- Shares of DocuSign dived after the firm’s sales forecast disappointed.
- Declining rates of customer sign-ups and weakening customer monetization also pose challenges.
- A 30% drop in pricing is likely exaggerated.
Shares of DocuSign (NASDAQ:DOCU), a leader in e-Signatures, plunged 30% after the company submitted its third-quarter earnings card yesterday. A weaker than expected sales forecast is weighing on DocuSign’s valuation, but the market is overreacting!
Why DocuSign is a long-term buy
Significant drops in pricing present an opportunity to buy shares when the market appears to overreact to some particular event. This seems to be happening here as shares of DocuSign cratered after the e-Signature company opened up its books for the third-quarter on Thursday. For the three months ending October, DocuSign reported revenues of $545.5M and earnings-per-share of $(0.03). Both figures beat predictions.
(Source: Seeking Alpha)
DocuSign’s revenue growth in the third-quarter, however, experienced a material slowdown… and that’s always a problem for a growth stock. DocuSign’s third-quarter revenues grew at a 42% rate year over year, which is significantly below last year’s revenue growth rate of 53%. Subscription revenues, responsible for a massive 97% share of total revenues, increased to $528.6M. DocuSign also experienced moderating revenue growth in the subscription business where the year over year growth rates dropped from 54% in the year-earlier period to just 44% in the third-quarter FY 2022.
The rate at which customers are signing on to DocuSign’s e-Signature platform is also showing signs of a slowdown. DocuSign ended the third-quarter with 1.11M customers and added only 60 thousand new accounts in Q3’22. DocuSign added 160 thousand customers to its business in the previous two quarters which calculates to an average on-boarding rate of 80 thousand per quarter. For that reason, a continual slowdown in customer acquisition must be expected.
Weakening customer retention
What has me a bit worried is that DocuSign’s net dollar retention rate is also dropping. DocuSign’s net dollar retention rate is a measure that expresses success in customer monetization: it relates revenues generated in the current reporting period to revenues produced by the same customers in the previous reporting period. The result is a figure, expressed as a percentage, that shows how much an existing group of customers increased its spending over time. In Q2’22, DocuSign already experienced a 1 PP drop in the NDR rate to 124%. In Q3’22, the NDR rate dropped another 3 PP to 121%… which means the existing customer base is slowing down its spending. Together with a slowdown in customer sign-ups and revenue growth, this is concerning.
Weak sales forecast
DocuSign’s sales forecast also wasn’t very convincing… and it stoked fears that growth will slow down faster than previously expected. For Q4’22 -- the quarter ending January 31, 2022 -- DocuSign expects total revenues of $557M to $563M, implying a growth rate of 30% year over year. Expected fourth-quarter revenues would bring FY 2022 total revenues to around $2.08B, implying a growth rate of 43%. In FY 2021, DocuSign’s revenues grew at a 49% rate year over year.
DocuSign’s profitability, however, is improving as the firm’s operating income and free cash flow were solidly positive in the third-quarter. The e-Signature firm generated free cash flow of $90M on sales of $545M which calculates to a free cash flow margin of 17%.
My estimate of $6.0B to $6.5B in FY 2026 revenues is now dated and no longer defensible after new information about DocuSign’s sales growth has been made public. For that reason, I lower my FY 2026 revenue estimate, to account for an expected post-pandemic slowdown in sales growth, to $5.5B. Based on this new estimate, DocuSign could grow revenues at an annual rate of 27% over the next four years. I am also making an adjustment to DocuSign’s expected free cash flow margin which I lower from 40% to 35% to account for the firm’s declining NDR rate. A 35% FCF margin applied to projected FY 2026 revenues implies an annual free cash flow figure of $1.93B… which is about the equivalent of DocuSign’s total sales volume this year.
DocuSign may not grow as fast as expected until FY 2026, but the firm is still going to grow at a much faster rate than most businesses. Based off of next year’s projected sales, shares of DocuSign trade at a P-S ratio of 17 X. Because of the 30% drop in pricing, pre-market, DocuSign’s sales growth has also been discounted by 30%.
Risks with DocuSign
Slowing revenue growth, post-pandemic, is a real challenge for DocuSign. The pandemic fueled the firm’s business growth, and customer sign-ups surged when the economy adjusted to COVID-19 and businesses endorsed digital transformation trends. This period of hyper-growth looks to be coming to an end which could result in lower revenue expectations and a lower sales multiplier factor for DocuSign.
The slowdown in revenue growth is a problem for DocuSign, there is no point in arguing this away. However, I feel the market is overreacting to the firm’s revenue forecast. Even with lowered sales growth expectations, DocuSign is set to grow revenues at a rate higher than 20% annually over the next four financial years. The 30% drop in pricing is exaggerated!
This article was written by
Analyst’s Disclosure: I/we have a beneficial long position in the shares of DOCU either through stock ownership, options, or other derivatives. 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.
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