Cloud computing provider DigitalOcean (DOCN -0.36%) went public last March and quickly became a market darling. The stock rocketed higher in the second half of 2021, topping out around $133 per share. That's nearly triple the IPO price of $47 per share.
Enthusiasm for the disruptive cloud company has all but vanished over the past few months. The stock now trades just a few dollars higher than its IPO price following a brutal decline. Nothing about the company or its story has really changed, but investor sentiment has done a 180.
With shares of DigitalOcean so beaten down, is now a good time to buy the stock? Let's look at the pros and cons of investing in the cloud computing provider.
Image source: DigitalOcean.
Why you should buy DigitalOcean
It may seem the cloud computing market has already been won by Amazon Web Services (AWS), Microsoft Azure, and Alphabet's Google Cloud. These cloud giants take in the majority of spending on cloud infrastructure services, offer an immense list of products and features, and are backed by trillion-dollar companies.
But it's not that simple. The big cloud platforms do a great job serving enterprise customers, but they're not really tuned for small businesses or individual developers. Pricing is complex and sometimes opaque, getting started is not easy, and the sheer number of options can be overwhelming. If you need real support, you'll probably have to pay for it.
DigitalOcean is in some ways the anti-AWS. The company's platform puts simplicity above all else, offering a short list of products, simple and transparent pricing, and a wealth of resources to help developers. Spinning up a virtual server or database is quick and easy, and the company doesn't try to lock in customers by charging excessive data transfer fees.
This type of platform is exactly what many developers want, and it shows. DigitalOcean has around 600,000 customers, and those customers are happily ramping up spending on the platform. In its most recent quarter, average revenue per customer jumped 28% and the net dollar retention rate hit 116%. DigitalOcean has a decent amount of churn because its customers skew small, but those who stick around are happy with the platform, by all indications.
DigitalOcean is targeting 30% annual revenue growth in the long run. That will require solid execution, but the potential is certainly there. The company expects to report revenue of around $428 million for 2021, a tiny fraction of the $115 billion market it expects to be growing into by 2024. DigitalOcean is clearly resonating with developers, and it can grow into a much larger company if it can maintain that momentum.
Why you should avoid DigitalOcean
There are two big risks for DigitalOcean investors.
First, there is a tremendous amount of competition. Not only is DigitalOcean going up against cloud giants with deep pockets, but there are also plenty of privately held cloud companies going after smaller customers. There's Linode, Vultr, and UpCloud, to name a few. DigitalOcean is far from the only game in town.
There are also platforms that focus more strictly on application development and hosting. Netlify, Vercel, and even Cloudflare offer the ability to host websites and execute backend logic. For many developers, not needing to worry about cloud servers is a big selling point.
Second, there's the matter of valuation. DigitalOcean stock has fallen sharply, but it's still not particularly cheap. Valued around $5.7 billion, DigitalOcean trades for roughly 13 times sales. The company isn't profitable, although it is producing some free cash flow.
DigitalOcean is not a software company, so it certainly does not deserve the ultra-high valuations some software companies have been awarded. A double-digit price-to-sales ratio looks a bit optimistic.
A mixed bag
There are a lot of companies gunning for the same customers that DigitalOcean is going after. In the portion of the cloud computing market not dominated by the cloud giants, competition is heating up. There's room to innovate on developer experience, and the opportunity is enormous.
There will probably be multiple winners, and DigitalOcean can certainly be one of them if it can continue to win over developers. But investors need to weigh that against a lofty valuation and an ever-growing slate of competitors.
