DocuSign: Signing Up For Solid Growth

About: DocuSign, Inc. (DOCU), Includes: ADBE
by: The Value Investor

DocuSign reported very resilient second quarter results at a time when many SaaS players are struggling a bit.

The company is demonstrating on a continuation of impressive growth, yet fails to deliver on improvements on the bottom line.

Despite a nice recovery in the share price, valuation multiples have come down a bit over time, although lack of earnings prevents me from signing on.

A year ago I looked at DocuSign (DOCU) as I wondered if the provider of safe documentation offered a safe investment as well. In that article I observed that I liked the valuation at the offer price of $29 per share, which valued the company at a reasonable 7.1 times sales multiple at the time, while sales grew by 36%.

In September of last year shares rose to levels in their 60s, killing all the (relative) appeal, at least in my book, at a valuation of 16 times sales. Such an elevated sales multiple was too high given that sales growth in the mid-30s was not high enough for me to find any appeal.

Revisiting Events

The promise of DocuSign is very good of course as it claims to be a market leader for "agreements" through the removal of paper. By moving this traditional market to the e-version, clients can more easily store documentation, speed up the entire process, reduce errors, all while reducing costs as well.

Founded in 2003 already the company's technique was used nearly a quarter of a billion times in 2017, as strong focus on technology, the platform, reliability and APIs makes for the successful rise of the company in this fairly large market.

Despite the great promise I decided to be very cautious in September of last year at $68 as the 16 times sales multiple was simply too high given the growth and the anticipated competitive pressure from perhaps Adobe (ADBE) and others as well, as the progress on the bottom line was not impressive enough in my eyes.

Days following the release of the article last year, selling shareholders offered a sizeable amount of shares at $55 per share as shares fell back to $40 by the end of the year despite relatively sound third quarter results.

In March of this year, the company reported the results for all of 2018. The company ended the final quarter of the year with 34% revenue growth, marking full year revenue growth of 35%. Revenues came in just shy of $200 million in the final quarter and totaled just over $700 million for the year while billings totaled $801 million. A diluted share count of 167 million shares made for an equity valuation of $6.7 billion at $40, as net cash holdings made for an enterprise value of $6.2 billion, equal to 7.7 times the billings reported for 2018.

As the company guided for billings around $1.02 billion in the calendar year of 2019, that multiple dropped quite a bit to just over 6 times, even though billing growth was expected to slow a bit to around 27%.

The real problem was the margin picture. The company reported a fourth quarter net loss of $66 million, more than 10 times increase compared to the final quarter of 2017. This was mostly driven by a nearly $50 million stock-based compensation expense for the fourth quarter, while stock-based compensation ran just at $6 million the quarter a year before. While adjusted earnings kindly exclude for these payments, they are a real expense for investors of course.

2019 So Far

For the current fiscal year of 2020, the company started the year on a solid note. In June the company reported first quarter sales growth of 37%, although billing growth of 27% was far less impressive with a book-to-bill ratio equal to just 1.0 times. While shares have recovered to levels in the mid-50s this spring, they fell back to the high-40s upon the release of the first quarter results on the back of the billings numbers. Shares jumped from $46 to $56 in early September upon the release of the second quarter results and trade around $60 now.

Second quarter sales growth of 41% was rather impressive, yet the 47% increase in billings was even more impressive, although the book-to-bill ratio only came in at nearly 1.1 times. The company promptly raised the full year revenue guidance by around $30 million and the billing guidance by about $50 million. The problem is that the bottom line remains a real issue with second quarter operating losses still coming in at $65 million for the quarter.

With sales now easily running at around $1.1 billion in terms of billings, valuations have expanded a great deal again at $60. The 175 million shares outstanding value equity at $10.5 billion, or $10 billion after accounting for net cash holdings. This results in a 9 times billings multiple which seems reasonable given the 40% growth rate, yet the problem is that it becomes more difficult to maintain these growth rates as the company continues to grow larger and lack of leverage on the bottom line is not helpful either.

Hence the situation seems more compelling today at $60 compared to levels at $68 at which shares traded this time last year, certainly as the company has seen another year of 40% growth, reducing sales multiples quite a bit from 16 to 9 times. This makes for a compelling relative valuation play compared to other SaaS players, yet the real issue is that of lack of leverage on the bottom line. While it is not a major concern given net cash balances and the fact that most of the losses stem from stock-based compensation, thereby not creating a cash crunch, it is painful for investors nonetheless.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.