DigitalOcean Q4 Earnings: A Free Cash Flow Machine

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Neon Lightning Glowing Lines and Cloud complete nan Sea


Investment Thesis

DigitalOcean (NYSE:DOCN) is simply a unreality computing level specialising successful infrastructure and level tools, pinch a attraction connected serving mini and medium-sized businesses (aka SMBs). This SMB conception has been mostly ignored by nan unreality behemoths of Amazon (AMZN), Microsoft (MSFT), and Google (GOOGL), who connection enterprise-focused solutions that are overly analyzable and excessively opaque for smaller companies.

This is wherever DigitalOcean differentiates itself, by offering unreality infrastructure and level technologies that tin beryllium implemented quickly, intuitively, and independently - pinch highly affordable and transparent prices.

DigitalOcean solves a problem for mini businesses

DigitalOcean Q4'22 Investor Presentation

I outlined my elaborate finance thesis for DigitalOcean successful a previous article, but nan short type is this: DigitalOcean is targeting an under-served conception of nan marketplace erstwhile it comes to unreality services, and it's doing this successfully. Cloud take is moreover much nascent successful SMBs, giving DigitalOcean a immense runway and nan expertise to standard alongside its customers. Basically, it conscionable needs to support capturing nan opportunity successful beforehand of it.

Cloud infrastructure and level marketplace size for mini and mean sized businesses

DigitalOcean Q4'22 Investor Presentation

The institution conscionable reported its Q4 results, and whilst nan gross outlook for 2023 was somewhat disappointing, nan free rate travel expectations surely made a scatter connected Wall Street.

Let's return a look done nan highlights from DigitalOcean's results to spot precisely why nan marketplace rewarded investors pinch an 8% jump successful nan stock price.

DigitalOcean's Q4 Earnings Overview

Starting from nan top, DigitalOcean's Q4 gross grew 36.2% YoY to $163m, coming successful comfortably up of analysts' $157-$160m estimates.

It's worthy highlighting present that DigitalOcean precocious acquired Cloudways for $350m, and this acquisition will boost DigitalOcean's results and YoY comparisons from Q3'22 onwards. I personally deliberation this was a bully acquisition, and touched connected it successful a recent article.

DigitalOcean quarterly gross hit analysts expectations but guidance was beneath estimates

Author's Work

Looking up to Q1'23, guidance guided for gross of $163-$165m. Despite this representing an awesome YoY maturation complaint of 28.8% successful a reliable macroeconomic environment, it came successful beneath analysts' estimates of $169m.

The weaker-than-expected capacity connected revenues was carried done to DigitalOcean's afloat twelvemonth guidance for 2023. Management expects gross of $700-$720m for FY23, representing YoY maturation of 23.2% and coming successful beneath analysts' expectations of $740m.

DigitalOcean's afloat twelvemonth gross guidance came successful beneath management's expectations

Author's Work

However, Wall Street didn't look to mind, and nan adjacent mates of graphs will allude arsenic to why.

Moving down nan income statement, DigitalOcean delivered adjusted EPS successful Q4 of $0.28, coming successful comfortably up of analysts' $0.19 expectations.

DigitalOcean's Q4 EPS hit expectations and profit guidance came successful supra analysts estimates

Author's Work

Looking up to Q1'23, guidance guided for adjusted EPS of $0.28-$0.29, which besides came successful up of nan $0.24 analysts were expecting despite gross coming successful light. What does that mean? It intends DigitalOcean is going to beryllium acold much profitable than expected, fixed that it's churning retired a higher profit pinch little revenue.

This is reflected erstwhile we look up to nan afloat twelvemonth for 2023, arsenic guidance guided for EPS of $1.65-$1.69 pinch analysts' expecting $1.16.

DigitalOcean gave afloat twelvemonth profit guidance up of wall street's expectations

Author's Work

This is simply a immense ramp up successful profitability for DigitalOcean and was 1 of nan reasons that shares rallied aft this net report.

These results tin beryllium summed up simply: complete nan adjacent fewer years, DigitalOcean is going to turn astatine a slower complaint than expected, but it will beryllium acold much profitable than expected.

Customer Growth and Soaring Free Cash Flow

One metric I ever way pinch DigitalOcean is its maturation of ample customers and its dollar-based nett retention rate, pinch nan beneath chart summarising them nicely.

DigitalOcean's quarterly ample customer maturation and dollar-based nett retention rate

Author's Work

The maturation successful ample customers has intelligibly slowed down, pinch DigitalOcean only adding ~2,100 customers into this bucket during Q4. That's nary astonishment fixed nan macroeconomic uncertainty; however, I'm still pleased pinch these numbers. I had expected nan SMBs that DigitalOcean serves to beryllium much heavy impacted by an economical slowdown, but truthful acold this institution (and by hold its customers) has coped good and continues to turn astatine a patient rate.

It astir apt helps that these 'large' customers (defined arsenic customers spending much than $50 per month, which really isn't that large) dress up 86% of DigitalOcean's revenue. The larger nan business, nan much apt it is to header pinch these economical shocks, truthful this is simply a bully motion for DigitalOcean and is yet different logic why it continues to present beardown results.

DigitalOcean's Q4 cardinal capacity indicators

DigitalOcean's Q4'22 Investor Presentation / Author's Work

But nan astir breathtaking facet of these results for shareholders is DigitalOcean's margins, and successful peculiar nan company's free rate flow.

Management stunned Wall Street by forecasting free rate travel margins of 21-22% successful 2023, up from 13% successful nan twelvemonth conscionable vanished and conscionable 6% successful 2021. CFO Matt Steinfort implied connected nan earnings call that this was only nan beginning, and that DigitalOcean would caput into 2024 pinch free rate travel margins approaching 30%:

On nan backmost of nan beardown capacity successful 2022 and our announced costs simplification initiatives, we person assurance successful our plans to propulsion guardant our longer-term free rate travel target and exit 2023 pinch free rate travel margins successful nan precocious 20s.

This should get shareholders excited, and worth investors should besides beryllium paying attention. DigitalOcean is starting to go a free rate travel machine, and fixed that a institution is theoretically worthy nan coming worth of each early rate flows, these expanding margins should person a very affirmative effect connected DigitalOcean's intrinsic valuation.

Quick Take: DigitalOcean's Financial Trends

I won't talk excessively overmuch connected nan beneath table, but I deliberation it's useful to spot precisely what's going connected pinch DigitalOcean's financials.

DigitalOcean quarterly financial information

Author's Work

The free rate travel continues to beryllium improving rapidly, nan stock-based compensation continues to beryllium impacted by (one-off) performance-based awards granted to CEO Yancey Spruill, and nan equilibrium expanse has deteriorated chiefly owed to nan acquisition of Cloudways.

DigitalOcean remains a financially beardown business, and it plans to usage immoderate of nan rate it's generating to bargain backmost shares astatine what I judge to beryllium very inexpensive prices.

Normally I'd for illustration a institution to rightsize its equilibrium expanse if indebtedness > cash, nevertheless nan indebtedness is 0% convertible notes and nan stock value is incredibly inexpensive successful my view… so, surprisingly, I don't mind nan prime to walk rate connected stock repurchases.

DOCN Stock Valuation

As pinch each precocious growth, innovative companies, valuation is tough. I judge that my attack will springiness maine an thought astir whether DigitalOcean is insanely overvalued aliases undervalued, but valuation is nan last point I look astatine - nan value of nan business itself is acold much important successful nan agelong run.

DOCN Stock digitalocean stock value valuation model

Author's Work

The assumptions successful my exemplary are reasonably akin to my previous article, nevertheless I've started to incorporated analysts' estimates into my guidelines lawsuit script and usage nan carnivore and bull lawsuit scenarios for my ain assumptions. I'm besides now capable to see nan effect of DigitalOcean's Cloudways acquisition, which I wasn't capable to do previously.

Putting this each together, I tin spot shares of DigitalOcean achieving a CAGR done to 2027 of 10%, 27%, and 50% successful my respective bear, base, and bull lawsuit scenarios. In my eyes, it's very difficult to telephone this existent value thing but enticing for semipermanent investors.

Bottom Line

Whilst we are seeing a slowdown, and guidance did push backmost it's $1 cardinal yearly gross target from 2024 to 2025, I judge this is mostly macro-induced and that DigitalOcean is continuing to execute swimmingly.

The velocity pinch which this institution has been capable to amended its free rate travel margins has been staggering, and pinch gross still expected to turn astatine a patient complaint contempt nan recessionary environment, mixed will nan secular tailwinds successful DigitalOcean's back, I deliberation this institution is only going 1 measurement complete nan adjacent decade.

Take each that, and adhd successful a stock value that I judge is genuinely undervalued, and it's nary astonishment that I'll beryllium reiterating my erstwhile 'Strong Buy' proposal connected DigitalOcean.

This article was written by

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We're Andreea & Jamie, 2 finance professionals based successful nan UK pinch a passion for helping others to study astir investing & individual finance. Follow our Instagram @stocksandsavings for regular investing content!

Disclosure: I/we person a beneficial agelong position successful nan shares of DOCN, AMZN either done banal ownership, options, aliases different derivatives. I wrote this article myself, and it expresses my ain opinions. I americium not receiving compensation for it (other than from Seeking Alpha). I person nary business narration pinch immoderate institution whose banal is mentioned successful this article.

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