What happened
Shares of DigitalOcean (DOCN 3.30%) popped on Thursday after the company announced a $111 million acquisition of cloud infrastructure company Paperspace. As of 3:30 p.m. ET, DigitalOcean stock was up 13%.
So what
Paperspace is all about fast and powerful cloud computing and DigitalOcean wants its infrastructure so that it can offer better tools for artificial intelligence (AI). AI takes a lot of computing power. But Paperspace's graphic processing units (GPUs) are up to the task.
Investors who aren't living under a rock know that AI stocks have captured Wall Street's full attention in 2023. Therefore, when DigitalOcean said it was expanding its AI offerings, it was just the right thing to excite investors.
Now what
There's reason to like DigitalOcean's acquisition of Paperspace. The two companies are similar -- they both offer cloud computing services to small and medium-sized businesses. So DigitalOcean will grow its customer base from this deal and it can potentially upsell Paperspace's customers with other products.
Moreover, DigitalOcean is free-cash-flow positive and expects to generate around $150 million in free cash flow this year. Therefore, management has the means to make this move. And it's paying all cash, which can be more shareholder friendly than using stock to make the deal happen.
However, the growth-by-acquisition strategy is a hard thing to pull off. And DigitalOcean spent $350 million to acquire Cloudways less than a year ago. In short, investors are still evaluating the Cloudways deal and they can't be confident management is creating value with its acquisition strategy.
One area to watch will be revenue growth. Ideally, these acquisitions would accelerate DigitalOcean's growth rate and management expects that to happen with Paperspace in 2024. If its growth rate tapers off next year, that would suggest that management isn't making good use of its cash. But investors will have to wait before drawing that conclusion.
