DigitalOcean (DOCN -0.95%), a cloud computing platform that pitches itself as a simpler alternative to Amazon Web Services and Microsoft Azure, is rapidly scaling up its artificial intelligence (AI) ambitions. The company acquired AI start-up Paperspace in mid-2023 to get its foot in the door. Under CEO Paddy Srinivasan, who took over in early 2024, DigitalOcean has been building out a full-scale AI computing platform.
On top of offering virtual servers outfitted with powerful graphics processing units (GPUs), DigitalOcean's new Gradient AI platform enables customers to build AI agents without managing infrastructure. The company's AI-related revenue more than doubled year over year in the second quarter, which was one reason why the stock exploded higher. The day after that earnings report, DigitalOcean stock soared nearly 29%.
AI is helping reaccelerate growth for DigitalOcean, and the stock looks like a solid buy, despite the higher price tag.
Moving in the right direction
DigitalOcean's total revenue rose by 14% year over year in the second quarter, a bit faster than the 13% growth the company reported for the same period last year. Under the surface, revenue is shifting toward larger customers willing to spend more on the platform. The number of Scalers+ customers, which spend at least $100,000 annually on DigitalOcean's platform, rose by 23%, while the revenue generated by those large customers surged by 35%.
These larger customers help make DigitalOcean's revenue more reliable and predictable. The company still has plenty of small customers, with 174,000 customers who spend at least $50 per month. But 24% of total revenue now comes from the roughly 500 customers spending at least $100,000 per year on the platform.
This growth in larger customers and the improvement in the net dollar retention rate in the second quarter to 99% is partly due to DigitalOcean's quicker pace in launching new products and features. The company launched more than 60 new features across its cloud computing and AI products in the second quarter, including the general availability of its Gradient AI platform. While DigitalOcean must strike a balance between keeping its platform simple and rolling out new features, the AI industry is moving so quickly that the company can't afford to sit still.
With a strong second quarter under its belt, DigitalOcean raised its outlook for the full year. Revenue is now expected to grow by 13.8% to 14.3%, and the free-cash-flow margin is now expected to be between 17% and 19%. Free cash flow had taken a hit from the company's AI infrastructure investments, but it now appears to be recovering as the AI business takes flight.
DigitalOcean's accelerating revenue growth and boosted guidance come despite a tough economic backdrop. By not having a customer base loaded with big enterprise customers, the company may be less exposed to the phenomenon of cloud customers hunting for cost savings during tough times.
Image source: Getty Images.
A reasonable valuation
Based on DigitalOcean's outlook for 2025, the company is on track to generate around $160 million in free cash flow at the midpoint of its guidance range for the full year. With a market capitalization hovering around $3 billion, that puts the price-to-free-cash-flow ratio at just under 19.
With DigitalOcean's revenue growth accelerating, thanks in part to the company's progress building out its AI platform, that seems like a reasonable price to pay. While a volatile macroeconomic environment could negatively impact the company later this year, DigitalOcean's AI efforts look likely to drive revenue and free-cash-flow growth in the long run as companies embrace AI technology.
