DocuSign: The Market Is Overreacting, Strong Buy

Summary

• 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.

Michael Vi/iStock Editorial via Getty Images

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.

(Source: DocuSign)

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.

(Source: DocuSign)

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.

(Source: DocuSign)

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.

Improving profitability

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%.

(Source: DocuSign)

Sales expectations

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%.

Data by YCharts

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.

Final thoughts

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!

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.

Comments

[reardongalt]

I think what it boils down to is that holding for the long term is very risky. Sure, we've all looked back on stocks like Visa, Microsoft and a whole bunch of others and saw how holding for the long term would have made us rich. The problem though is you never know which ones will do it, and anyway, most stocks have massive "corrections" along the way, and they're usually way too painful to sit through. Look at what Cisco did from the end of 99 to 2003. Who could sit through that? Any time I've attempted to hold for the long term, especially with a stock like DOCU, I've always lived to regret it. It's much better to have profit goals and take the profit when it's hit. You can always buy back in later. Maybe you'll want to and maybe you won't. Bernard Baruch once said it was easy making money in stocks if you never buy at the bottom and you always sell too soon. I wouldn't touch DOCU with a ten foot pole right now. Maybe a year from now. Maybe not.

[Wexforde]

I guess we can debate the severity of any pullback or crash. My point is up until recently, growth at any price was king. The companies crashing today have growth but it's slowing and more appalling very few don't make any profit and have huge losses that not changing anytime soon. In 2000 (I was there also) there were companies that were concepts (no revenue), profitless, and some real that were huge (NOK, Nortel, Lucent, Sun Microsystems). Today you have the same gene editing (concept stocks), growth companies with now profits (MBD tonight), and the safe (??) stocks like AAPL, GOOGL that are bought up with no regard to anything. When the pullback came people denied it and then it turned into a full out crash everything went down. Even now I for one have been denying any kind of pull back as I drank the kool-aid. I am caught on some "growth" companies that are now 50% off and still going lower. We are at extremes and when the bump comes it may just turn into a crash. It is time to exit the fallen angels before they fall more, hedge, and raise cash. No buy and hold, only trading. I managed to get a piece of the DOCU bounce today and said thanks and now out. Good luck to those that stay in thinking it's different this time.

[bluescorpion0]

@Wexforde how to hedge biotech portfolio, or any new tech portfolio?

[Hurray]

@Wexforde I'd say the main difference between 2000 and now is that back then the FED put was not there. I'd expect Powell to talk tough but once the market starts dropping, he will bring back all the tools.

[Wexforde]

In your Nov 25 article you said to buy the dip on DOCU when the stock was approximately $250. This present article is sure a gutsy average down move with the stock at $135 on Friday. The market sentiment has and is shifting away from growth at any price to I don't care about growth just get me out of here before I lose 50% in a day. It is not just DOCU but companies with huge valuations and/or profitless are all getting smashed. The market feels like December, 1999 when the dot.com profitless and overvalued companies fell from the sky. Back then it was BTFD just like now, all the way down to when Nasdaq hit 25% of it's high. I ain't buying DOCU other than maybe for a bounce of a few dollars. I am surprised you even have money still left to average down after suffering a 46% drop from your Nov 25 article. I assume you're investing with real money and not paper money?

[Kirby Muxloe]

@Wexforde Whilst I agree I wouldn't be buying DOCU now either and I agree we are in a growth stock pullback/rotation, I completely disagree that this is the dotcom crash we are facing all over again. There's a huge difference between companies now that are growing much faster than internet companies were back then and are actually making $bns in revenue versus a market full of not just profitless companies but in many cases no revenues and broken business models. SaaS companies are debt free, fast growth and potentially massively profitable as soon as they want to be. This is a world away from December 1999, (and yes I was an investor back then).

[The Asian Investor]

@Wexforde Sorry I didn't forecast this insane drop that happened last week. Unfortunately, in the stock market, stock prices can fall unexpectedly and drops may not always make sense. The reaction we are seeing in the market to Docu's results makes no sense to me, 42% down in a single day is ridiculous.

[KFYY]

@The Asian Investor Other similar stocks will soon have similar crashes. Get ready!

[my_symphony2003]

DocuSign is in a niche market with very little entry barriers, what is so special about them that competitors like Adobe can't do?

[The Asian Investor]

@my_symphony2003 They are a market leader in e-Signature solution and are expanding their product suite. Not saying there is no competition, but they are a market leader with significant clout.

[my_symphony2003]

@The Asian Investor Adobe is a much bigger company, DocuSign has no clout, it has some first-mover advantage, nothing else.

[The Asian Investor]

@my_symphony2003 It has significant market share in the e-Signature market and has huge potential to build on this first-mover advantage. The product suite is developing and more and more workloads are going to shift to the cloud. I believe Docu will be a long term winner.

[bihmurdoch]

Sarcasm is a feature and not a bug of this comment.

Heard on the street:
All corporations/governments/corporations/hospitals/notary and anything involving contracts ...........are going back to paper/ink method!!!

Imagine $ADBE is being punished for $DOCU taking eye of the ball in building bookings pipeline.
$ADBE fell 8.24% on Friday. That means if you buy $ADBE today and when this mayhem is over (in the next 2 days till Dec 23 when the next mayhem starts) , you just made 8% in a matter of few days.

[bihmurdoch]

@bihmurdoch If any one was listening to my $ADBE comment, I hope you bought it on Friday for $616 and sold it today for $648, you just made 5.2% in 7 days. Some people in dividend world of quality big cap stock wait for such a yield for two years.

[KFYY]

DOCU share price will go much lower during the next few months.

The general stock market will continue to crash, the FED will increase interest rates and I would not be surprised to also see a recession starting during the next quarters.

DOCU will definitely have lower results than current expectations during the next 3-4:quarters. It will go much, much lower.

[reardongalt]

@Daniel07 I tend to agree. I think that's the assumption traders should operate under.

[Tommy84]

@Daniel07 Yes and the alternative to the stock market will be so much more attractive. Oh wait...

[The Asian Investor]

@Daniel07 Maybe, maybe not :)

[As I was saying]

The problem is not the company, it's the astronomical valuation (that now has come back a bit). It has some first mover advantage, like Tesla, but like Tesla, it also has competitors that will eventually level the playing field. The real problem is the net retention margin; when your own customers start using you less, that's a problem that can't be solved by just adding new customers. And I'm just not sure management has a hold on this, or how to fix it. Probably why this company is better suited not as a standalone, but part of a larger platform that provides real synergies, customer retention, and symbiotic growth.

[No Guilt]

@mikefaulk

So what should the valuation be for a company growing over 40%?

A 15 PE?

[The Asian Investor]

@mikefaulk The valuation has to make sense in relation to the expected sales and profit growth... look how quickly Docu has been growing, it is a growth stock and will always, and should, always have a high valuation factor

[The Asian Investor]

@No Guilt My point. See above :)

[dmau3]

I never owned DOCU before because of its over valuation, but have taken a closer look at it over the the past two days and have initiated a starting position. This purchase had nothing to do with the AI's posts on this stock.

[The Asian Investor]

@dmau3 It is massively oversold now... that in itself is an opportunity

[dmau3]

@The Asian Investor yes, the 14 day RSI for the stock is 13.59.

[The Asian Investor]

@dmau3 I wouldn't be surprised if the stock bounced back to $200

[ZeissGirls]

There is no problem with DocuSign's business. The problem is that investors continue to buy stocks at bubble prices.

[The Asian Investor]

@ZeissGirls Given the sales ramp, DocuSign's valuation was not outrageous

[spinlessandfactful]

@The Asian Investor hope one quarter does not make a trend. The CEO on yahoo finance was saying that they were not creating demand probably this past quarter for the billing to suffer versus when even meeting the demand suddenly fueled by the pandemic was just being met which had led to the growth that it witnessed in prior quarters. Around Sept 2020 the stock was volatile and I wasn’t convinced then that the increase in customer interest to go for esigning with DOCU was sustainable only to be proved wrong when the sp went from around $200 then all the way to $391 or so in just 2 to 3 quarters. Granted some of that had to do with the overall bullish market sentiment with the FOMO by a number of traders/investors. Hope they could sustain the newly experienced interest and enthusiasm for their service going forward. All of the new internet darlings remind me of the amzn’s of the 90’s that not only survived the internet stock bubble of that era but also thrived and continue to this day. GLTA.

[No Guilt]

@ZeissGirls

Is paying 30x earnings for a no growth zombie company bubble prices?

Is lending money to the government for 10 years for 1.5% bubble prices?

[9013185412]

When I look at the 5 year, I don’t get why it’s at $130. Did they invent something brand new since 2019?
Also, what moat do they have to prevent Microsoft from offering the same service for free one day?

[spinlessandfactful]

@9013185412 whenever msft enters an emerging hot field initially by buying up, and then using size to corner mkt share it does not always work too great and as planned. Forays into music player, search engine, browser, and os wars have all been too familiar. Plus this is a niche and a noncore item which may not add all that to its top or bottom line and could take their focus and time away other hot pursuits for domination in areas they are beginning to get entrenched recently like cloud computing. So DOCU is a pioneer and would see more dominance and continued high market share even as the size and scope of the market for DIY contract design, and execution expand immensely lockdown or not, covid imposed or not. So go figure. CEO committing $5M to share purchases in the open market right after the extreme market reaction, hopefully is just one positive we all could hang onto, on a doomy, and gloomy day of price action. While sp could continue its descend on Monday after another round of margin calls and liquidation, I think it could stage a smart turnaround in the not too distant future. Look at the action in Zillow today. Do your own DD. GLTA.

[The Asian Investor]

@9013185412 The pandemic fueled the business and customer acquisition

[No Guilt]

@9013185412

Do you see their growth rates or do you only look at stock price?

[The Calculated Optimist]

I did 60 insurance contracts with 20 major carriers this fall, every one was closed with DocuSign.. So WTF, is everyone thinking. This software is used all over the place.. it’s like an IPhone. Ie it just works seamlessly.

[Convoluted]

I created a MOMO ETF-similar to the Goldman basket of high-flying, non-profitable stocks. I start with bear call spreads and slowly use those gains to buy puts. Thus, the puts are ‘free’ so I don’t mind holding until expiration. If conditions are favorable, I’ll sell shorter expiry puts against the longer expirations.

This requires several months of work. But, I’ve done this long enough to know that it’s never, never, never an ‘if’ question-but a ‘when’ proposition. It’s an inviolate rule that humans will panic. And, when people panic, they puke their guts out. It matters not whether it’s DOCU, UPST-take your pick.

It’s ‘amazing’ how all the accolades and bravado come crashing down-that’s why the short side can be so profitable. Indeed, the ‘elevator down’ can wipe out a huge swath of folks in the blink of an eye. For those that have read my comments over the years, you know that I’ve stressed playing both sides of the street.

People are optimistic-but seldom rational. Once they buy a stock, they tend to irreparably blind themselves. They don’t just drink the kool-aid, they get violent at even the hint of a contrary opinion. The proper approach is to make your best decision, and then rip apart your hypothesis. So, when the stock craters, solace is found by concluding that the market ‘overreacted’.

I’m betting that the market will continue to overreact.

[The Asian Investor]

@Convoluted Thank you for your very long comment. The market is really very much overreacting right now. I bet in 3-4 months we are at new highs, I wouldn't be surprised...

[Convoluted]

@The Asian Investor

It’s up to JP and his merry band of central planners. It would appear that their old nemesis (inflation) will be front and center.

Market history suggests we get the January effect-as funds need to buy back shares after tax-loss selling. But, as you know, a loss of X% is not salvaged by an X% gain.

[retiredboeingeng]

@The Asian Investor I hope you are correct. Picked some up at $135 yesterday. I would be happy to see a 50% rebound over the next few months.

[ttanphat]

I am not buying anything until powell take back his word that taper faster and rate hike

[cbonk22]

Ummm. The article seemed quite contrary to the headline.

[The Asian Investor]

@cbonk22 Perhaps I have made my point not strongly enough. My point is this: Despite moderating growth, DocuSign will continue to grow at high rates and the sales growth has been heavily discounted. The market is also overreacting to the sales forecast.

[NextLevelTrading]

I started a DOCU position today.

I love it when funds try to exit a position in one day. It creates panic and euphoria. This stock is WAY oversold.

Solid company. Back to 180 soon.

[ttanphat]

@NextLevelTrading back to 80 soon son

[Alsome1]

@NextLevelTrading selling when a company’s fundamentals are poor isn’t exactly bullish

[The Asian Investor]

@NextLevelTrading You need a good stomach for it but chances are good that you will be rewarded. Docu is totally oversold.

[spinlessandfactful]

I think more gamblers are hooked into buying at any price using margin at the cheapest possible. This has been one of the most leveraged in the history of markets. Over the last 3 months even as the economy showed signs of opening up after being ravaged by the delta variant. The price action today is an adjustment to what had happened during these last 3 months, and it has been pretty quick and brutal. Having said that, I personally think DOCU is still in a growth and greener mode. Imagine cutting down on travel, and other hurdles to get the deal put in writing by going virtual. More mainstream adoption including for esigning of tax, and a slew of other documents is ahead. While we do not know if any bubble in the stock's valuation has been done addressing by Mr Market today, the fact remains this company looks far and away a leader in its domain, and is a survivor in the years ahead. If they could create new avenues of demand, then the sp will have a positive correction to the upside. My 2 cents. GLTA.

[bihmurdoch]

1) Institutions run algos
2) They short stock and invest 100 million in losses for themselves.
3) The stock starts falling and triggering stop losses
4) Stock tumbles and creates margin calls to leveraged investors
5) Leveraged investors sell to cover margin calls
6) Stock goes further down and triggers more stop losses
7) That leads to more margin calls.................
8) Company losses $20B in capitalization
9) Institutions sweep in and start accumulating
10) Rinse and repeat, keeps working for last 50 years.

[TechnicalEntry]

The real play was this guy on WSB. $30k in puts turned in to $770k in a day:

www.reddit.com/...

[binks613]

@TechnicalEntry ended up being a scam

[my_symphony2003]

needs to drop another 75% to make some sense in terms of valuation. The everything bubble seems to be bursting.

[BoringDude]

@my_symphony2003 wait for the stock split.

[Long-Short Manager]

It's always interesting how anchored people become on prior highs. If a stock reaches 300 and it's at 140 now yah its more than half off. My kid could do that math when he was 5. What he couldn't get until a few years later is that it could still be twice more than he should pay. It is rarer and rarer on SA.com to see the an article that actually models a growth ramp, discounts it at a sufficiently high rate to account for the risk of being wrong, and comes up with a reasonable range of fair value estimates. Its always "heres the growth rate, heres the P/S". So what? What's the relationship between growth rates, margins, discount rates and the price you should want to pay? I don't think people who do this should really be writing articles in good conscience and certainly readers shouldn't be following them. They are pied pipers leading people over a cliff.

[dacaan]

@long-short Manager added a follower

[bluescorpion0]

@Long-Short Manager that is their goal. SA goal is to create chatter and entertainment and 'action'. I hope nobody here is trying to make money - or if they are usually they are rather silent about what they are doing.