DigitalOcean Sold Off After Earnings — Buy the Dip?

In this video, we're gonna be talking about DigitalOcean, and this is an excerpt from one of our CSI Lives that we have weekly every Wednesday at 8:00 AM Pacific. Besides getting those weekly live events, weekly live Q&A with Kasey and I, we have a lot of new stuff coming to the research dashboard starting on September 1st. Lots of more data will be in there, new tools to help you analyze businesses, track the changes that are most important to you with those businesses, and manage your portfolio. Check it out at chipstockinvestor.com. All right. Let's talk about DigitalOcean. You had a write-up on DigitalOcean a couple months ago, perhaps. Haven't done a video about it in a while. Fits into tech equipment and devices. But here's an update from a few months ago. DigitalOcean has gone beyond just catering to the small and mid-sized business. They're definitely growing to address more developers and large scale businesses. You can see the types of customers that they have. On the left, 100,000 plus customer spend AR versus 500,000 customer AR versus 1 million customer ARR. Obviously growing significantly. Yeah. After meeting with Paddy after he took over we felt things were not going super great, but let's just give it time for things to work out, and it got pretty rough there. But now, things have most definitely changed a lot. And let's walk through what this is. So Kasey, you mentioned the pivot, no longer just small and mid-sized business cloud provider, but also developer and scaler platform as well. And so there's a cohort of customers that are scaling rapidly, and as soon as DigitalOcean can get the capacity up and running for them, they're going to buy it. And you can see that in the guidance increase for 2026. Previously 25 to 27%. They just raised it. 30 to 31%. Pretty big increase in guidance. It gets better. They expect a 50% growth by the end of fiscal year 2027. 50% plus or more. It's early. So it depends on how quickly they can get capacity up and running. They have the customers now that are scaling rapidly, and so this is just really a supply-constrained environment. How should we see the implications of data center construction lagging behind hyperscaler CapEx? The delays stem from power scarcity, community and regulatory resistance, and supply bottlenecks. Consequently, this creates a low-efficiency pipeline from investment to usable compute, ultimately threatening the future revenue stream these investments were meant to secure. We also saw something similar in the Microsoft earnings call where they talked about skewing some of the CapEx this year towards actual equipment, servers and networking, and pushing out and delaying some of the construction. Basically, they need the compute capacity now, and the construction part has all these delays. It's hard to get that up and running. And so, the hyperscalers need to do that, but it doesn't lead to the immediate revenue growth right now. It's a longer term project. I think DigitalOcean has a benefit that they can kind of throw up some compute capacity within co-location services, rather than building from the ground up themselves And so they can rely on that. But, the same issue remains. There's customers that are rapidly growing and scaling, and so how do you generate revenue right now? You skew towards, "Okay, let's purchase as much computing equipment as we can now. We'll deal with construction concerns later on." And that's where this guidance through end of 2027 comes in. DigitalOcean just needs to get computing capacity on, and they will sell it as far as they can tell right now. And so we're pretty early on here. Here's the revenue GAAP net income and free cash flow. Are we still pretty early in this becoming, like a hockey stick growth inflection point for DigitalOcean? Yeah, it would actually seem so. Management said over the next six quarters it's gonna get a lot better. So by the end of 2027, could be 400 million in revenue per quarter. Yeah. So 1.6 billion to 2 billion per year revenue business, depending on how quickly they can get that, compute supply online. Maybe I'll hold off on that. Okay Okay, balance sheet. Take us through these balance sheet items subsequent to Q2. I should say. Yeah. So they've completely reworked the balance sheet. They used the run-up in the stock price very wisely. They sold some stock to raise cash just a few weeks ago, so this was after the quarter had finished up. Paid off some convertible notes that were due in 2030. That's on the left side of this chart. Convertible debt that's due later this year, they're going to retire at the end of maturity. So completed that debt repurchase, and that's gonna change how this makes this balance sheet look. That purple bar is long-term debt. That's actually gonna be basically gone by the time we look at this next quarter. And all of that current debt's gonna mature. Company continues to have a share repurchase plan in place to offset that dilution. So what does that mean for this as an investment? The stock price has gotten a little wild since it hit all-time highs late in the spring, couple months ago. What it does, though, is provide a clear path to profitable growth for what is not exactly a neo cloud, 'cause remember DigitalOcean has this core traditional cloud business, and they're building GPU-based services alongside that now. So it's not really a neo cloud per se, but if you wanted to classify it as a smaller neo cloud competitor, it's unique. What it lacks in triple-digit revenue growth, you more than make up for in the fact that they have nearly a completely clean balance sheet with net cash on balance and a stock repurchase program. Fancy that, a high-growth cloud infrastructure provider that's actually repurchasing stock to offset dilution. They have ability to now fund future capacity increases with cash and fresh debt if they decide to do that at perhaps more agreeable terms. And they have customers lined up, actual software customers too, not just reselling the compute and the bare metal like a lot of the Bitcoin miners and altcoin miners turned GPU providers have been selling bare metal or energy capacity to the hyperscalers. DigitalOcean actually has product customers, which is also unique. The DCF scenario, yeah, it's aggressive. 36% per share profit CAGR for five years, terminal rate of 5% gets it to roughly fair value today. But they're going to exceed that if their guidance holds true through the end of 2027. They're profitable both on a GAAP and free cash flow basis. I think this is a pretty unique asset, and I think it's why we called it out at the mid-year stock pick contest as being notable. We added to it maybe last month and in May. If we had the ability to right now, I'd be kind of interested in adding to it again today. There was a sell-off after Q2 earnings, but it was a solid report. The guidance keeps getting better. And this just ticks off a lot of the boxes. Plus, it's a midcap. I do like midcap stocks. We just keep harping on that again. You get a bit higher statistical probability of landing an actual profitable investment with a lot of upside, more so than picking a small cap. DigitalOcean very much kind of in midcap territory these days. So they've emerged. They've proven their business model out and graduated from small cap to midcap. We gave Paddy a couple years to turn things around, and it would appear they most certainly have pulled this off. Nice work.