IPO Update: DigitalOcean Seeks $751 Million In U.S. IPO

Summary

• DigitalOcean has filed to raise $751 million in gross proceeds from a U.S. IPO.
• The firm provides a self-serve SaaS IT infrastructure as a service platform for small and mid-sized businesses worldwide.
• DOCN is growing quickly and is well positioned in a growing industry, so the IPO is worth a close look.
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Photo by alvarez/E+ via Getty Images

Quick Take

DigitalOcean (NYSE:DOCN) has filed to raise $751 million from the sale of its common stock in an IPO, according to an amended registration statement.

The company provides self-service cloud SaaS computing infrastructure for small and mid-sized businesses globally.

DOCN is growing quickly and is well positioned to reap the benefits of accelerated business transition to the cloud in the years ahead.

The IPO is worth a close look.

Company & Technology

New York, NY-based DigitalOcean was founded to develop an IT infrastructure platform that enables SMBs to acquire, configure and deploy their applications on its cloud-based SaaS subscription-based system.

Management is headed by Chief Executive Officer Yancey Spruill, who has been with the firm since 2019 and was previously COO and CFO of SendGrid.

Below is a brief overview video of a comparison of DigitalOcean with AWS:

Source: linuxhint

The company’s primary offerings include:

• Compute

• Managed Databases

• Developer Tools

• Storage

• Networking

DigitalOcean has received at least $273 million from investors including AI Droplet Holdings, Andreessen Horowitz, IA Ventures and others.

Customer Acquisition

The firm acquires SMB customers primarily through online marketing efforts, funneling prospects to its self-serve service offerings.

DOCN had more than 570,000 customers from over 185 countries and 34,000 developer tutorials as of December 31, 2020.

Sales and Marketing expenses as a percentage of total revenue have dropped as revenues have increased, as the figures below indicate:

Sales and Marketing	Expenses vs. Revenue
Period	Percentage
2020	10.5%
2019	12.3%

Click to enlarge

Source: Company registration statement

The Sales and Marketing efficiency rate, defined as how many dollars of additional new revenue are generated by each dollar of Sales and Marketing spend, was 1.9x in the most recent reporting period.

The company’s Average Revenue per Customer grew by 18.3% in 2020 versus 2019, as the table shows below:

Average Revenue Per Customer
Period	ARPC	Variance
2020	$555.68	18.3%
2019	$469.54

Click to enlarge

Source: Company registration statement

DOCN’s net dollar revenue retention rate has been relatively stable at or around 100%, increasing slightly to 103% in 2020. A figure of $100% or greater is considered good as it indicates the firm is producing at least the same amount of revenue from its cohort of customers from year to year.

Market & Competition

According to a 2021 market research report, the global market for platform-as-a-service services was an estimated $6.9 billion in 2020 and is forecast to reach $19.2 billion by 2026.

This represents a forecast very strong CAGR of 18.5% from 2021 to 2026.

The main drivers for this expected growth are a continued transition from on-premises IT infrastructure to cloud-based systems as small to large businesses seek improvements in their information system capabilities.

Also, as customers need to integrate a greater number of services, they are looking for service simplification and vendor consolidation whenever possible.

Major competitive or other industry participants include:

• Amazon [AWS]

• Microsoft (MSFT)

• Google (GOOG)

• IBM (IBM)

• Oracle (ORCL)

• OVH

• Vultr

• Heroku

• Linode

Financial Performance

DigitalOcean’s recent financial results can be summarized as follows:

• Strong growth in topline revenue

• Growing gross profit and gross margin

• Reduced operating losses

• Increased cash flow from operations

Below are relevant financial results derived from the firm’s registration statement:

Total Revenue
Period	Total Revenue	% Variance vs. Prior
2020	$ 318,380,000	24.9%
2019	$ 254,823,000
Gross Profit (Loss)
Period	Gross Profit (Loss)	% Variance vs. Prior
2020	$ 172,848,000	30.4%
2019	$ 132,564,000
Gross Margin
Period	Gross Margin
2020	54.29%
2019	52.02%
Operating Profit (Loss)
Period	Operating Profit (Loss)	Operating Margin
2020	$ (15,791,000)	-5.0%
2019	$ (29,905,000)	-11.7%
Net Income (Loss)
Period	Net Income (Loss)
2020	$ (43,568,000)
2019	$ (40,390,000)
Cash Flow From Operations
Period	Cash Flow From Operations
2020	$ 58,115,000
2019	$ 39,902,000
(Glossary Of Terms)

Click to enlarge

Source: Company registration statement

As of December 31, 2020, DigitalOcean had $100.3 million in cash and $329.3 million in total liabilities.

Free cash flow during the twelve months ended December 31, 2020, was negative ($52.3 million).

IPO Details

DOCN intends to sell 16.5 million shares of common stock at a proposed midpoint price of $45.50 per share for gross proceeds of approximately $751 million, not including the sale of customary underwriter options.

Tiger Global Management and affiliated funds have indicated an interest to purchase shares of up to $175 million in the offering at the IPO price.

Assuming a successful IPO at the midpoint of the proposed price range, the company’s enterprise value at IPO would approximate $5.1 billion.

Excluding effects of underwriter options and private placement shares or restricted stock, if any, the float to outstanding shares ratio will be approximately 15.67%.

Per the firm’s most recent regulatory filing, the firm plans to use the net proceeds as follows:

The principal purposes of this offering are to create a public market for our common stock, facilitate our future access to the capital markets and increase our capitalization and financial flexibility. As of the date of this prospectus, we cannot specify with certainty all of the particular uses for the net proceeds to us from this offering. However, we currently intend to use the net proceeds we receive from this offering for general corporate purposes, including working capital, operating expenses and capital expenditures.

Management’s presentation of the company roadshow is available here.

Listed underwriters of the IPO are Morgan Stanley, Goldman Sachs, J.P. Morgan, BofA Securities, Barclays, KeyBanc Capital Markets, Canaccord Genuity, JMP Securities, and Stifel.

Commentary

DOCN is seeking to IPO to increase its available capital for its expansion initiatives and to enable its investor base to exit their investment positions after the lockup expires.

The company's financials show strong topline revenue growth, high and increasing gross profit and gross margin.

Sales and Marketing expenses as a percentage of total revenue have dropped as revenues have increased and its Sales and Marketing efficiency ratio was a relatively robust 1.9x in 2020.

The market opportunity for providing infrastructure as a service to small and mid-sized businesses is expected to grow markedly in the coming years, so the firm has positive industry growth dynamics in its favor.

Morgan Stanley is the lead left underwriter and IPOs led by the firm over the last 12-month period have generated an average return of 63.5% since their IPO. This is a middle-tier performance for all major underwriters during the period.

The primary risk to the company’s outlook is the competitive landscape, with major technology companies with deep pockets seeking to gain market share.

DOCN’s net dollar revenue retention rate has been relatively stable at or around 100%, increasing slightly to 103% in 2020. This is a decent figure, although I would like to have seen higher.

As for valuation, management is asking IPO investors to pay an EV/Revenue multiple of 16x on trailing twelve month revenues. Assuming a 20% forward revenue growth rate, the forward EV/Revenue multiple would drop to 13.4x.

Given the pandemic’s forcing function for businesses of all sizes to improve their digital presence, DOCN is well positioned for continued growth into 2021 and beyond as businesses continue their historic transition to the cloud.

The IPO is worth a close look.

Expected IPO Pricing Date: March 23, 2021.

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.