Amazon Web Services, Microsoft Azure, and Alphabet's Google Cloud are the three largest cloud computing platforms in the world, in that order.
They offer hundreds of digital services to help businesses run their operations, manage remote workforces, develop software, and reach a global customer base. But artificial intelligence (AI) is the next frontier in cloud computing, and each of those providers is investing billions of dollars to help their business customers access the technology.
Then there is DigitalOcean (DOCN 3.30%). It's a cloud provider on a mission to give small and midsize businesses (SMBs) access to the same technology normally reserved for larger organizations. DigitalOcean is valued at just $3.4 billion, so it's tiny compared to the abovementioned providers, which are backed by their trillion-dollar parent companies.
However, DigitalOcean is winning over SMB customers in droves; here's why its stock might be a great long-term buy for investors.
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DigitalOcean is bringing the power of AI to SMBs
DigitalOcean's strategy to win the hearts and dollars of SMBs is simple. It offers cheap and transparent pricing, highly attentive support, and a wealth of educational resources to help customers extract the most value from their cloud experience. Those features are ideal for cost-conscious businesses at the start-up phase, right up to those with 500 employees.
It isn't always economical for the dominant cloud providers to cater to SMBs in the same way, because they make most of their money targeting larger organizations with more complicated needs.
DigitalOcean offers services ranging from simple web hosting and data storage to complex tools for game and software development. However, thanks to its $111 million acquisition of Paperspace last year, its business customers can also access the required computing power to develop AI models and applications.
Paperspace operates data center infrastructure designed specifically to process AI workloads. Those data centers are constructed using graphics processing units (GPUs) from a range of different chip manufacturers, including Nvidia's industry-leading H100. Given Paperspace has such a simple business model, it can offer pricing that is up to 70% cheaper than cloud giants like Microsoft Azure, which have bloated cost structures.
Paperspace and DigitalOcean share a mission to level the technological playing field for SMBs. In the past, they might have otherwise been priced out of using new, advanced tech like AI. Paperspace already has more than 500,000 customers, adding to DigitalOcean's base of 644,000.
DigitalOcean is sacrificing some of its growth to generate profit
Prior to 2023, DigitalOcean was investing heavily in growth even at the expense of profitability, and it led to routine increases in revenue of more than 30% each quarter. However, the company is currently navigating a challenging economic environment impaired by a multidecade high in interest rates, which is forcing businesses of all sizes to carefully manage their spending.
As a result, DigitalOcean pulled back on some of its growth initiatives in favor of delivering a profit, which creates a more stable future and increases certainty for investors. In the recent fourth quarter of 2023 (ended Dec. 31), the company's revenue came in at a record high of $180.9 million, but it represented year-over-year growth of just 11%.
While that is a notable deceleration in growth, DigitalOcean delivered net income (profit) of $15.9 million for the quarter, which was a positive swing from the $10.3 million net loss it generated in the year-ago period.
Considering DigitalOcean has $411 million in cash and marketable securities on its balance sheet, continued profitability means it probably won't need a cash infusion anytime soon. That's positive because the cost of capital is much higher today than a couple of years ago on account of the steep rise in interest rates.
Why DigitalOcean stock is a buy now
DigitalOcean believes its opportunity in the SMB cloud industry is worth $114 billion right now, and it expects growth of 23% per year until 2027 when it will reach $213 billion. Considering the company has about $730 million in annual recurring revenue on the books, it has barely scratched the surface of its addressable market.
But AI offers a significant expansion of that opportunity. Cathie Wood's Ark Investment Management believes companies that offer AI software will generate $14 trillion in revenue by 2030 collectively, and many businesses on the smaller end of the spectrum might be using DigitalOcean and Paperspace to develop it. Therefore, DigitalOcean stock is a unique picks-and-shovels play on the fast-growing AI industry.
Plus, the stock is currently trading 70% below its all-time high, which was set during the tech frenzy of 2021. Investors assigned a unrealistic valuation to the company back then, but the subsequent dip offers an opportunity for patient investors to buy.
Those willing to hold on to DigitalOcean stock for the next five years (or more) might be glad they took this chance to buy in.
