I’m considering a position in Digital Ocean, a cloud services provider that is down 63% from 2021:
- It has successfully cornered the SMB market by offering affordable, transparent pricing and a user-friendly platform. Its unique ‘Droplets’ feature bundles compute power, storage, and network bandwidth into a single package – instead of selling these elements separately, like with AWS or Azure – making cloud computing more accessible for SMB.
- Despite SMBs sensitivity to macro volatility, business has been growing at a healthy clip, with revenue recently growing by 30% YOY and churn remaining stable. A testament to its value prop is its strong customer loyalty: most new business comes via word of mouth (minimizing marketing costs) and its net-dollar retention rate has grown from 103% in 2020 to 115% in 2022.
- What happens when SMBs turn into BBs? Well, it’s continually expanding its features and types of Droplets to accommodate businesses' evolving needs as they grow, encouraging users to stick with the platform. This strategy has been working, with its base of ‘scalers,’ or users who spend more than $500 per month, most recently growing by 24% YOY.
- Management puts a strong emphasis on balancing high growth with FCF generation, and it’s on track to reach a 30% FCF margin by year-end. Cash is used for share buybacks and strategic acquisitions, including its purchase of Paperspace last week, which makes AI-app development cheap and easy for SMBs. Given the benefits of AI on work efficiency, this tool could turn more customers into 'scalers'.
It may not be the next Azure or AWS, but its niche in SMB could potentially make it an acquisition target for larger cloud providers.
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