Despite impressive annual financial results, DocuSign (NASDAQ: DOCU) the stock is down 22% after the report was released due to lackluster management guidelines. Soon, shares rebounded when the CEO bought $5 million worth of company stock. The market seems to have forgotten the recent disappointment. Nevertheless, in our view, investors’ initial fears were not unfounded. Several alerts signal that the pace of revenue growth could slow much more than Street currently expects.
Although the company has become significantly more profitable, the current price does not provide a sufficient margin of safety. We are neutral on the DOCU.
Brilliant results, grim expectations
DocuSign ended fiscal 2022 with strong growth across all operational and financial metrics. Revenues increased 45% to $2.11 billion, billings increased 37% to $2.35 billion. However, we are seeing a sharp quarterly decline in growth that signals a return to pre-pandemic levels.
Plus, DocuSign has become a much more efficient business. Non-GAAP gross margin for the year increased three percentage points to 82%, operating leverage also improved significantly.
The tectonic shift in consumer behavior amid a global epidemic has become the single most important growth driver for which software-as-a-service companies are being forced to pay with a huge settlement base in the post- pandemic. In other words, declining growth rates are a common and expected problem for SaaS companies, and the market was ready for it. Either way, investors were disappointed with the company’s guidance for the first quarter and full fiscal year 2023. Shares corrected 22%, but a strong CEO stock buy makes the market forget the gloomy forecasts.
In the last article, we noted that despite the natural decline in revenue growth, the growth rate of the customer base remains high. This is important because DOCU benefits from what is known as the network effect: the more customers a company has, the more counterparties can benefit from a free user experience and become new DocuSign customers by signing documents. Here we see several alerts that may indicate that the business is struggling to attract customers.
It’s simple arithmetic. At the end of Q4 2022, revenue per customer was $496.6. DOCU’s forecast suggests first-quarter revenue will hit $579 million to $583 million, an average of 23.88% year-over-year. Thus, with average revenue of $581 million and comparable revenue per customer, the number of customers would be 1,170, unchanged from the previous quarter. In the past four years, there has not been a single quarter with zero quarter-over-quarter customer growth.
By the end of fiscal 2023, management expects revenue of $2,470 to $2,482 million, or $2,476 million in the middle of the range (+23.88% in year-on-year). If DOCU maintains annual revenue per customer at its current level of $1,801, the number of customers will reach 1,375 when the goal is reached, an absolute increase of 205 customers, the lowest in three years. However, this absolute increase is still higher than before the pandemic. If DocuSign experiences the same absolute customer growth in fiscal 2024, with comparable revenue per customer, total expected revenue could increase 14.9% year-over-year to $2.845 million, well below the Wall Street consensus of $2.930 million. If absolute customer growth returns to pre-pandemic levels, financial performance will disappoint the street even more.
The bulls can make two counterarguments: a) DocuSign can increase revenue per customer and exceed market expectations; b) management may be too conservative in revenue forecasts.
First, indeed, revenue per customer has increased significantly over the past five years and, by the end of 2022, it has peaked. However, we are seeing a permanent decline in the net dollar retention rate as the impact of the pandemic subsides, meaning that future revenue per customer could be even lower than today. Additionally, DocuSign operates in a highly competitive market.
Second, Dan Springer told investors on the latest earnings call that the company was hiring a new head of sales and bringing in executives from Oracle and Salesforce. While management may be cautious in their directions, they clearly see some challenges in attracting customers.
Our DCF valuation is based on several assumptions. We assume revenue will grow in line with the Wall Street consensus. Over the past six years, gross margin has increased by an average of 1.29 percentage points per year due to the realization of economies of scale, and we expect this trend to continue shortly. We use a similar methodology to forecast future operating margin, which has grown by an average of 7.5% percentage points per year over the past six years. D&A expenses and capital expenses as a percentage of revenue forecasts are based on averages for the past five years. The terminal growth rate is 5%. Our assumptions are presented below:
Based on the assumptions, the expected dynamics of the main financial indicators are shown below:
With a cost of equity of 10%, the weighted average cost of capital (WACC) is 9.8% because DocuSign has low leverage.
With a Terminal EV/EBITDA of 13.19x, the model projects a fair market value of $20,033 million, or $100.82 per share. Thus, DocuSign is trading close to our estimate of fair value.
You can see the model here.
At current and future multiples, DocuSign also seems quite expensive.
Despite strong financial results for the year, the market’s negative reaction to forecasts seems reasonable. The key question for a growing business is how long it can sustain that growth. We see signs that DocuSign is struggling to attract new customers. And while the company has become much more profitable lately, it trades as a growth company, not a value one. We are neutral on DocuSign.