When DigitalOcean (DOCN 3.30%) went public two years ago, many investors were skeptical of its strategy of providing cloud infrastructure platform services to small and medium-sized businesses. After all, the market was already dominated by cloud behemoths like Amazon Web Services (AWS).
That's why DigitalOcean started trading at $41.50 on its first day, which was about 12% below its initial public offering (IPO) price of $47. Its stock soared to an all-time high of $130.26 at the peak of the buying frenzy in growth stocks in November 2021, but it subsequently slid back to about $46.
DigitalOcean's roundtrip back to its IPO price was disappointing, but its business has actually been growing at a healthy clip. Revenue rose 25% in 2020, 35% in 2021, and 34% to $576 million in 2022. The company expects revenue to rise another 22% to 25% this year, even as macroeconomic headwinds force many companies to rein in their cloud spending.
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The underlying numbers are also impressive. Its total number of customers grew 6% in both 2020 and 2021, then increased another 11% to 677,000 in 2022. Average revenue per user (ARPU) grew 19% in 2020, 25% in 2021, and 25% to $75.19 in 2022, as its net dollar retention rate -- which gauges its year-over-year revenue growth per existing customer -- rose from 103% in 2020 to 115% in 2022.
Its earnings before interest, taxes, depreciation, and amortization (EBITDA), adjusted gross, operating, and free cash flow (FCF) margins have also been expanding over the past three years.
All those strengths seem to make DigitalOcean a great growth stock, and it doesn't look expensive at six times this year's sales. But could this oft-overlooked cloud underdog blossom into the next Amazon over the next few decades?
How much larger could DigitalOcean grow?
DigitalOcean provides cloud computing power to smaller developers and businesses through tiny "droplets" of larger servers. For those smaller customers, that pricing model is generally more cost-efficient than using larger cloud platforms like AWS or Microsoft's Azure, which are geared toward larger enterprise customers.
If DigitalOcean can continue growing within that niche, it could expand at a faster rate than the global cloud computing market -- which Grand View Research estimates will increase at a compound annual growth rate (CAGR) of 14% from 2023 to 2030.
Between 2022 and 2025, analysts expect DigitalOcean's revenue to grow at a CAGR of 19% as its adjusted EBITDA increases at a CAGR of 26%. Assuming it meets those estimates and continues to grow both figures at a reasonable rate of 15% from 2025 through 2033, it could generate $3 billion in revenues and $1.2 billion in adjusted EBITDA by the final year. That would be about five times higher than its revenue and six times higher than its adjusted EBITDA in 2022.
If DigitalOcean reaches those levels and continues to grow at a CAGR of 15% for another 10 years, we could see its annual revenue hit $12 billion in 2043 with an adjusted EBITDA of $4.8 billion. However, that would still make it much smaller than today's Amazon -- which generated $80 billion in sales from AWS alone in 2022. That also only accounted for just 16% of Amazon's total revenues of $514 billion for the full year.
Therefore, it's highly unlikely that DigitalOcean will come anywhere close to becoming the "next Amazon" or even the "next AWS" within the next few decades. Instead, it's more likely to become a takeover target for Amazon, Microsoft, or Alphabet's Google as those cloud giants try to pull more small businesses and developers into their ecosystems.
But on the flip side, those larger cloud companies could also simply expand their dominant platforms with more services for smaller businesses. If that happens, DigitalOcean could face fierce competitive headwinds.
It still has a lot more growth potential
Instead of wondering if DigitalOcean can become the next Amazon, investors should focus on the fact that it could generate more impressive gains than the market leader. If DigitalOcean grows its revenue and adjusted EBITDA fivefold over the next decade and its valuations hold steady, it could generate a five-bagger gain and become a $20 billion company by 2033. It would be much tougher for Amazon -- which already has a market capitalization of $1.3 trillion -- to generate a comparable return.
