Amazon, Microsoft and Google parent Alphabet have a few things in common. First, they're all worth more than $1 trillion. Second, they're the top three players in the cloud computing industry.
The cloud is a transformative technology. It has allowed businesses, small and large, to move their operations online -- and to broaden their customer bases by opening digital sales channels. Not only does that create new revenue opportunities, but the cloud is also a major cost saver.
According to one estimate by Grand View Research, the industry could be worth more than $1.5 trillion a year by 2030. While the three aforementioned giants are fiercely battling each other for a slice of that pie, DigitalOcean Holdings (DOCN -2.79%) is quietly growing faster than all of them.
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DigitalOcean has found a lucrative niche
Amazon Web Services, Microsoft Azure, and Google Cloud tend to focus on large enterprise customers because it's the most profitable strategy. One customer spending $10 million on cloud services costs less to maintain than 100 customers each spending $100,000. As a result, small- to mid-sized businesses (SMBs) are often overlooked by those industry leaders.
That's where DigitalOcean has found its stride. It focuses on start-ups and organizations with fewer than 500 employees. The company estimates there are 100 million SMBs worldwide, with 14 million new ones opening each year. So the opportunity is enormous, and its services are designed to suit them perfectly, whether they need simple data storage, or more advanced software development tools.
First, it has a relentless focus on live, personalized service, regardless of how much a customer is spending. Second, it has built a platform that is simple to use, and that can be deployed quickly with basic technical expertise. After all, SMBs often don't have the budget for dedicated technical staff.
Third, the company has built a library with tens of thousands of items of digital content designed to educate customers, helping them get the most from their cloud services. These nuances typically aren't compatible with the business models of the larger cloud providers, because their customers have much bigger budgets and are also more technologically sophisticated.
It just out-grew those gargantuan competitors
DigitalOcean's fourth-quarter 2022 financial results gave investors plenty of reasons to be excited.
The company focuses on customers that are spending at least $50 per month, because that cohort makes up 86% of its total revenue. There were 144,200 of them by the end of Q4, up 45% year over year, and the average revenue generated per customer set another all-time high of $80.27.
The result was $163 million in Q4 revenue, up 36% year over year. That crushed the growth rates of Amazon Web Services (20%), Microsoft Azure (31%), and Google Cloud (32%).
While still a small fish compared to the industry leaders, DigitalOcean's faster growth rate suggests it's capturing increased market share. In fact, the company estimates its addressable market will be worth $98 billion in 2023, and $195 billion by 2026, which represents a 26% compound annual growth rate. That's substantially faster than the 15.7% compound annual growth rate implied by Grand View Research's industry-wide value estimate.
Put simply, the market for cloud services among small- to mid-sized businesses is one of the fastest-growing cohorts of the entire industry.
DigitalOcean is marching toward profitability
The company typically runs at a loss because it's focused on investing in customer acquisition, which drives growth. However, it delivered one profitable quarter in 2022 (Q3), and it's inching closer to the milestone on an annual basis, too.
DigitalOcean generated $576.3 million in revenue during the whole of 2022 and made a net loss of $24.2 million, or 4.2% of revenue. That was an improvement from 4.5% of revenue in 2021.
Besides DigitalOcean's strong revenue growth, it's also managing costs well in this difficult economic environment. In Q4 its capital expenditures represented just 19% of revenue, which was the lowest level in two years. And it might improve further -- the company has announced plans to reduce its workforce by 11%.
Amid the broader sell-off in the technology sector, DigitalOcean stock has fallen 72% from its all-time high. Combined with its continued revenue growth, its price to sales ratio has declined to just 5.8, which is the cheapest level since the company began trading publicly in 2021.
That feels like quite the bargain for a cloud business that's outperforming the industry leaders, so investors might want to take advantage by buying in now.