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In the ever-evolving landscape of cloud computing and artificial intelligence (AI), the emergence of smaller players to challenge industry giants is a compelling narrative for investors. One such contender that's been making waves is DigitalOcean Holdings (DOCN), a company that has been steadily carving its path in the fiercely competitive tech space.
The cloud giants Amazon (AMZN), Microsoft (MSFT), and Alphabet (GOOGL) collectively control 65% of the cloud computing market. Though not a significant player in the cloud market yet, with AI advancing at a rapid pace, DigitalOcean appears to be a growth stock that could bring long-term value to investors.
DOCN shares are currently trading 47% below their 52-week high. Could this be a good opportunity for growth-oriented investors looking to grab a piece of this burgeoning AI stock? Let's find out.
DigitalOcean’s Story of Growth and Innovation
Founded in 2011, DigitalOcean, in comparison to the larger players, is relatively new to the game. With a market cap of $2.34 billion, the company aims to simplify cloud infrastructure for developers. Over the last few years, with an easy-to-use and affordable cloud platform, it has gained a strong foothold in the market, primarily targeting smaller businesses and individual developers.
What sets DigitalOcean apart from industry giants' cloud platforms, such as Amazon Web Services (AWS), Microsoft Azure, and Google Cloud? While these titans dominate the cloud computing space, DigitalOcean found its edge by specializing in simplicity and user-friendliness. As a result, the company's finances are gradually improving.
In the recent third quarter, revenue came in at $177.06 million, reflecting 16% year-over-year growth, driven by the addition of new products and services. Revenue also exceeded consensus estimates by $3.7 million. Its annual run-rate revenue (ARR) also increased 11% to $713 million in the quarter. Adjusted earnings per share of $0.44 also surpassed estimates by $0.08.
The Road Ahead for DOCN
DigitalOcean raised the stakes in the AI game by acquiring Paperspace to expand its AI capabilities, which it completed in the quarter. Small and medium-sized businesses will now be capable of testing, building, and scaling AI models in the cloud, thanks to the integration of Paperspace's advanced Nvidia (NVDA) graphic processing units (GPUs) into DOCN's offerings.
While DigitalOcean has ventured into AI-driven solutions, competing in this hot market requires continuous innovation and agility to meet the rapid demands of an increasingly AI-centric market.
Investors may be concerned about the company's net dollar retention (NDR) rate dropping to 96% in Q3 from 104% in the previous quarter. Notably, NDR measures changes in recurring revenue, which assists businesses in determining the viability of their operations. However, a good sign is that its average revenue per user increased 14% year-over-year in the quarter.
In August, DigitalOcean announced that its CEO, Yancey Spruill, would be stepping down from his position. This leadership transition is weighing on the company's stock price until a new CEO is appointed. C-suite leadership changes are critical to stock performance, which may be part of the reason why DOCN has gained only 3.6% so far in 2023, compared to the outsized gains other AI stocks have seen.
However, new product launches with AI-integrated offerings are expected to benefit the company in the coming quarters. A new CEO could also steer the company toward greater expansion. DigitalOcean’s ability to innovate, address market demands, and maintain its unique positioning in the cloud ecosystem will determine its continued success.
Although DigitalOcean's growth as a cloud company has been impressive, challenges remain in an industry dominated by tech titans with vast resources. To stand out and make its mark, the company must continually differentiate itself in the face of fierce competition and an ever-changing landscape of cloud services.
Expect More Growth From This Evolving Cloud Company
Turning to guidance, management anticipates fourth-quarter revenue to be around $178 million, in line with analysts’ estimates. That forecast indicates year-over-year growth of 9%. Adjusted EPS could be in the $0.36 to $0.37 range, with analysts’ estimates standing at $0.36 for the quarter.
For the full year 2023, DigitalOcean expects EPS to be in the $1.52 to $1.54 range. What’s more, the company also anticipated an adjusted free cash flow margin of around 21% to 22% on revenue of $690 million.
Meanwhile, analysts' expectations are in line with the company, with a top line jump from $576 million in 2022 to $690 million in 2023. That represents year-over-year growth of 20%.
Additionally, analysts expect adjusted EPS to jump 60% to $1.51 in 2023. Trading at 16 times forward earnings and three times forward sales, DigitalOcean seems reasonably priced for a growth stock with AI prospects. In 2024, analysts predict revenue could grow by 11.5% to $769 million, and EPS will rise to $1.66.
What Is Wall Street’s View on DigitalOcean?
After its Q3 results, Goldman Sachs upgraded DOCN to “buy” from "sell,” noting that, “as macro stabilizes, we believe the structural improvements that DO has made to its mix shift and cost structure will become more obvious, driving better revenue growth and continued FCF margin expansion." Goldman Sachs has a target price of $33 for DOCN.
Overall, Wall Street rates DOCN as a “moderate buy.” Out of the 13 analysts covering DOCN, 5 have a “strong buy” recommendation, 7 suggest a “hold,” and 1 calls it a “moderate sell.”
Based on analysts' average price target of $32, Wall Street sees a potential upside of about 17% in the next 12 months. The price target ranges from a high of $47 to a low of $25 for DOCN.
The Verdict on DigitalOcean
With the integration of AI, Amazon Web Services, Azure AI, and Google Cloud are driving exceptional growth for the top three cloud market players.
While it might not compete head-on in every aspect, DigitalOcean’s dedication to simplicity, commitment to its target audience, and exploration of AI position it as a notable contender in the ongoing evolution of cloud computing and AI. Only time will tell how far this small-cap AI company can make its way among the industry's titans. For now, I am cautiously optimistic about DigitalOcean stock.
On the date of publication, Sushree Mohanty did not have (either directly or indirectly) positions in any of the securities mentioned in this article. All information and data in this article is solely for informational purposes. For more information please view the Barchart Disclosure Policy here.
