It turns out that investors interested in small upstart cloud computing platform DigitalOcean (DOCN 1.27%) got not one but two opportunities to buy the big dip. After bottoming during the bear market at the very end of 2022, shares rocketed higher in the first half of 2023. But then the stock reached fresh all-time lows later in the year after slowing revenue growth hit, past accounting errors were found, and a shake-up at the CEO level was announced.
DigitalOcean (DO from here on out) is back on the mend again, and it has doubled in value over the last four months. The final earnings update of 2023 and the outlook for 2024 have the market feeling okay about the cloud business again. Is it too late to buy?
A new CEO with a technical background
DO performed fairly well last year considering some of its drama. The company provides remote data center computing power for start-ups and small and mid-sized businesses (or SMBs), a high-growth industry that sailed through much of the bear market of the last couple years.
But when looking at DO to kick off 2024, we should start by addressing the CEO issue. Yancey Spruill announced his departure in the second half of last year, and it was a notable tenure at the helm that included the DO IPO in early 2021, the acquisitions of managed cloud hosting company Cloudways in 2022 and GPU-based AI training platform Paperspace last year, and the repurchase of nearly $1.1 billion of stock to more than offset the effects of stock-based compensation over the last two years.
Along the way, Spruill kept the small cloud platform in growth mode despite tech titan competition while helping DO become profitable by all measures. DO finished 2023 with a GAAP net income margin of 2.8% (including an 8.8% net margin in Q4 2023), and full-year free cash flow (FCF) of $110 million (a FCF margin of 15.9%).
However, now that the bear market is over and investors are satisfied (for now) with the balance of growth and profitability, the board of directors likely saw the need for a change. That’s where new CEO Paddy Srinivasan comes in. Srinivasan has a software engineering background, having served in various roles at Amazon, Oracle, and Microsoft. He was also the founder and CEO of a cloud monitoring start-up that was acquired by Microsoft in 2012, and most recently, he was CEO of IT software service company GoTo (formerly called LogMeIn).
At least to me, the change in leadership is clear: DO is looking to go back on the offensive with cloud computing still very much a secular growth trend. Bringing in a fresh perspective with a technical background could help DO in developing new services, which could help with picking up new developer and SMB customers.
Is DigitalOcean gearing up for another run higher?
DO stock is back on the rise, but that’s likely due to the fact it was mighty cheap again a few months ago. Even after doubling in price, shares trade for about 33 times trailing-12-month FCF as of this writing.
Is DO about to soar even higher? It could, but it will depend on execution. Tech researcher Gartner predicts that cloud computing spending will increase over 20% in 2024 with cloud infrastructure and related app development services (DO’s specialty) leading the charge higher.
However, Srinivasan and the top team’s initial outlook for 2024 is for revenue to increase just 10% at the midpoint of guidance to $765 million. There are a lot of factors that could be affecting this predicted underperformance to the cloud market overall, including weakness among DO’s primarily SMB customers in light of tough economic conditions. DO could also simply be taking a cautious stance on predicting growth as Srinivasan gets familiar with the business.
When I invest in smaller businesses like this one, I like to hold ones that are outpacing the industries they participate in. At any rate, DO expects to maintain its FCF profitability this year as it invests in new growth initiatives. It’s been a wild ride, and there’s some trust that needs to be rebuilt. But I’m happy to keep holding onto my stake in DO, even though it isn’t the value it was a few months ago. I’ll give DigitalOcean and its new CEO at least a few quarters before making up my mind.
John Mackey, former CEO of Whole Foods Market, an Amazon subsidiary, is a member of The Motley Fool’s board of directors. Nick Rossolillo and his clients have positions in Amazon and DigitalOcean. The Motley Fool has positions in and recommends Amazon, DigitalOcean, Microsoft, and Oracle. The Motley Fool recommends Gartner and recommends the following options: long January 2026 $395 calls on Microsoft and short January 2026 $405 calls on Microsoft. The Motley Fool has a disclosure policy.
