The pandemic impacted businesses in many different ways, including the exchange of how agreements were executed. Prior to the pandemic, it was not uncommon to be asked for a wet signature on important documents such as receipts, sales agreements, or leases. However, due to lockdowns and stay-at-home protocols, people were forced to adapt to new ways of performing daily tasks.
This dynamic made DocuSign's (DOCU 0.97%) digital e-signature solution a pandemic-era lifeline as well as a household name. From January 2020 to December 2020, DocuSign's stock rose over 200%. However, the stock is down nearly 32% from this January and it has plunged nearly 35% after reporting Q3 earnings on Dec. 2. Let's dig in and find out if this dramatic decline in DocuSign stock was warranted.
DocuSign's long-term growth profile is beginning to raise eyebrows
For the fiscal quarter ended Oct. 31, DocuSign's total revenue was $545.5 million, which represented a 42% year-over-year increase. Subscription revenue was $528.6 million, which was an increase of 44% year over year, and the professional services and other segment revenue grew 4% year over year to $16.9 million.
On the surface, these results appear very positive, with it being the company's sixth consecutive quarter of revenue growth in excess of 40%. However, management provided guidance of $557 million to $563 million in total revenue for Q4, which was well below analyst expectations of $574 million. Should DocuSign achieve Q4 revenue at the midpoint of its guidance, this would imply a 30% year-over-year growth rate when compared to Q4 revenue of $430.9 million.
This contraction in DocuSign's growth caused some concern from investors as well as management. CEO Dan Springer said the following when referencing Q4 guidance: "While we had expected an eventual step down from the peak levels of growth achieved during the height of the pandemic, the environment shifted more quickly than we anticipated." DocuSign's stock was down 42% by day's end on Dec. 3.
Competition is tough, and the current market pullback isn't helping
The pandemic transformed many industries and daily behaviors. However, this dynamic does not necessarily justify hyperbolic increases in a company's stock price. Although DocuSign grew its revenue by nearly 50% in fiscal 2020, it clearly experienced a boom from the pandemic. It's reasonable to think the 200% run-up in DocuSign's stock price was unjustified and general stock market euphoria, especially relating to stay-at-home stocks, were bound for a pullback.
Despite its weak Q4 guidance and slowing revenue growth, macro factors are also contributing to the recent decline in stock price. As investors rerate risk and weigh inflation concerns, stock price valuations will continue to compress. To put this into context, DocuSign stock closed at an intra-year high of $310.05 in early December. Nearly two months later, the stock has declined by over 40%.
The company faces fierce competition, namely from Adobe, Dropbox-owned HelloSign, and venture-backed PandaDoc, which was valued at $1 billion in September upon closing its Series C financing. Management realizes that the company cannot rely on its core digital signature solution and that it must diversify its product offerings in order to compete in the long term.
Visionary fund or marketing gimmick?
In October, DocuSign announced that it was forming an in-house investment vehicle, DocuSign Ventures. The fund will focus on what company leadership calls the "agreement cloud." DocuSign's vision is to combine digital signatures with services such as identity verification and digital payments. The start-up portfolio currently includes Pactum, Snapdocs, and LegalTech Fund.
It is not uncommon for companies to form venture arms. The genesis of these funds is for larger enterprises to identify companies and technologies that could be leveraged and are adjacent to existing product offerings. Occasionally, these investments lead to larger acquisitions down the road. Salesforce.com formed Salesforce Ventures, while Microsoft's venture arm is called M12.
On some level, e-signatures could be viewed as a commodity, and given the amount of competition that DocuSign faces, forming a venture fund to build on its core offering could be smart. The company has effectively changed the legacy system of agreements, and long-term investors should be optimistic about its ability to identify and integrate tangential technology that it can cross-sell while it differentiates its platform. However, unless DocuSign begins offering and cross-selling more products, it will be difficult for the company to compete with Adobe or Dropbox, both of which already offer additional services and are not primarily reliant on digital signature platforms.
Differentiation is the key for DocuSign's future
As investors continue evaluating inflation concerns and what a post-pandemic world may look like, compression in stock market valuations, especially growth companies, should be expected. So DocuSign's recent pullback is not overly concerning; the company is still poised to grow revenue upwards of 40% from 2020 to 2021. However, management needs to prove it can be flexible and show that the business can navigate beyond digital signatures in order to command a premium valuation.
With so much competition from both large public enterprises and well-capitalized venture-backed companies, I'm waiting to see the company's next few quarters of financials and if DocuSign Ventures makes any interesting investments or acquisitions before I initiate a position in the company.