DigitalOcean rises on AI-powered infrastructure service demand

Key Points

• DigitalOcean reported an EPS beat by 8 cents and raised its revenue guidance.
• Goldman Sachs raised its rating on DigitalOcean from a Sell to a Buy with a $33 price target.
• DOCN shares trade at 19X forward earnings and have a 12.85% short interest.

Cloud computing platform and hosting provider DigitalOcean Holdings Inc. NASDAQ: DOCN saw its shares jump 20% on strong Q3 2023 earnings and raised guidance. The company is a member of the Computer and Technology sector, providing on-demand cloud infrastructure services and tools to start-up companies and small and medium-sized businesses (SMBs), with the majority of its revenues being generated internationally. Despite the weakened macroeconomic climate being notably harsh on SMBs, the artificial intelligence (AI) trend has been a boon for the company. DigitalOcean offers cloud infrastructure (CIaaS), platform (PaaS) and software-as-a-service (SaaS) solutions.

Building and scaling AI applications

DigitalOcean's Paperspace machine learning platform enables customers to build and scale AI models utilizing high-performance GPU-powered virtual machines called droplets powered by Nvidia Co. NASDAQ: NVDA GPUs. Paperspace offers several pre-configured machine learning networks, including TensorFlow, PyTorch, and MXNet, making it simpler to start with machine learning without having to install and configure frameworks.

Jupyter notebooks

DigitalOcean offers Jupyter integrated development environment (IDE) notebooks. These aren't physical laptop notebooks but a web-based app like a virtual notebook pad that enables the sharing of documents containing live code, visualizations and equations. The company closed on its Paperspace acquisition in the latest quarter and is excited by the addition of its AI/ML capabilities to expand the market opportunity for the company.

Bears get gut-punched with Q3 earnings results

DigitalOcean released its Q3 2023 earnings report on November 2, 2023. The company reported an EPS profit of 44 cents, excluding non-recurring items, versus consensus analyst estimates for 36 cents, an 8-cent beat. GAAP net income was $19 million, and adjusted EBITDA was $76 million. Gross profit was 60% of revenue. Revenues grew 16.4% YoY to $177.06 million, beating analyst estimates of $173.36 million. Annual run-rate revenue rose 11% to $713 million. Average revenue per customer (ARPU) rose 6% to $92.06. DigitalOcean closed the quarter with $384 million in cash and cash equivalents.

Raising the bar

DigitalOcean raised guidance for Q4 2023, targeting $178 million in revenues versus $175.16 million consensus analyst estimates. The company expects non-GAAP EPS of 36 cents to 37 cents versus 36 cents analyst estimates and adjusted EBITDA margin of 36% to 37%.

Full-year 2023 total revenues are expected to be around $690 million versus $683.4 million consensus estimates, with an adjusted EBITDA margin of 38% to 39%. Non-GAAP diluted net income is expected to be between $1.52 to $1.54 per share versus $1.42 consensus analyst estimates.

CEO Insights

DigitalOcean CEO Yancey Spruill affirmed that the CEO search is well underway and making good progress, but it is still too early to communicate a specific timeline. At the end of Q2, the company started to see positive signs in Q3 and early Q4 of abating trends from the growth headwinds over the past 12 to 18 months.

He commented, "We are encouraged by the stabilization we saw in our key revenue growth metrics in Q3, and we continued to both invest in our platform and drive further margin improvements." He continued, "We added several new products and features for our customers while also generating strong free cash flow."

Goldman Sachs Buy Upgrade

On November 7, 2023, Goldman Sachs upgraded shares of DOCN to a Buy from a Sell rating with a 12-month price target of $33 per share. Analysts believe the business is reaching a cyclical trough, as evidenced by the Goldman Sachs SMB index. The management's Q3 2023 earnings conference call commentary and contributions from new initiatives, including the Paperspace acquisition and ramp-up of Cloudways, are rising tailwinds. Structural improvements will become more evident as the macro stabilizes, steering to improved revenue growth and continued margin and free cash flow expansion.  

Digital Ocean analyst ratings and price targets are at MarketBeat. Digital Ocean peers and competitor stocks can be found with the MarketBeat stock screener.

Daily cup pattern and gap fill   

The daily candlestick chart on DOCN illustrates a cup pattern with the potential for a price gap fill at $31.15. The cup lip line formed at $29.62 on the gap down on August 31, 2023. Shares continued selling off to a low of $19.39 by November 1, 2023. Its Q3 2023 earnings surprise caused shares to gap 20% to $23.65 and surge higher on a combination of the Goldman Sachs upgrade and short squeeze momentum. The daily relative strength index (RSI) has been climbing towards the 70-band as shares reach to complete the cup pattern at $29.62. Pullback support levels are at $25.12, $23.65, $21.37 and $20.21.