cloudflare the day after their report because I felt they should be growing faster at their size and with their opportunity than they currently are and/or guiding stronger such that even with beats their rate of growth would trend higher than hovering around 50%, and we all only have so many companies to put out money into, so it missed my cut FOR NOW…they are absolutely still on my radar to put back in my portfolio if they crush it the next few quarters and I do love the long term play and think they’ve been executing much better than their chief competitor (Fastly).

-Chris

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I think discussions like this sometimes get buried in detail and miss the forest for the trees.

On the one hand, if one has any LTBH positions at all, I personally think both DOCU and NET are “must own for 2030” companies. For me, both DOCU and NET are very high conviction because of 1/what they do and 2/ limited potential for new serious competition.

On the other hand, as with others here, I do look at maximizing current performance as well, hence I have been adding elsewhere. So I have positions in both DOCU and NET, but I am adding to neither. I am tempted but I believe there are better multiple to growth ratios elsewhere–NARI, thanks Saul!, and BAND–where I added a week ago. Today, I moved some money into DDOG as well.

In sum, there is nothing wrong with owning DOCU, NET as well as a bunch of other great companies.

It seems to me that one should not concentrate without firm conviction. If you believe only 6 companies are worth your money today, do only invest in those 6. If you really like 20, invest in 20, don’t force yourself in following Saul strictly; forge your own path.

My 2c

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I agree with you for the most part. I may change my mind or weighting but I expect to be closing out my Docusign position entirely and reducing my Cloudflare a bit but still not insignificant in size. I plan to post some details in a portfolio review once I do decide.

I’ve said this before and it is true here again: You are probably seeing Cloudflare awarded a richer valuation because they deserve it. Expectations are higher. Rarely is a cheap stock a good deal.

I already posted my thoughts on Docusign (a company I was in real early on and do like, but the numbers seem to be telling me all I need to know). I have a place for the funds.

The reason I am still very bullish on Cloudflare is

  • their TAM is huge and growing. There is no end in sight.
  • They have been a stable grower and are still relatively small (at about 23 billion they are roughly half the size of DOCU). So there is room here too.
  • they seem to keep winning. Well run. Smart decisions. True for both companies here actually.

Compare that to docusign which has a somewhat fixed TAM until they get their machine learning and lifecycle management products to a size that they drive revenue. The thesis all this time has been that I am happy to own a company performing NOW while I wait for this other stuff, but I will NOT invest ONLY in the potential of future products. I thought we had another year at least to see it play out but Managment has just told me it isn’t happening early enough.

I may end up wrong but I see no reason to hold DOCU during the next few quarters while things develop when I can build positions is Ligtspeed, Inari, ZScaler, etc

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I own both companies but with totally different allocation size. Cloudflare is my top position, rapid development cycles, innovation, massive and expanding TAM, killing it at any level. It takes a lot of time and technical knowledge for one to actually grasp the potential of this company. Their CAGR has been 50% since 2016 and will continue to be in that range IMO for a longer time than some of the companies being followed on this board. I actually don’t know if any other currently followed companies have achieved such performance and have a TAM of $100B and growing.

Docu is one of my smaller size positions but I had actually picked shares yesterday since I thought they were on sale. I do plan on adding slowly throughout the year. Their current growth might be comparable to Cloudflare but I don’t anticipate them maintaining growth in the 40s or even mid 30s for long unless they can materialize their efforts from CLM and future AI products. Business is super sticky, with huge potential and definitely not a covid19 play.

It’s hard to say how market sees these or any other companies right now. I think the drops with pretty much any company this year after earning were due the anticipated marker correction in growth stocks, that just took place

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Great discussion!

I did a brief comparison of NET vs SMAR in my December 2020 portfolio writeup, trying to figure out why NET was valued so much higher than SMAR at the time. At least so far, both companies’ stock prices have been about flat since January 1st, although SMAR is yet to release earnings for the latest quarter.

Preface

Let me preface this by saying that the main reason I have never owned Cloudflare is because I don’t feel like I understand the company, and what it does, at least not as well as most of the other companies in my portfolio. That being said, I do follow and track their earnings reports and stock prices, as I do with SNOW, because so many smart people on this board think highly of the company, and if the valuation drops to where I can get excited about it, I would consider an investment.

I do factor valuation into my investment decisions more than many folks on this board, and one of the primary metrics I tend to focus on when looking at a company, is how much revenue and gross margin dollars do I think they will be generating three years from now, and how fast might they still be growing at that time. Obviously a lot of guesswork involved, but here is a quick summary of what I’m currently estimating for DOCU and NET.

Forecasting out 3 years

I must have had much more conservative projections for Docusign than some of you, because last week’s earnings release actually led me to increase what I am estimating for the next year. Previously, I was anticipating 40% for 2021, which along with my longer term expectations for the company was enough for me to keep DOCU as a medium sized holding (5%). After last week’s earnings release, I’ve bumped up my estimate to 42% for next year (still hopefully conservative), 37% in year two, and 32% in year three (again, I’m betting they will hold at least 35% growth for three years, especially since I expect Agreement Cloud will start having a meaningful contribution 24-36 months from now, but I typically try to be conservative. If they are able to meet those projections, and keep their gross margin percentage flat with where it has been over the past year, they will bring in $2.8 Billion of gross margin (not revenue, margins) dollars in year 3, and still potentially be growing at more than 30%.

Cloudflare, I’m currently estimating 45% revenue growth over the next year, followed by 40% in year two, and another 40% in year three. Again, assuming gross margin percentage stays flat with where it has been over the past year, that would mean NET will be generating about $940 million of gross margin dollars in year three, only one-third of what I project for DOCU, despite growing at slightly higher rates for another three years.

So in summary, and again, these are purely my own estimates/projections fully acknowledging my limited expertise in Cloudflare’s business:


                   NET       DOCU

Past 12mos GM$    $330m    $1,453m

Yr 1 growth       +45%       +42%
Yr 2 growth       +40%       +37%
Yr 3 growth       +40%       +32%

Year 3 GM$        $938m    $2,796m

Market Cap today  $23.6B    $40.2B

So yes, there are many other factors that could impact the next three years. Cloudflare’s GM% could increase. Docusign’s GM% could decline. Or vice versa. They could manage their operating expenses better or worse than they do today or make a good or bad acquisition or two.

But ultimately, just looking at these assumptions, which I think will prove to be conservative growth rates for both companies, Docusign will still be generating three times as much margin as Cloudflare will, three years from now. And if DOCU continues to grow at about 30% beyond this term, their increase in GM in year 4 of about a billion dollars (just the incremental growth that year), will be nearly as much as Cloudflare’s total gross margin dollars generated for a full year.

I don’t mean to show this as any attempt to bash Cloudflare. NET’s valuation today isn’t crazy, and especially if they outpace my estimates above, it will probably be a good investment going forward. But this is how I look at the companies, and rationalize my current stake in Docusign.

What I did

As I mentioned, this is an increase to what I was previously forecasting for DOCU and, to me, the strong quarter just reported, and my expectations going forward, not to mention Docusign’s price drop yesterday, makes DOCU’s valuation today, to me, appear downright cheap. As result I did add to my Docusign position Friday, about 0.7% of my portfolio on Friday when the stock dropped after what appeared to me to a great quarter, and perfectly fine guidance. So my DOCU holdings are probably closer to 5.5%-6% of my portfolio today.

Beyond the numbers, qualitatively, I do think there is still lots of room for growth in DOCU’s core e-signature business. I work with a midsized commercial bank and we were executing a new agreement recently, expecting to sign the document digitally. Even after a year of pandemic remote working, they informed me that they are still not using e-signature for much of anything yet, and I had to print, sign, and scan the document in order to email it back to them. Additionally, I really think Agreement Cloud will eventually become a very big business for them as well. At the same time, I know there are lots of qualitative positives for NET right now too.

So that’s at least my rationalization for why Docusign is still a solid long term holding.

-mekong

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I concur that this is an interesting thread. From what I have gleaned from this board, it’s incredibly important to follow the numbers and that’s just what is being done here.

I was slow to understand the excitement around Cloudflare because they seemed so richly valued and I didn’t understand their business.

To keep it simple, the difference between these two companies valuations is justified on the stage of product life cycle and market fit, no?

DocuSign is a year away from rolling out a second core product, after which there will likely be one to two years of learning the fit within the market before we see growth relevant to their business, assuming it’s a hit. Their core business has plenty of room to run, but it is maturing.

Cloudflare appears to be in the product market fit stage for a colossal number of products. Only once I dug into the product offerings did I learn just how much the comparison to fastly does them a disservice (I know, plenty here had pointed that out many a time and it took me digging to really learn it).

I’m not a techie so please cover your ears if you are (though I wouldn’t mind the correction and for those who aren’t maybe this will be helpful). Ultimately, after learning more, I came to an understanding that cloudflare is not just a CDN or an edge computing company. They are a cloud native operating system / network infrastructure company. Cloudflare access is your basic vpn, Cloudflare gateway is your basic antivirus. Cloudflare workers is the underbelly that can drive a huge number of applications. And the list goes on…

In a simple sense, I think of Cloudflare as a story stock with enough existing growth to convince me it’s real. But despite their impressive growth, I don’t think we’ve yet seen them find product market fit! For me the valuation mandates acceleration and I expect acceleration.

Put another way, my bear case for DocuSign is 35% growth slowing to 30% before they get CLM to market and the bull case is 45% growth sustaining until they do.

For Cloudflare, my bear case is they continue to grow at 45-50% for the next 5 years and the bull case is wild acceleration as their product suite integrates together and finds markets.

Conor

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