Businesses of all sizes are increasingly adopting cloud technology to stay competitive in today's digital-first world. While larger businesses have multiple eager partners -- such as Amazon, Microsoft, and Alphabet -- to help them realize their cloud ambitions, small businesses often struggle to get the desired level of support suited to their needs.
One company that has recognized this unmet need and developed a cloud platform specifically for small businesses is DigitalOcean (DOCN -1.52%). The market is reacting harshly to DigitalOcean's latest quarterly results, but the business fundamentals for the company look as strong as ever. Here are four reasons why now could be a great time for patient investors to take a small stake in this budding cloud star.
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1. Cloud has been a game-changer
Cloud technology has been enabling mission-critical operations for companies across all industries. Amazon Web Services streaming Netflix shows, Microsoft's Azure cloud platform hosting HSBC's banking operations, and Alphabet's Google Cloud Platform powering the logistics network for UPS are just a few examples.
With the cloud, organizations are able to develop and scale their businesses much faster than ever, and in many cases at a lower cost. Using cloud technology also allows organizations to focus on their core mission rather than reluctantly allocate valuable time to IT infrastructure. Adoption of the cloud has been a game-changer for many, including DigitalOcean.
2. Tailored for a perfect fit
DigitalOcean is simplifying the usage of the cloud for the underserved segment of small and medium-sized businesses. Established cloud providers, with their extensive product catalogs, do a great job of solving complex problems for their clients, typically large enterprises with big pockets and IT staff. The needs and expectations of smaller businesses, however, are fundamentally different. They're looking to build relatively basic capabilities, such as simple marketing websites, or online channels for consumers to book appointments or order products.
DigitalOcean has superbly tailored its platform and services to make cloud computing easily accessible for small- and medium-sized businesses. The company offers extensive knowledge resources for free to educate its prospects and clients. When compared to larger providers, the company's products are much easier to understand and implement. Additionally, quick onboarding and personalized service make DigitalOcean even more appealing. Finally, the company is very transparent in its pricing, and makes cloud computing truly accessible to any business, with offerings available for as low as $5 a month.
DigitalOcean has positioned itself very well to be the go-to cloud partner for young upstarts.
3. The numbers speak for themselves
The company's first-quarter 2022 results, reported on May 4, further validate the success of its carefully crafted offering and customer-centric approach. More and more customers are partnering with DigitalOcean, and spending a greater amount of money with the company.
| Customer Metrics | Q1 2020 | Q1 2021 | Q1 2022 | CAGR |
|---|---|---|---|---|
| Total Customers | 546,000 | 585,000 | 623,000 | 6.82% |
| Customers Paying > $50/month | 69,800 | 85,200 | 102,500 | 20.71% |
| Average Revenue per Customer | $44.68 | $53.68 | $68.90 | 24.81% |
Source: Company earnings releases. CAGR = compound annual growth rate.
Strong traction with customers is translating into outstanding revenue growth. DigitalOcean grew its revenue to $127.3 million in the first quarter of 2022, an increase of 36% year-over-year. DigitalOcean has now grown revenue by over 35% for four consecutive quarters, up from the growth rate of mid-to-high 20% in the quarters before. This acceleration shows the momentum behind the company's business.
| Revenue Metrics | Q1 2020 | Q1 2021 | Q1 2022 | CAGR |
|---|---|---|---|---|
| Revenue | $72.8 million | $93.7 million | $127.3 million | 32.24% |
| Year-over-Year Revenue Growth | 25% | 29% | 36% | - |
Source: Company earnings releases. CAGR = compound annual growth rate.
DigitalOcean also turned free-cash-flow positive -- meaning it has cash left over after paying its bills -- in 2021. The company expects to further improve its free cash flow margin from 6% in 2021 to 9% in 2022.
DigitalOcean's ability to produce positive cash flows while growing revenue underscores the scalability of its business model. The company's focus on profitability in its relatively early days also highlights that management wants to run the business in a fiscally responsible manner, which should please investors.
4. Well-positioned to ride the tailwinds
Cloud is a key enabler of the digital economy, and its role in the future of business cannot be overstated. According to IDC, small and medium businesses' spending on the cloud is expected to grow from $72 billion in 2022 to $145 billion in 2025, implying an annual growth rate of 27%. With its 2021 full-year revenue of just $429 million, DigitalOcean has a tremendous opportunity to expand its horizons.
Future growth for DigitalOcean will by no means come easily. Cloud computing is a fiercely competitive space, and DigitalOcean will have to continue to prove its superior fit for small and medium-sized businesses to fight rivals like Amazon, Microsoft, Google, IBM, and Oracle. But so far the company has shown that it can.
One other factor for investors to keep an eye on is DigitalOcean's net dollar retention rate (NDR), or how much more the average existing client spends from one year to the next. The company has grown its NDR from 107% in the first quarter of 2021 to 117% in the first of 2022. Increasing or even maintaining the NDR at its current healthy level will validate that small businesses, as they grow in size, are not outgrowing DigitalOcean's products and services.
DigitalOcean stock is trading at a steep discount
DOCN PS Ratio data by YCharts
At the time of this writing, shares of DigitalOcean are trading 70% lower than their all-time high value in November 2021. With the company's strong revenue growth, improving profitability, and the enticing opportunity in front of it, a price-to-sales valuation of around 7.6 doesn't seem too rich. Taking a small stake in this promising business now will likely reward long-term investors splendidly.
