DocuSign: Opportunity Remains, But Growth Is Slowing
Summary
- DOCU is heading the wrong direction in a couple of key metrics.
- The company faces economic headwinds, and a lackluster market environment for cloud stocks. That being said, the opportunity is still great.
- I'm a buyer here, but walk in eyes open to the possibility it doesn't turn around.
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I've spent quite a bit of time looking at beaten-down cloud stocks recently. They were the darlings of the work from home craze during the post-COVID stock market boom, and almost without exception have crashed back to pre-pandemic valuations. Some, like DocuSign (NASDAQ:DOCU) are trading below IPO values (IPO in 2019) due to a mixture of slowing growth and overall market malaise. Although I won't posit DOCU is without risk, the opportunity is very real, the company has managed to fend off competitors to maintain a leading market position, and this would be an excellent time to look at scaling in if it's been on your radar.
I was first introduced to this company when purchasing my first house. I don't have first-hand knowledge of the annoyance when handling 100+ signatures for every real estate transaction, as the process was relatively painless for me. Additionally, my real estate agents for my next two home purchases and property management contracts also used DOCU. The experience was seamless, and took exactly as long as was required for me to read the document. Identity verification is baked into the platform, it saves all relevant documents in one place for you to peruse later in the cloud, and sends the emails back and forth for each party to sign as the certifications are made. Needless to say, when the company went public in 2019, I was very interested.
Company Presentation
DOCU aims to be more than just an e-signature business. Management throws around a $50B TAM number frequently (I'll maintain some skepticism on that number), with half from signatures and half from the rest of their agreement cloud. The agreement cloud handles other transactions within an organization, like HR, contract negotiation, and post-contract execution management. With that, the average user is going to subscribe to the base monthly e-signature offering, while larger businesses can spend the big bucks to have additional utility built in to their existing infrastructure by the DOCU sales and integration team. This approach allows for some sheltering of revenues, considering SMB and individual accounts are prone to excessive churn and lower consistency. The company is definitely feeling that currently.
Company Presentation Company Presentation
Like I mentioned above, revenue growth has been slowing as the company scales up. 25% YOY growth is nothing to downplay, but the market doesn't like to see growth slowing in what is seen as a mostly greenfield market. E-signature demand is growing rapidly, and the company's key competitor is Adobe (NYSE:ADBE) Sign, which I have used separately but the use case tends to skew a little differently. My anecdotal use-case here is Adobe's product is much better for filling out a form electronically for say, a doctor's office or to open a bank account, while I've used DOCU historically for more transactional contracts.
The slowing growth isn't great, but things to consider are the slowing housing market, for one, and recessionary pressures. DOCU won't be immune to the economic climate as overall financial activity slows down. Looking below, subscription revenues comprise the vast majority of the business, with the caveat that the smaller accounts are on a month-to-month basis versus longer term contracts.
Company Presentation
Company Presentation
Adding to the lower revenue growth, net dollar retention has slowed heading into this year. I don't see anything fundamentally changing with the product, but this is a metric worth watching. Over 100% shows net growth in subscriber revenue over time, but the downtick is indicative of growing churn.
The company boasts ~1.3M paid users with ~1B unpaid users currently, and can be considered the market leader in e-signatures. Use cases are continuing to grow as it becomes less and less defensible to wait over a week for paper documents to shuffle back and forth when closing contracts. Any company handling sales contracts (nearly all of them) is a potential customer, but as mentioned above, the major markets currently are real estate, health care, government, and life sciences. Only one user in the transaction has to pay, which lowers the likely friction of asking the recipient of the document to sign up for a monthly subscription service to close on the agreement. The company projects each signature saves the user $5-100, and can be achieved inside 15 minutes versus using a company like FedEx (FDX) to ship documents back and forth. As an owner of out-of-state rental properties, it's been a fantastic quality of life improvement.
The company's gross margins clock in at a healthy 83%, unsurprisingly for a cloud subscription tech company, with operating margins hovering around 20%. Although the company generates free cash flow and is non-GAAP profitable, it will likely be some time before it claims GAAP profitability, which as always is a key risk with these types of companies.
One last thing to consider before moving into some valuation metrics. DOCU is a relatively smaller company, at a market capitalization of ~$10B. The market opportunity it targets is a lucrative one, and would make a great tack-on to the offerings of many of the other tech giants, like ADBE or Microsoft (NYSE:MSFT). I won't buy a company expecting a buyout, but that's something that could be in the cards for DOCU in the future in my opinion.
Clouded Judgement Substack
Looking at the cloud cohort above, courtesy of Jamin Ball's excellent Clouded Judgement Substack, DOCU clocks in under the median valuation of EV/next twelve months revenues at 4X.
Clouded Judgement Substack
Using a graph I like even better, DOCU hovers right around the mean valuation for cloud companies based on its projected growth rates. Like I mentioned above, the entire sector has been shocked and is currently trading for fractions of what it did two years ago. DOCU is in the lower cohort for expected growth.
Clouded Judgement Substack
Clouded Judgement Substack
Some additional numbers to keep in mind from the table above. DOCU is on the lower end of the average in stock based compensation, at 21% of revenues. This remains my least favorite thing about cloud companies, but remains the sector's favorite way to attract talent and minimize overhead costs. Ultimately, you will likely be looking at dilution if you buy cloud tech. DOCU did authorize its first share buyback program of $200M in the middle of last year, which seems like a decent decision considering how much lower stock valuations are today.
The balance sheet doesn't ring any alarm bells for me, the company carries some debt, but it appears very serviceable, and is free cash flow positive. I'm not concerned from a liquidity standpoint.
The Rule of 40 puts DOCU right at 40%, which is a first for me when analyzing a company. None of the other values really stand out besides the two metrics I mentioned above, revenue growth and net revenue retention.
FAST Graphs
Looking above, it's been a horror show for anyone who bought into the COVID boom. The company's price has settled down for now right along it's longer-term adjusted earnings growth rate.
FAST Graphs
Although the company doesn't necessarily track P/E ratios, if it maintains its current ~24X adjusted earnings and maintains projected growth rates, it would yield around a 20% annualized rate of return.
There's tons of risk baked in here. The company's opportunity is immense, but its metrics aren't pointed in the right direction. I'm a buyer at these levels, but consider the pros and cons before making your own decision. If you're already an investor in DOCU, watch the quarterly reports for the slowing revenue growth and shrinking net revenue retention rates. There is inevitably a point where those metrics are bad enough that it no longer makes sense to remain an investor in the company in my view.
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Disclosure: I/we have a beneficial long position in the shares of DOCU, ADBE 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.