Wait For The Pullback To Buy DocuSign

Summary

• E-signature continues to be a key revenue driver for DocuSign.
• The company is focused on expanding its product portfolio and customer base.
• Investors should consider risks such as high valuations, lack of profitability, and competitive pressures.

Enterprise software companies seem to have been spared from the brunt of the COVID-19 pandemic. DocuSign (NASDAQ:DOCU), a leading player in the electronic signature space, is fast emerging as a major winner in 2020. This SAAS (software-as-a-service) stock is already up 39.68% YTD (year-to-date). While valuations seem stretched at this point, DocuSign is definitely a fundamentally strong story for 2020.

DocuSign is not a pure-play in the healthcare space. However, the company is now increasingly focusing on increasing its exposure to the healthcare segment. Founded in 2003, DocuSign is a pioneer in the e-signature space and has made major strides in the financial services industry. The company went public in April 2018. Since 2012, the company has been making steady progress in ramping up the adoption of its e-signature business.

DocuSign is one of the few coronavirus-resilient stocks in the market. While the company is not profitable yet, Wall Street expects the company’s EPS to rise YoY by 62.70% in 2020 and 72.75% in 2021. Analysts expect the company’s EPS to grow at a CAGR of 25.30% in the next five years. Despite all this, the forward PE (price-to-earnings) multiple of 122.80x and PS (price-to-sales) multiple of 19.39x is pretty expensive. The COVID-19 pandemic is bound to affect the spending capability of IT companies, which is DocuSign’s core client base. This, in turn, can present short-term headwinds for the company. However, this can also open up some attractive entry opportunities for investors. I believe retail investors should be on a lookout of any pullback to pick up this stock.

DocuSign’s e-signature platform is a key growth driver for the company

The COVID-19 pandemic has forced companies, big and small, to transition to the remote working environment. However, this switch was unanticipated and most of the companies are not yet well-equipped to handle the virtual workforce dynamic. DocuSign is one of the few companies providing solutions to make it easier to work from home. The company’s e-signature allows people to authenticate documents over the internet, without the use of paper or any physical contact. The company’s e-signature platform will continue to be in demand especially from IT companies. In such uncertain times, clients also become more risk-averse and will prefer to go with trusted names. DocuSign also stands to benefit from its unparalleled brand position in the e-signature space. The company is targeting a TAM (total addressable market) worth $25.0 billion in the e-signature space.

Considering the TAM, this market-leading cloud-based solution provider definitely has much more scope to grow both its top line and bottom line. In fiscal 2020, the company reported billings of $1.1 billion, a YoY jump of 38%. Revenues were up YoY by 39% to $974 million. Of these, 87% were attributed to the Enterprise & Commercial business segment, while the remaining was to Web & Mobile segment.

DocuSign enjoys exceptionally high revenue visibility. The company earns a major portion of its revenues from long-term contracts, which is a source of recurring and consistent revenue stream. The company is also rapidly increasing its customer base and had 589K customers at the end of fiscal 2020. Of these, 75k were Enterprise & Commercial customers. While the total customer base rose YoY by 24%, Enterprise & Commercial customers grew at an even faster pace of 33% YoY.

The company’s dollar net retention rate, which compares monthly service revenue from the same set of clients across comparable periods, came in at 117% at the end of fiscal 2020. This metric measures the combined impact of customer attrition rate and cross-selling of new products to existing customers. This implies, that even in the absence of new customers, the company would have shown a YoY jump in revenues. This metric highlights the brand loyalty of a software company.

The company has been consistently putting efforts to improve operating leverage and has seen operating margin improve from 2% in 2019 to 5% in 2020. The company has also improved operating cash flow 52% YoY to $116 million in fiscal 2020.

Finally, DocuSign came up with solid guidance for the first quarter of fiscal 2021 as well as for fiscal 2021. The most encouraging thing here is that the company has not withdrawn its guidance due to COVID-19 pressures. I see this as a sign of a very robust business.

On May 1, DocuSign completed the acquisition of Seal Software, one of the leading contract analytics and artificial intelligence (AI) technology providers. The fiscal 2021 guidance, however, does not include the impact of this acquisition on fiscal 2021 performance.

DocuSign is a cloud-based solution provider catering to every stage of the agreement process

DocuSign believes the Docusign Agreement Cloud product can target an additional TAM worth $25.0 billion. Launched in March 2019, this is a suite of applications and integrations that can help organizations automate the entire agreement process which includes preparing, signing, acting on and managing those agreements. The company sees demand for its Agreement Cloud product from corporations as a basic software stack to manage agreements. This will be integrated with other cloud software suites like sales, service, marketing, HR and finance. The company expects the DocuSign Agreement Cloud to become an essential service for digital payments and customer relationship management. Currently, Agreement Cloud is in development mode and does not contribute significantly to the company’s financial performance.

The company’s acquisition of Seal Software is aimed at adding contract analytics and artificial intelligence capabilities to its Docusign Agreement Cloud. The company aims to enable search in these agreements by the concept and not keywords as well as automate extraction, analysis, and comparison of contract terms. The company also aims to add functionality to identify areas of risk and business opportunities for customers.

DocuSign may see many new opportunities from its existing customer base

DocuSign has been focused on strengthening its relationship with Salesforce (CRM) and has built Agreement Cloud in a manner that can easily integrate with the latter’s CRM. This is a very smart move considering that Salesforce has a broad influence in the enterprise software segment. Both the companies are working together to automate agreement negotiations as much as possible.

DocuSign has been witnessing robust demand from financial services, telecom, and real estate segments. The company expects low-interest rates to help boost demand from the financial services industry due to increased refinancing volumes. In April 2020, CNBC has reported a solid spike in refinancing volumes due to mortgage rates dropping to the lowest level ever as per Mortgage Bankers Association’s 30-year-old weekly survey. This has presented a solid opportunity for DocuSign.

Healthcare is emerging as a major customer base for the company

DocuSign is also making major inroads in the healthcare segment. Currently, more than 100 hospitals in the U.S. are using the company’s solutions in activities such as patient registration, HIPAA (Health Insurance Portability and Accountability Act) compliance, talent acquisition, and physician credentialing. All these are independently huge market opportunities with significant unmet demand.

DocuSign has also come up with solutions targeting healthcare plans such as those for simplifying claims processing to easing the burdens associated with agent onboarding. Companies like UnitedHealth Group (UNH), Health Care Service Corporation, Anthem (ANTM), Vision Service Plan, and WellCare (WCG) have already partnered with DocuSign for improving patient experience and increasing employee productivity.

Finally, DocuSign is also exploring opportunities in the global life sciences segment and partnering with drug developers. The company sees myriad opportunities to improve compliance and efficiency in areas such as patient consents and vendor contracts during clinical trials. DocuSign has already partnered with 14 of the top 15 global pharmaceutical companies.

Partnering with a large number of big players in the healthcare space will ensure significant sales for DocuSign in the coming years.

Investors should consider these risks

DocuSign is not a profitable company yet. Despite this, the company is trading at lofty valuations. This dynamic is especially worrisome. Such stocks can see exceptionally high share price volatility in case of an unfavourable earnings announcement or any negative news event.

DocuSign is also facing competition from well-established Adobe (ADBE) in the e-signature space. In July 2011, Adobe acquired electronic signature startup EchoSign for an undisclosed price. Despite having more resources, Adobe Sign has garnered only 5.48% of the e-signature market while DocuSign makes up a whopping 56.69% of this growing market. Citrix Systems (CTXS) RightSignature, SignNow, MyLiveSignature, HelloSign, and SignRequest account for 9.37%, 7.12%, 4.40%, 4.23%, and 2.25%, respectively, of the total market share.

To fend off this competition, DocuSign has to invest heavily to maintain leadership in the signature business and bolster its position in document management. Software companies need to aggressively capture users since switching costs in terms of direct expenses, inconvenience caused to users, or time required to train employees on the new system can be significant. Hence, DocuSign has to grab those customers before competitors get them. In this backdrop, despite growing revenues at a rapid pace, the company continues to report operating losses. Although these investments may pay off in the long run, they can have a downward pressure on share prices in the short run.

Investors should also pay attention to the rate of cash spent by software companies to expand the customer base. A good proxy for customer acquisition costs is S&M (selling and marketing) expenses. Although software companies have to aggressively add members, the cash burn rate has to remain manageable. In fiscal 2020, DocuSign’s S&M expenses jumped YoY by 35.51%, a little faster than the YoY growth in the customer base.

At the end of fiscal 2020, the company has $656 million in cash and short-term investments and around $465 million in debt on its balance sheet. However, the debt is structured as convertible senior notes due 2023. Hence, there is a risk of potential equity dilution in future years.

What price is right here?

According to finviz, the 12-month consensus target price of DocuSign is $88.58, which is a realistic estimate of the growth potential of the stock.

The majority of analysts are optimistic about DocuSign, although there is quite some variability in their target prices. On April 20, Evercore ISI analyst Kirk Materne downgraded the company’s rating to In-Line from Outperform. On April 16, Wedbush analyst Daniel Ives raised the target price to $115 from $90 but reiterated an Outperform rating. On March 13, RBC Capital analyst Alex Zukin lowered the target price to $85 from $93 but maintained Outperform rating. On March 12, Wedbush analyst Daniel Ives highlighted DocuSign as one of the stocks to hold during the COVID-19 pandemic.

Although DocuSign is an attractive opportunity, I believe that the pandemic may have some short-term impact on the company’s growth prospects. Besides, there are times when stocks get hammered with the broader market on nothing much but negative investor sentiment. I believe that there will be such short-term selloffs on the back of emotional selling for many good stocks including DocuSign in 2020. These can be excellent opportunities for retail investors with above-average risk appetite to start building a position in DocuSign at reasonable prices.

Analyst’s 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.