Why I bought Digital Ocean (DOCN)

I see there is some interest in Digital Ocean (DOCN) on this board and many people hold it in their portfolio. I bought DOCN on Nov 10 after I sold out some positions in my portfolio at $114 and then added more at $130. Currently sitting at 10% position. After the SaaS stocks selloff, I am down -15%. I am in it for the long term so I am not worried about the short term fluctuations.

Other people may wonder why we bought this company when it’s growing so slowly?
This is a special case and worth my time to do a write up to explain.

What does this company do:
It offers simple and cheap cloud computing solutions to developers, startups and SMBs.

In DOCN earning presentation:
“DigitalOcean simplifies cloud computing so developers and businesses can spend more time creating software that changes the world. ”

Financials:
It started slow.
YoY Revenue growth rate:
2021:34.28%
2020: 24.71%
2019:25.62%

QoQ sequential Revenue growth rate from past 6 quarters: (From recent to older)
7.32%,10.78%, 7.09%, 7.76%, 5.59%, 5.63%
Annualized:
32.66%,50.60%,31.50%,34.84%,24.31%,24.50%

DBNRR from past 6 quarters: (From recent to older)
116%,113%,107%,104%,102%,101%

ARPU QoQ growth rate from past 4 quarters.(From recent to older)
6.72%,8.18%,4.20%,3.87%

We can see there’s a clear acceleration of revenue ,DBNRR, and ARPU.
The reason will be explained below.

It’s well run financially and rapidly approaching net profit:
Net income from past few quarters (from recent to older)
-$1,852,-$2,187,-$3,339,-$13,851,-$10,214

Competitions:
DOCN is not trying to compete with big public cloud providers: AWS, Azure, GC etc at least for now. It’s trying to carve out its own market by offering simple to use and cheap Cloud computing solutions.

Addressable market:
45M developers by 2030.
100M SMBs globally
14M /year new SMB

Here’s the reasons why I bought it:
#1 Reason:
It’s a personal reason. I like to own a balanced mix of companies with different growth rates
from 30% to 100%. Ideally, it’s best to own just 100% growers. However, this strategy is very
risky and prone to big mistakes as evidenced by my experiences back in early 2021.

#2 Reason:
There are two types of stocks worth owning:

  1. Companies that can sustain hyper growth consistently: e.g. MNDY, DDOG, CRWD, SNOW. 2. Companies that started slow but accelerate growth: e.g. BILL, NET.

I think DOCN belongs to the second type of companies.

Why Digital Ocean is accelerating:

Digital Ocean reminds me of Cloudflare. Both grew slowly at the beginning. Cloudflare grew just 43% YoY in 2018 and gradually accelerated to a current rate of 63% annualized.
How Cloudflare did this is by acquiring large numbers of loyal customers(e.g. developers) and kept releasing more and more products and services. This is a land and expand strategy.

While I don’t think Digital Ocean will be as innovative as Cloudflare, it shares some similarities.
It grew slowly at the beginning and is poised to accelerate.

How did it do it? As mentioned above, It offers simple and cheap cloud computing solutions to large number of developers, startups and SMBs. Developers love the simple and cheap platform and some moved from AWS to Digital ocean because AWS is complicated in both solutions and pricing to even smart people like developers. And developers tend to work in startups. For startups, there’s a high failure rate.So churn rate is high for all customers of DOCN. For some startups, they became successful and grew bigger. As a result, they ordered more products from Digital Ocean. Essentially, Digital Ocean nurtures startups and grows as they grow.

Quote from earning calls:
“These larger customers represent roughly 15% of our total customer base, yet generate roughly 85% of our total revenue. They grow substantially faster than our reported top line growth with ARPU growth of over 50%, NDR of 118% in Q3, also better than our Company average and up meaningfully from 104% in Q3 of 2020

These customers have a higher net expansion rate, as many of them buy multiple products, and churn at a much lower rate, in the mid-single digits versus low double digits for the entire Company. Importantly, the number of larger customers are growing several times faster than our overall customer growth rate. We expect these trends to continue where these larger customers grow faster, have a higher NDR, and therefore will represent a larger share of our total revenue mix over time. Our continued investment in product, direct sales and focus on customer support is paying off as the size of our customer base gets bigger, and we attract more of the SMB market.

Many of these fast-growing customers have incubated on our platform for a period of time before their businesses launch and they ramp. We have an incredible customer ecosystem where we nurture early stage developers and entrepreneurs until they get liftoff of their ideas and support the growth of rapidly growing startups and SMBs as they get traction. To boot, we do this at a very low customer acquisition cost and at increasingly compelling unit economics as expressed by our NDR results.”

So, the total customer number is growing at 7% per year. It’s not interesting.
However, the number of large customers is growing several times faster than the overall customer base. So let’s assume it’s 3x faster. That’s 21% per year growth in the number of large customers. It’s close to BILL.com’s growth rate. It’s interesting because both focus on SMBs.
Not only that, the ARPU of large customers is growing at 50% per year. The overall growth of ARPU is accelerating.

Customer testimonial:
“I have used both AWS and DigitalOcean for my personal IOT projects. I like DigitalOcean better. With AWS, it’s hard to control the cost and it’s hard to completely stop it from charging you after you stop using it.”

“Digital Ocean is easy for the user to select his machine, but in a aws even developer is confused for select the machine type. Upgrading is very easy as compared aws.”

“digitalocean internet speed is more than 10 time faster than AWS EC2.”

Revenue source:

“Roughly 90% of our revenue comes from the core compute network and storage
solutions that are typically called Infrastructure as a service. 10% are Kubernetes,
our Database as a Service.”

Customer enthusiasm:

“When Citron initially published on Shopify, we were most surprised not by the
enthusiasm of the shareholders, but rather the passion of the end users. Who
gets so passionate over software???
After speaking with former employees, customers, and even the competition, we
have found that DigitalOcean’s customer base is even more passionate and
evangelical than that of Shopify, which leads us to believe that DigitalOcean will
become the dominant SMB cloud provider.”. - Citron Research report
(Note: Citron Research gave up shorting and changed to longs. Good for him! )

Digital Ocean has substantial customer followings!
Twitter followers:

Digital Ocean: (last quarter revenue: 111m)
214.7k

Twilio: (last quarter revenue: 740m)
81.1k

Cloudflare: (last quarter revenue: 172m)
133.8k

Total customer numbers:
DIgital Ocean has
598k paying customers !

Cloudflare has:
132k paying customers

Large customer base acts as a landing strategy. They have small ARPU. Then as the small customer grows bigger. It enters the next phase of expanding. It results in higher ARPU growth, revenue growth and DBNRR. This is land and expand.

Conclusion:
Cloud computing has a big TAM and long term growth. I believe DOCN will continue to accelerate and grow for a long time by offering simple, cheap cloud computer solutions to developers, startups, and SMBs. . Big Clouds will not pay attention to small markets because they don’t have lots of potential for immediate ROI. Sound familiar? Cloudflare offered edge networks to a large number of developers, startup, SMBs and big clouds didn’t care until it’s too late.

On Oct 19, 2021, Digital Ocean hired Gabe Monroy as Chief Product Officer who worked as Vice President of the Microsoft Azure Developer Experience group. Hopefully, he’ll bring more product innovations to Digital Ocean.

Long DOCN 10%

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