Artificial intelligence (AI) and cloud computing go hand-in-hand. The cloud is where companies store all of their data, and it's also where developers go to build new software products. As a result, businesses have been rushing to cloud providers like Amazon Web Services and Microsoft Azure to develop AI applications.
DigitalOcean (DOCN 0.41%) is a much smaller, stand-alone player in the cloud industry targeting small to mid-sized enterprises. It has never offered cloud products or services in the accelerated computing or AI space, but it just acquired a small company called Paperspace for $111 million, which might change all of that.
DigitalOcean stock has soared 84% in 2023, but it's still down 63% from its all-time high following the tech sell-off last year. But the move into AI could pave the way to a full recovery (and beyond), so here's why that's a dip worth buying right now.
DigitalOcean serves an important niche in the cloud industry
As I touched on, DigitalOcean is focused on serving small to mid-sized businesses, typically those between the start-up phase and those with up to 500 employees. According to its first-quarter earnings presentation, 468,000 of the company's 614,000 customers are spending an average of just $15 per month on its cloud services!
DigitalOcean differentiates itself from its larger competitors by offering cheap and transparent pricing, unparalleled personal service, and a host of training materials to help businesses get the most out of their cloud experience -- whether they're storing data, hosting a website, or building software.
Up until recently, only large, well-resourced companies could afford to develop AI applications, which is why cloud platforms like Amazon Web Services and Microsoft Azure have invested billions of dollars in comprehensive toolsets to meet their customers' needs.
According to Ark Investment Management, run by tech investor Cathie Wood, the cost to train a large language model to GPT-3 capabilities (the standard set by OpenAI's ChatGPT in early 2023) was $4.6 million in 2020. That cost fell to $450,000 in 2022, and it's expected to fall as low as $30 by 2030!
As a result, AI will quickly become more accessible to small and mid-sized businesses, which is why now is the perfect time for DigitalOcean to start building a portfolio of products and services in this space.
DigitalOcean buys Paperspace
Paperspace is a cloud platform that helps over 500,000 developers build, train, and deploy AI applications at a far cheaper rate than larger providers. It charges an equivalent of just $0.78 per hour for the use of its accelerated cloud infrastructure, which runs primarily on Nvidia A100 graphics (GPU) chips. By comparison, Paperspace is about 70% cheaper than Microsoft Azure, which charges $2.23 per hour.
It achieves those savings with per-second billing, and because it requires no commitment from its customers at all -- they can sign up and start training AI models immediately, and they can leave just as easily. Of course, Paperspace is a specialist provider, so it doesn't have all the overhead costs of a much larger cloud platform like Azure.
As a result, it's a natural fit for DigitalOcean. The company announced its acquisition of Paperspace on July 6 for $111 million, expressing its excitement about giving small and mid-sized enterprises access to AI technology that has, until now, been reserved for much larger organizations. DigitalOcean says its customers will be able to access generative media, text analysis, recommendation engines, and more.
Such applications are significant drivers of productivity in the corporate world, because they're capable of instantly creating content, whether it be text, images, video, or even computer code. In fact, Ark Invest thinks generative AI will make software engineers 10 times more productive by 2030 because of its ability to instantly write code.
Why DigitalOcean stock is a buy now
As I mentioned earlier, DigitalOcean has 614,000 total customers. While most of them spend a tiny amount of money, a small minority of 15,000 -- which it calls "scalers" -- are spending an average of $1,962 on the platform per month. DigitalOcean's strategy is to nurture hundreds of thousands of start-ups and small enterprises to help produce a few scalers that will eventually contribute a significant amount of revenue to the company.
With the introduction of AI, more businesses should be able to grow into scalers (and do so far more quickly). There are wide-ranging estimates on the amount of value these businesses will create in the future; research firm McKinsey & Company believes AI will add $13 trillion to global economic output by 2030, and early adopters could more than double their free cash flow between now and then.
Ark Invest thinks AI will add a whopping $200 trillion to the economy by that same year, with companies like DigitalOcean sharing in $14 trillion worth of revenue.
The company generated just $614 million in revenue over the last four quarters, which is a drop in the bucket compared to that potential opportunity. Plus, as of this writing, DigitalOcean is valued at just $4.1 billion, so there could be substantial upside in its future, and its $111 million bet on Paperspace could wind up looking like an absolute bargain in the long run.