DocuSign (DOCU) allows individuals and businesses to conduct business faster with reduced risk and costs. The company also delivers a more delightful experience for clients and employees alike.
DocuSign’s platform has fundamentally transformed the way digital agreements are executed by developing a safe signing procedure with minimal frictions. As a result of the COVID-19 pandemic, DocuSign gained increased momentum as the need to conduct agreements remotely surged. It also solidified the remote signing process as the new standard while anchoring DocuSign’s industry-leading position.
However, the stock has been facing headwinds over the past several months. Investors fear that DocuSign’s growth momentum has already started fading out. Further, the lack of sustainable profit generation and rich stock-based compensation could signal soft shareholder value creation prospects. Consequently, shares are now trading almost 80% lower from their 52-week highs of $314.76.
While these concerns are valid, it is quite likely that DocuSign’s growth will persist strongly over the medium-to-long run. This is because a growing number of businesses should be adopting virtual contracts over physical ones moving forward. In that regard, DocuSign’s total addressable market is quite inexhaustible.
Considering DocuSign’s industry-leading position, growth prospects, and the recent valuation squeeze, I feel that the stock’s investment case is the most enticing it has been in years. Accordingly, I remain bullish on the stock.
Is Growth Slowing Down?
Earlier in June, DocuSign reported its Fiscal Q1-2023 results, with numbers coming in somewhat mixed. Revenues grew by 25% to $588.7 million, as DocuSign added nearly 67,000 new customers, carrying its total customer base to 1.24 million. At first, these numbers confirm the market’s worries over the company’s expansion slowing down.
Still, we have to put things into perspective and realize that this compares to tough Q1 2022 when revenues had grown by 58%, boosted by accelerated virtual-signing adoption as a result of the pandemic. In that sense, it is quite reasonable to expect softer numbers in the coming quarters.
When it comes to DocuSign’s profitability, though, the situation becomes a little harder to excuse. Non-GAAP earnings per share during the quarter actually declined from $0.44 to $0.38 year-over-year. Further, stock-based compensation remained very rich, amounting to $110.7 million. This implies a substantial dilution rate.
To illustrate how high this amount is, an annualized rate of $440 million in stock-based compensation implies a dilution of around 3.3% per annum at the company’s present market cap.
These levels of stock-based compensation could be sustainable if shares were trading at their past highs (since fewer shares would be issued for the same amount of cash). At their current levels, however, shareholder value could be deteriorating in relative terms. This is illustrated in the company’s GAAP EPS, which recorded a loss of $0.14 on 200 million shares outstanding versus a gain of $0.04 on 194 million shares outstanding over the comparable period last year.
Overall, DocuSign’s profitability is seriously underwhelming, especially taking into account how asset and capital-light the actual business model is and the fact that gross margins remain above 77%. Hopefully, this situation will change sooner than later if management wishes to regain shareholders’ faith in the stock.
For its upcoming results, management expects revenues to land between $600 million and $604 million, implying year-over-year growth of around 17.6% at the midpoint. Again, while these numbers compare against the inflated results of last year, the market remains spooked over what seems to be a strong deceleration in growth. This further stretches the need for DocuSign to start reporting sustainable profits and minimize dilution.
Wall Street’s Take
Turning to Wall Street, DocuSign has a Hold consensus rating based on four Buys, nine Holds, and two Sells assigned in the past three months. At $76.46, the average DocuSign price target implies 15.5% upside potential.
Valuation & Takeaway
Following the stock’s massive correction, DocuSign’s valuation has been significantly compressed. For Fiscal 2023, management expects DocuSign’s revenues to come out between $2.47 billion and $2.48 billion, suggesting that shares are currently trading at a forward P/S of around 5.3x.
On the one hand, this appears to be a very attractive multiple considering the company’s dominance in the space, its high-quality recurring revenues due to a sticky business model, and the possibility for future profits to be substantial, as gross margins are quite lofty. Because of these traits, I remain bullish on DocuSign.
On the other hand, however, management will need to become more shareholder-friendly when it comes to future dilution, ramp up its operating margins, and sustain revenue growth in the mid-to-high teens.
We can already identify some signs that point in this direction. For instance, in its Fiscal 2023 outlook, management predicts it will end the year with a maximum of 210 million shares, suggesting that stock-based compensation will likely ease in the coming quarters.
Further, international revenues grew 43% year-over-year in Q1. They now comprise 25% of total revenues compared to 21% in the prior-year period. Thus, the international revenue expansion could help sustain the aggregate revenue growth elevated as we advance.
Still, if these much-needed catalysts fail to actually materialize, shares could remain under pressure and even decline further during the ongoing macroeconomic environment. Thus, investors should remain wary of the underlying risks attached to DocuSign’s investment case.
