Have you ever explored Amazon Web Services or experimented with creating something on Microsoft’s Azure? If so, you’d understand that even executing simple tasks can sometimes become intricate. This is where the focal point of today’s breakdown comes in.
DigitalOcean is a cloud computing vendor based in America, delivering cloud services designed to assist in the deployment, management, and scaling of modern web applications or websites. Established in 2011, this New York-based enterprise has successfully carved a niche for itself, primarily serving developers, startups, and small-to-medium enterprises. The unique selling proposition of DigitalOcean revolves around the simplicity and cost-effectiveness of its services, intending to eliminate the typical complexities associated with cloud computing. This allows developers more time to concentrate on their highest priority—developing outstanding software.
The company went public in March 2021 and trades under the ticker “DOCN.”
A Brief History of DigitalOcean
DigitalOcean was founded in 2011 by Ben Uretsky, Moisey Uretsky, Alec Hartman, Jeff Carr, and Mitch Wainer. The founders sought to bridge a notable gap in the market: the complexity and cost impediments that developers and small businesses encountered when trying to access cloud infrastructure services. Their objective? To create a platform that was developer-centric and user-friendly—a goal that continues to resonate within the company today.
The company received a substantial boost in its early days, being accepted into Y Combinator‘s Winter 2012 batch. If you’re not acquainted with the program, it suffices to know that it’s an accelerator renowned for nurturing numerous successful ventures.
After graduating from Y Combinator, DigitalOcean procured a $37.2 million Series A in 2013. Naturally, this facilitated the scaling of operations and the continued development of the products we recognize today.
DigitalOcean’s principal offering, and indeed the catalyst for the company’s success, is “Droplets,” its virtual private servers (VPS).
Droplets were conceived to be straightforward, economical, and quick to set up, allowing users to deploy a cloud server in under a minute, sharply contrasting with the complexities inherent to larger, more entrenched cloud providers.
Over time, DigitalOcean has significantly broadened its product range, transitioning from primarily a VPS provider to presenting a suite of cloud-based solutions.
Like many cloud providers, DigitalOcean has a plethora of offerings. Below, we’ll delineate some of the pivotal ones.
- Droplets: These aforementioned virtual private servers are the linchpin of DigitalOcean’s cloud infrastructure, offering diverse types of storage, CPUs, and memory.
- Kubernetes: DigitalOcean Kubernetes (DOKS) is a managed Kubernetes service facilitating container orchestration, simplifying the deployment, management, and scaling of containerized applications.
- App Platform: This Platform-as-a-Service (PaaS) offering enables developers to construct, deploy, and scale applications swiftly without concerning themselves with the underlying infrastructure.
In the realm of the internet, storage is paramount, and DigitalOcean proposes numerous solutions in this sector.
The most prevalent form of storage, “Object Storage,” corresponds to what is offered by Amazon’s S3. DigitalOcean proffers object storage under the moniker “Spaces,” which is apt for storing items like images, videos, backups, etc.
Additionally, DigitalOcean provides Block Storage, typically high-performance SSDs, easily attached to a Droplet and scalable.
Managing databases can be complex. They may seem uncomplicated, but maintaining them and ensuring smooth operation can be challenging. This is where managed databases enter the fray.
DigitalOcean handles the strenuous work; you merely specify your requirements. The offerings in this domain include widespread database services like PostgreSQL, MySQL, and Redis.
Much like other substantial cloud providers, DigitalOcean has a wealth of offerings, and it’s not feasible to discuss them all here. Instead, here are some additional noteworthy offerings:
- Cloudways: A managed cloud hosting solution, Cloudways facilitates one-click installs of systems like WordPress, Magento, and Laravel.
- Paperspace: This is DigitalOcean’s venture into AI. Paperspace assists developers in constructing, maintaining, and scaling AI applications in a hassle-free manner.
- Load Balancers: While not possessing a catchy name, the technology is impressive. Load balancers enable developers to distribute traffic across multiple Droplets worldwide to circumvent downtime.
If you’re reading this, and assuming my audience targeting is accurate, your interest likely lies in the business perspective of DigitalOcean. Essentially, you’re probably pondering “why.”
Why would someone opt for DigitalOcean over the colossal cloud players? What constitutes this company’s competitive edge?
Answering this is challenging. Reflecting on my own profession, my career in software engineering, proposing “Let’s switch to DigitalOcean, AWS isn’t sufficing,” would surely elicit baffled expressions.
This, I believe, does pinpoint DigitalOcean’s distinctive approach—they focus on the smaller entities, individual developers, and startups, aiming to secure their loyalty for the long haul. They’re not focused on, and likely would have a hard time landing, large enterprises.
DigitalOcean achieves this by presenting a more user-friendly, straightforward, and intuitive interface, catering to those who neither need nor desire extensive configurations (though available). The design of DigitalOcean aims to expedite the developer’s initial setup process.
The company offers exemplary documentation, often resulting in high-ranking articles in Google Search. It’s no exaggeration to say that a query like “how to install postgres on ubuntu” brings up a DigitalOcean article as the second result. This instance is emblematic—if you explore deeply technical, infrastructure-related queries, DigitalOcean likely ranks among the top results. The implications and benefits of such rankings are substantial, serving as the core marketing strategy for many firms, especially with high-value searches.
Another point of differentiation—though anecdotal—is DigitalOcean’s steadfast focus on its core services. Those who follow developments in this sector may notice giants like AWS regularly rolling out new features, while innovations from DigitalOcean are comparatively sparse. This doesn’t imply stagnation—quite the opposite—but the company does release fewer new products than its competitors, a characteristic many find refreshing.
Concluding with price points and performance—while more potent solutions may exist elsewhere, DigitalOcean offers commendable performance at its price level.
In summary, while AWS, Azure, and Google Cloud are possibly more aligned with large enterprises possessing diverse and intricate needs, DigitalOcean emerges as a favored alternative for developers, startups, and SMEs who prioritize simplicity, price predictability, and a nurturing community. This unambiguous emphasis on a niche market segment grants DigitalOcean a competitive advantage in catering efficiently to its target demographic.
Now, let’s delve into the financial aspect, where we’ll examine the company’s stock performance and its growth trajectory.
DigitalOcean Stock Performance
DigitalOcean operates under the stock ticker DOCN. Its shares opened at $41.50 and closed at $49 on the first day of trading in March 2021.
Following the IPO, the company experienced substantial gains, attributed to the pandemic-induced surge in demand for cloud services, with the stock reaching $133 per share by November 2021—quite a lucrative return for those who timed it well.
However, the scenario dimmed for long-term holders as 2022 ushered in a widespread selloff in high-growth tech stocks, with DigitalOcean being no exception. By May 2022, the shares had plummeted back to the $40 range, aligning with its IPO price.
The situation further deteriorated, with DigitalOcean witnessing a 20+% drop in a single trading day in August, prompted by a reduction in its fiscal year 2023 outlook. The revised forecast slashed the revenue projections from $700-720M to $680-685M, potentially an overreaction, but it emphasizes that high-growth companies are expected to sustain high growth. Any downward revisions are unfavorable for companies in positions like DigitalOcean’s.
Currently, the company’s shares are trading at approximately $24, rendering it a loss for the initial holders.
DigitalOcean Financial Metrics
Given the subpar stock performance highlighted above, it’s pertinent to scrutinize the financials to ascertain any remaining potential.
The most reliable source for such information is the company’s own filings. I will share snapshots from these filings in this section. All screenshots come, primarily, from the company’s most recent earnings presentation.
The slide linked above succinctly depicts the recent Key Performance Indicators (KPIs). The company has an ARR of $681.5M, reflecting a 25% growth compared to the same period in the previous year. While growth is certainly positive, the pace appears somewhat sluggish.
The rise in ARPU indicates that existing DigitalOcean users are amplifying their expenditure, which, coupled with the expansion of cash flow margins, is a favorable trend for high-growth tech companies.
Regarding ARPU and customer metrics, a notable concern is the decline in the net dollar retention rate. As illustrated in the aforementioned slide, it has decreased from a respectable 112% in Q2’22 to a meager 104% in Q2’23.
The net dollar retention rate gauges the variation in recurring revenue from existing customers over time, contrasting the ARR from a customer cohort at the beginning of the period against the ARR from the same cohort at the end.
A rate exceeding 100% signifies an increase in ARR from existing customers during the period, indicative of customer expenditure expansion. This expansion can stem from upsells, cross-sells, or increment in usage inducing additional charges.
Though 104% leans toward favorable net dollar retention outcomes, the abrupt decline and its proximity to 100% paint a less-than-ideal picture for investors.
Concluding with revenue, the chart above delineates DigitalOcean’s quarterly revenue. It’s evident that the revenue is ascending, but the momentum of growth is decelerating.
This section represents my personal perspective, which may undergo changes with time, so readers from the distant future, please, no harsh judgments 😅.
Stated Goals and Financial Position
Firstly, it’s crucial to acknowledge that DigitalOcean has set an ambitious goal of achieving $1B in revenue by the end of 2024. Given the current trajectory and potential macroeconomic challenges, reaching this goal seems a bit of a stretch.
At the time of writing, DigitalOcean’s market value stands at $2.1B, juxtaposed against ~$700M in revenue. A 3x sales ratio isn’t alarming for a growing entity, but it raises eyebrows when the growth rate is decelerating. If growth stalls, there could be a lot of investor remorse looming on the horizon.
Company Operations and Sales Approach
Despite these challenges, I maintain that DigitalOcean operates a well-orchestrated business. It is navigating through a “land & expand” phase, seemingly leaning more towards “land”. The emphasis on SEO for customer acquisition has yielded long-term benefits, yet, CEO Spruill seems to champion direct sales, a challenging avenue when facing giants like Amazon, Google, and Microsoft.
If I were to don my CEO hat, my focus would revolve around three pivotal strategies to spur growth and sustain the company. Should I, as an investor, witness DigitalOcean aligning its focus on these aspects, I might revisit the idea of investing:
- Multicloud Partnerships:
DigitalOcean has solidified its position in core cloud hosting infrastructure. The logical progression is to facilitate users in leveraging DigitalOcean’s exemplary tooling to orchestrate multi-cloud strategies. This approach can help in retaining customers who are surpassing the capacities that DigitalOcean offers.
- International Growth:
With over 50% of revenue being churned from international clients, global expansion should be a priority. The competitive pricing and user-friendly interface of DigitalOcean can serve as lucrative differentiators in diverse markets.
- Investments in Community & Education:
As you might have discerned throughout this article, I place immense value on the educational content and community contributions made by DigitalOcean. The company should bolster investments in this domain, amplifying the educational arm of its operations.
Wrapping it up
DigitalOcean has indeed etched a distinctive mark in the cloud computing domain, building its forte around simplicity and user-centric designs. It has adeptly created a niche, serving as the go-to platform for developers, startups, and SMEs who prefer straightforward and intuitive interfaces, and its unwavering commitment to educational initiatives and community engagements is commendable.
Nevertheless, the journey ahead is strewn with formidable challenges, with the colossal shadows of AWS, Azure, and Google Cloud looming large. The current financial trajectory paints a somber picture, causing trepidation among potential investors, more so with the ebbing growth and stocks plummeting to unprecedented lows.
The trajectory for DigitalOcean seems marred with uncertainties, but glimpses of potential light up the horizon. By directing its focus towards fostering multicloud partnerships, spearheading international growth initiatives, and relentlessly fuelling its community and educational endeavours, DigitalOcean could unearth avenues to sustainable growth and solidify its distinct identity in this cutthroat marketplace.
For current and prospective investors, a meticulous evaluation of these dynamics is crucial, balancing the impending risks against the prospective rewards. The strategic maneuvers DigitalOcean elects to deploy in the ensuing years, particularly in counteracting the ever-evolving market needs and burgeoning competition, will be instrumental in sculpting its long-term resilience and prosperity.
While the attainment of the audacious revenue target of $1 billion by the close of 2024 hangs in the balance, the enduring appeal of the company’s core values and streamlined offerings continues to resonate with a market segment that prizes simplicity and candor over the expansive and often convoluted solutions proffered by the behemoths of cloud services.
In conclusion, DigitalOcean’s commitment to simplifying cloud computing, its demonstrable emphasis on community and education, and its sustained appeal to a dedicated market segment make it a unique player in the industry. The outcomes of its strategic choices and adaptability will be decisive in navigating the competitive currents and realizing its aspirations, offering interesting possibilities for those keeping a watchful eye on its journey.