The agreement is a foundational business process that has been around for centuries. However, even in today's digital world, most agreements still take place the old-fashioned way: with pen and paper. This important but antiquated process is slow, costly, and unnecessarily difficult on all parties.
An entrepreneur named Tom Gonser felt that the agreement was ripe for disruption so he founded DocuSign (NASDAQ:DOCU) in 2003 to take advantage of the opportunity that he saw. Gonser's big idea was to move the agreement process online. Doing so would greatly increase speed, accuracy, and significantly lower costs.
Fast-forward to today DocuSign, has become wildly successful. More than 370,000 companies and millions of users have made use of DocuSign's technology in a variety of ways. Thus far, more than 700 million transactions have taken place on the company's platform.
DocuSign went public in April 2018 and demand for the company's stock was red-hot right out of the gate. Early investors banked a 60% gain in its first few months of trading. However, the stock has declined so much in recent weeks that it's back to trading near its IPO price.
Should investors buy DocuSign now that it's cooled off? Let's run the company through my detailed investment checklist to see if it could be a worthy investment.
- Balance sheet: DocuSign raised $629 million during its IPO (before subtracting fees). More than $440 million of that total went right into the company's bank account. Another $154 million was used to cash out existing shareholders. The hefty cash injection allowed it to boast more than $818 million in cash on its balance sheet as of the end of July and no debt. The company added another $500 million through a convertible note offering that closed in September.
- Profits: DocuSign is currently in growth mode and is purposely operating at a GAAP loss. In the second quarter, that loss totaled $36 million, which isn't much compared to its ample cash hoard. What's more, the company produced $18.4 million in free cash flow during the same period.
- Margins: DocuSign boasts a consolidated gross margin of 77% during its fiscal year ending January 2018. That figure was up 400 basis points versus the prior year, which is a great sign for investors. The company's operating margin was also solidly positive. However, its profit margin was negative.
Overall, DocuSign is in great financial shape thanks to its cash-heavy balance sheet and ability to crank out free cash flow positive. For that reason, its small loss doesn't concern me.
Capitalism is brutally competitive, which is why it's incredibly important for businesses to build a durable competitive advantage in order to protect its profits from current and future invaders.
I think that DocuSign currently has two competitive advantages in place:
- High switching costs: DocuSign offers its client more than 300 prebuilt integrations with a number of highly popular applications that are made by tech giants such as Microsoft, Oracle, Salesforce, and more. The company's focus on seamless integration with other leading products makes its own software very sticky. This is one reason why the company boasts a dollar-based net retention rate of 115%, which means that its clients not only stick around from year to year but also spend more on the platform over time.
- Brand: In 2016, Forrester Research published a report stating that "DocuSign is the strongest brand and market share leader: the company name is becoming a verb." This high level of brand identity should allow DocuSign to stand out in the marketplace.
I think these are reasons for investors to believe that DocuSign has built itself a strong moat.
DocuSign's customer base includes some of the largest companies on the planet as well as businesses with just a single employee. The company's base of users has expanded every year since the company's founding. Last year, it welcomed 85,000 new customers to the platform, which includes 10,000 companies with at least 250 employees. It ended the fiscal year with 370,000 total customers.
That number sounds impressive, but DocuSign believes that its current base of customers represents less than 1% of its core target market. What's more, the company has a history of upselling its current customers from year to year, so there's ample room to grow within its existing base of customers.
When combined, management estimates that its current total addressable market is about $25 billion. That's a big number when compared to the $518 million that it hauled in during its last fiscal year.
- Acquisition: Last year, the company added 85,000 new customers. During the same period, the company spent $278 million on sales and marketing. While that's a large amount of money to spend in a single year, I think it's smart to spend lavishly right now in order to capture as much market share as possible and continue to drive its top-line higher.
- Dependence: DocuSign's dollar-based net retention rate of 115% is a good indicator of customer dependence.
- Is revenue recurring? Yes. About 93% of DocuSign's revenue was earned from subscriptions last year.
- Pricing power: DocuSign's total gross margin grew from 71% in fiscal 2016 to 77% in fiscal 2018. That's a clear sign of pricing power.
5. Management and company culture
Gonser doesn't run the company anymore but he sits on the company's board of directors. He owns more than 2.1 million shares of DocuSign's stock, which at current prices is worth about $85 million. I like that he is still involved and that he has a financial incentive to see his company succeed.
Dan Springer is DocuSign's current CEO. He joined the company in 2017 and owns more than 580,000 shares of stock, which is worth more than $20 million at current prices. Employees seem to really like working for Springer because his approval rating on Glassdoor.com is a stellar 98%. He also placed third in Glassdoor's annual rating of CEOs and was ahead of a number of other famous leaders like Jeff Weiner, Marc Benioff, and Mark Zuckerberg.
The company has garnered a very strong 4.6 stars out of 5, which is a good indicator that DocuSign is a great place to work and has a good culture.
Another point worth noting is that executive officers and directors in general control more than 25% of shares outstanding. That's a very high level of insider ownership.
Overall, I think it's more than fair to say that DocuSign has a good corporate culture and strong leaders at the helm.
6. The stock
I'm a firm believer that winners keep on winning, so I prefer to buy stocks that have already crushed the market. DocuSign was on a great trajectory soon after it went public, but the stock has cooled off in recent months along with the rest of the tech sector. Given that the time frame is so short, I don't think investors can draw any real conclusions from the trajectory of the stock just yet.
- Is it a penny stock? No. Shares currently trade for about $42 each, and the market cap is over $6 billion.
- Is there excess customer concentration? No. The largest customer accounted for only 3% of revenue.
- Does the industry face long-term headwinds? No. The market for electronic signatures is growing.
- Does the business rely on any outside forces for success? No. The appeal of switching to electronic signatures should enable this company to grow even during an economic downturn.
- Is stock-based compensation excessive? Total stock-based compensation expense was just $29.7 million in the most recent fiscal year. That's a reasonable number when compared to the $518 million in revenue that was earned over the same period. It's also very modest when compared to its $6 billion market cap.
DocuSign is a buy
DocuSign scored extremely well on my checklist, so I think there are plenty of reasons for investors to be interested in buying this stock. If you think those are empty words, you should know that my plan is to add a few shares of this high-growth business to my portfolio as soon as the Fool's trading rules allow.