Summary
- DocuSign's revenue growth rate declined sharply and is expected to be below 10% in 2023.
- In contrast, the number of shares outstanding is on the rise.
- This, combined with fierce competition in the industry, creates a challenging environment.
Thesis
I like the idea of DocuSign (DOCU) because, as someone who deals with contracts, I really want a safer, faster and less risky option. Especially the part where you have bulletproof evidence and auditability would really solve a lot of problems. So I would be really happy to see a digitalisation of that process in my country and also when I deal with clients from other countries. But right now this valuation combined with the business metrics is insane. Let me show you why I do not like the current valuation.
Short Introduction
DocuSign has an e-signature product where they claim to be the leader, and they also do contract lifecycle management. They went public in 2018, but the company has been around since 2003.
Analysis
If you look at the picture above, you can see a large total addressable market that is currently underpenetrated. I think it is an attractive market, but I cannot say if it will really be that big. It will also be a very competitive market with many global players like SAP (SAP), Adobe (ADBE), who also have their own solutions. And the competitors are better funded and they can integrate their product into their existing products, which are widely used. And these are companies that make money. DocuSign is now almost 20 years old and they have never had a year of operating profit.
They improved their GAAP gross margins in the nine months to 31 October, which is a positive sign, but they are also one of the companies with excessive use of SBC. We will talk about SBC later.
Their GAAP gross margins looked promising, but if we look at their GAAP operating margins we see that they declined from -2% to -5%. And they can add all that stuff up to have a nice looking non-GAAP number, but the thing is, it is the GAAP numbers that matter.
If we look at sales, we see a continuing downward trend in the year-on-year growth rate. The problem was that they grew very fast and very strongly during the pandemic and now it is difficult to maintain that. But their outlook for the next financial year is only a high single digit growth rate for a company that is valued at ~26x Price/Cash Flow . That is not good enough for the kind of premium that you are paying. This company is still priced as if it is growing at 30%+ a year.
Another financial figure that they report is the net dollar retention, which is also on a steady downward trend, and they have also given guidance that this is likely to be lower in the future than it is now. Other than that, I do not see a moat for them at the moment. But I think it is possible that in the future there will be a company with a competitive advantage. There is an opportunity for moats in this industry.
There have been several CEO changes in the past. The new one has been in place since October 2022. New leadership always has the potential to be a game changer and turn the company around. But at the moment it is too early to judge his work. However, the Glassdoor reviews are not very good at the moment. There are some critical voices in the reviews about management decisions.
Like many technology companies that are not yet profitable, they have positive FCF. Some say this is enough to justify a premium valuation, combined with a good growth rate. Unfortunately, their FCF margin has also fallen from 22% on 31 October 2021 to 17% on 31 October 2022. In addition, there is $316,112 million of FCF versus $387,176 million of stock-based compensation. And even their attempts to buy back shares have a very small impact on shares outstanding.
Reverse DCF
The model is based on a TTM FCF per share of $1.93 and a terminal multiple of 20. The discount rate is set at 10%, which I believe is the hurdle rate for investments.
The current share price is pricing in FCF growth of over 17% per annum over the next 10 years. And I don't think that's possible if they're only going to grow revenues in the high single digits for the next couple of years. If they were still growing at over 30% a year, then I would say, okay, they have a chance of doing that, but not at the lower numbers.
Conclusion
I really like this industry and I think we will be using their products a lot in the future and it will make life easier for a lot of us. And along with AI, there will be even better and more opportunities for contract lifecycle management companies. But unfortunately, at this valuation, with a low revenue growth rate and no clear growth opportunities, DocuSign is too expensive.
If they can somehow accelerate growth again, they could have a bright future. Perhaps the new CEO will make it happen. But for now, I think it is time to wait and see if the metrics improve in the next few years or if the story of this stock is broken.
For further details see:
DocuSign: Lots Of Potential In An Expensive Stock; Taking A Wait-And-See Approach