Amazon (AMZN -1.14%) Web Services is the 800-pound gorilla of the cloud infrastructure market. The e-commerce giant's cloud business brought in more than $21 billion in revenue during the first quarter alone, and it claims a market share somewhere around one-third. For big enterprises, AWS is the de facto standard.
But AWS' size and enterprise focus has a downside. Economic uncertainty has forced those enterprises to take a good, hard look at their cloud computing bills. Something like 32% of all cloud computing spending is wasted, according to a survey by Flexera, and organizations generally have trouble keeping cloud spending under budget. Keeping a lid on cloud costs is now the order of the day.
The result of this shift in behavior has been a dramatic slowdown at AWS. Revenue grew by just 16% year over year in the first quarter, and it was essentially unchanged from the fourth quarter of 2022. Segment operating income plunged 21% from the prior-year period.
A small cloud platform for small businesses
Contrast AWS' performance with that of DigitalOcean (DOCN -0.90%). The small cloud computing provider is feeling the impact of a tough economic environment as well, but not nearly to the same degree. The company reported year-over-year revenue growth of 30% in the first quarter, average revenue per customer jumped 16%, and free-cash-flow margin quadrupled.
DigitalOcean focuses on small business and individual developers. Those types of customers will naturally be fickler than enterprise giants, but they may also be less likely to have a ton of fat to cut from their cloud computing bills. DigitalOcean's platform aims to be as simple as possible, with transparent pricing schemes and a tiny subset of what AWS offers. There's just less opportunity for cloud bills to get out of control in the first place.
DigitalOcean's strategy over the past few years has been to carefully expand its platform with new capabilities while ensuring that simplicity remains front and center. The acquisitions of Nimbella, which brought serverless functions to the platform, and Cloudways, which introduced a slate of pricey managed options, both mesh well with that plan.
Slowing growth but rising profits
DigitalOcean does expect revenue growth to slow to just 23% this year, but the company expects to become more profitable despite that slowdown. DigitalOcean converted 6% of revenue into free cash flow in 2021, and it improved that margin to 13% in 2022. This year, the company anticipates a 21.5% free cash flow margin.
DigitalOcean's self-serve sales model is part of the reason why increased scale is bringing vast improvements in cash flow. The company uses its vast catalog of high-quality content, as well as word-of-mouth, to bring in leads. It largely shuns sales teams, spending just 10.7% of revenue on sales and marketing in the first quarter. DigitalOcean isn't yet profitable on generally accepted accounting principles (GAAP) basis, but it's not far off.
The company is using some of that cash flow to buy back its own shares and boost per-share numbers. The company poured $266 million into share buybacks during the first quarter alone. The outstanding share count has dropped by more than 10% over the past year as DigitalOcean takes advantage of a depressed stock price.
Valued at about $2.9 billion, DigitalOcean trades for about 19 times free cash flow guidance. The company's long-term market opportunity is enormous and growing fast: It expects spending on cloud infrastructure-as-a-service and platform-as-a-service by individual and small companies to grow from $98 billion this year to $195 billion in 2026.
While DigitalOcean's growth is starting to slow, the company should be able to outpace the cloud giants as it goes after an underserved portion of the market.
