DigitalOcean Holdings (DOCN 3.30%) stock has been sinking beneath the waves in the past four months. Since hitting a 52-week high in mid-July, the stock has crashed by 50% due to investors' concerns that a slowdown in cloud spending will stymie the company's growth.
That's not surprising. DigitalOcean, which provides on-demand cloud computing infrastructure to start-ups, small and medium-sized companies, and developers, reduced its full-year revenue guidance three months ago. Additionally, in late August, the company abruptly announced that CEO Yancey Spruill will be stepping down once a replacement is found.
However, investors gave the company's latest quarterly report -- which was released on Nov. 2 -- a thumbs up, and since then DigitalOcean stock has surged by 17%. Can DigitalOcean sustain its newly found momentum?
Growth has slowed remarkably
In the third quarter, DigitalOcean's revenue increased 16% year over year to $177 million. That exceeded the high end of the company's original guidance range of $172.5 million to $174 million. What's more, management increased its full-year revenue guidance by $5 million to $690 million, indicating that it is witnessing an improvement in customer sentiment.
Based on the updated guidance, DigitalOcean is on track to deliver 19% growth in 2023. However, that would be a significant slowdown from the 34% revenue growth the company clocked in 2022. Moreover, DigitalOcean's guidance for Q4 revenue of $178 million suggests that customer spending on its cloud computing offerings isn't back to full strength yet -- that would equate to a year-over-year jump of just 9%.
The good part is that DigitalOcean management says it is witnessing "positive signs through Q3 and in early Q4 that there are aiding trends from the growth headwinds from our cohort that we have seen over the past 12 to 18 months." The company is also looking to boost customer spending by launching new products that it believes will help drive an increase in average revenue per user (ARPU).
It is worth noting that DigitalOcean's ARPU increased by just 6% year over year in the previous quarter, down from the 14% jump it delivered in the second quarter. Analysts are anticipating the slowdown to continue in 2024 as well, forecasting that the company's revenue may increase by only 11%. An acceleration in DigitalOcean's growth is anticipated only from 2025.
DOCN Revenue Estimates for Current Fiscal Year data by YCharts.
AI could reignite growth once again
Still, there are a few reasons why DigitalOcean may be able to regain its mojo and grow at a faster pace. DigitalOcean recently closed its acquisition of Paperspace, which it purchased for $111 million in cash. Paperspace is a cloud-based infrastructure provider that allows companies to accelerate their applications with the help of scalable GPUs (graphics processing units).
This move could turn out to be a smart one in the long run as the need for GPU-accelerated infrastructure in the cloud is increasing thanks to the growing demand for computing power sufficient to train large language models (LLMs), which are used to deploy AI applications. However, small companies and start-ups may not have enough resources to invest in the expensive hardware needed to train AI applications -- Nvidia's AI H100 GPUs cost $40,000 apiece.
That's where DigitalOcean's acquisition of Paperspace could come in handy as it offers usage-based plans to customers, giving them virtual access to a wide range of powerful GPUs, including Nvidia's flagship H100, but spares them from having to pour heavy resources into buying hardware.
Paperspace's usage-based pricing plans start from as low as $0.45 per hour and go to more than $3 per hour for more powerful GPUs such as the A100 from Nvidia. The company hasn't announced its hourly pricing for use of Nvidia's H100 GPUs yet. Given that the demand for GPU-as-a-service is forecast to grow at an annual pace of 35% through 2030 to $25 billion, this acquisition has unlocked a big new revenue opportunity for DigitalOcean.
Valuation and upside potential make the stock a no-brainer
In the wake of the slide in DigitalOcean's stock price over the past three months, it now trades at 3.6 times sales as compared to 5 times sales at the end of 2022. The company's forward price-to-earnings ratio of 23 is lower than the Nasdaq-100 index's forward earnings multiple of 26. Buying the stock at this valuation would be a smart thing to do, especially considering that DigitalOcean's earnings are expected to clock an annualized growth rate of 37% over the next five years.
Assuming that the company hits that forecast growth rate thanks to catalysts such as AI, its earnings could increase to $4.54 per share in 2027, using 2022's earnings of $0.94 per share as the base. Multiplying the projected earnings with DigitalOcean's forward earnings multiple of 23 points toward a stock price of $104 after five years. That would be more than four times DigitalOcean's current stock price, which is why investors should consider buying this AI stock now as big gains could be ahead.
