Artificial intelligence (AI) stocks were the place to be in 2023. Investors earned significant gains in leading AI names like Nvidia, Microsoft, and Amazon. Those companies are generating most of their AI-related revenue from the data center and the cloud, which is where businesses are developing, training, and deploying their latest AI applications.
However, not all AI-related stocks caught the attention of investors early on. There was one cloud company that joined the AI party late in 2023, which means its stock could be set up for outsized gains this year. That company is DigitalOcean (DOCN 3.30%). Its shares are trading 71% below their all-time high, which was set during the tech frenzy of 2021, when investors assigned the stock an ambitious valuation.
Below, I'll explain the significance of DigitalOcean's entry into AI, and why now might be an opportune time for investors to buy the stock.
Image source: Getty Images.
A cloud provider for small and mid-size businesses
Cloud services can involve anything from simple data storage to website hosting to video-streaming technology. AI represents a new chapter in which cloud providers fill their data centers with advanced chips from the likes of Nvidia in order for their business customers to have the computing power to process mountains of data used to develop large language models -- the building blocks of an AI application.
DigitalOcean specializes in providing cloud services to small and mid-size businesses (SMBs), ranging from the start-up phase to those with 500 employees. Its product suite is relatively narrow for that reason, and the company is worth just $3.1 billion. It's a tiny player competing with giants like Amazon Web Services, Microsoft Azure, and Alphabet's Google Cloud, which are backed by their trillion-dollar parent companies.
But DigitalOcean has an edge over these other tech giants because it tailored its entire offering to suit the needs of SMBs. Its pricing is cheap and transparent, its service is highly personalized, and it offers a digital library filled with educational materials to help customers maximize their cloud experience. The cloud leaders are focused on serving large organizations at scale, so it isn't economical for them to be so attentive to the needs of businesses at the smaller end of the spending scale.
Developing AI adds a whole new layer of complexity and cost. One Nvidia H100 GPU chip can cost $40,000, and many developers scale up to 20,000 of them! Therefore, most businesses can't build their own infrastructure, which is why they rely on centralized data centers managed by cloud providers.
Bringing that computing power to small businesses can help them unlock tremendous value through AI, and that's what DigitalOcean hopes to achieve with its $111 million acquisition of Paperspace last July.
Paperspace is a bridge to AI for SMBs
DigitalOcean recently conducted a survey that found that 43% of developers and SMBs currently use AI and machine learning. Furthermore, it found that 78% of them plan to increase their use of those tools this year. Research by Cathie Wood's Ark Investment Management estimates advancements in hardware and software will reduce the cost of training AI models by 70% per year between now and 2030, which could accelerate adoption.
Ark's projections suggest businesses will invest up to $41 trillion in AI by 2030 to boost their productivity, which could add a whopping $200 trillion to the global economy. That's an opportunity unlike anything cloud providers have seen before.
Paperspace has over 500,000 customers. It offers them a range of different GPUs designed to handle AI workloads, including Nvidia's industry-leading H100. Paperspace says its prices can be up to 70% cheaper than cloud leaders like Microsoft Azure because it offers per-second billing and no lock-in commitments, which ensures no expenditure is wasted. Plus, Paperspace is a specialist provider, so it doesn't have a bloated cost structure like its larger competitors, allowing it to pass on lower prices to customers.
Why DigitalOcean stock is a buy now
DigitalOcean has a unique strategy. It acquires customers at the start-up phase and supports them with low prices, in the hope they scale their operations and eventually become a significant source of revenue. That's why the Paperspace deal is such a good fit -- it follows a similar philosophy.
DigitalOcean will report its official financial results for 2023 in February. Wall Street expects its revenue will come in at $690 million, representing an increase of almost 20% compared to the prior year. That would actually mark a deceleration from the 34% growth rate it delivered in 2022.
Weaker economic conditions are one reason. Many of DigitalOcean's customers in the start-up space are funded by investors, and it has been harder to raise fresh money over the past two years. With that said, macroeconomic headwinds like high inflation and rising interest rates are subsiding, which bodes well for the company going forward.
The other reason is DigitalOcean's focus on profitability. The company only grew its operating expenses by 9% year over year through the first three quarters of 2023, which resulted in net income (profit) of $3.4 million. It was a positive swing from the $17.4 million net loss it delivered in the year-ago period.
In short, DigitalOcean has found a path to profitability while at the same time it's on the cusp of a potential acceleration in growth thanks to AI. The Paperspace integration is still underway and it could take a few quarters before investors see results. However, DigitalOcean stock is trading near its cheapest price-to-sales multiple since it came public in 2021, so now might be a great time to buy.
