AI/ML Investments And Atlanta Data Center Will Increase Future Operational Efficiencies

Key Takeaways

• Strategic enhancements in AI/ML and product innovation are poised to drive significant revenue growth and enhance customer retention.
  
• Operational efficiencies and strategic investments aim to sustain high EBITDA margins and improve free cash flow, bolstering earnings growth.
  
• Dependence on key customers and modest revenue growth expectations raise concerns about consistent earnings and market perception amidst significant investment pressures.

Catalysts

Through its subsidiaries, operates a cloud computing platform in North America, Europe, Asia, and internationally.

• DigitalOcean's strategy to enhance its AI/ML platform and achieve over 160% ARR growth in AI-related solutions is expected to drive significant future revenue growth.
  
• The expansion of its top customer cohort, Scalers+, which saw a 37% year-over-year revenue increase, indicates the potential for higher revenue retention and growth as these high-spend customers expand their wallet share with DigitalOcean.
  
• The new Atlanta data center is set to provide incremental capacity and operational efficiencies, potentially improving margins and supporting future revenue growth.
  
• The acceleration in product innovation, with 49 new products and features released in Q4 alone, is likely to enhance customer satisfaction and retention, positively impacting revenue and potentially net margins as DigitalOcean meets the demands of higher-spend customers.
  
• Ongoing discipline in operational efficiencies paired with strategic investments is projected to sustain high adjusted EBITDA margins and support improved free cash flow, which is expected to reach high teens in 2025, enhancing overall earnings growth.

DigitalOcean Holdings Future Earnings and Revenue Growth

Assumptions

• Analysts are assuming DigitalOcean Holdings's revenue will grow by 14.4% annually over the next 3 years.
• Analysts assume that profit margins will increase from 10.8% today to 15.6% in 3 years time.
• Analysts expect earnings to reach $182.0 million (and earnings per share of $1.51) by about April 2028, up from $84.5 million today. However, there is a considerable amount of disagreement amongst the analysts with the most bullish expecting $207.2 million in earnings, and the most bearish expecting $156.8 million.
• In order for the above numbers to justify the analysts price target, the company would need to trade at a PE ratio of 29.3x on those 2028 earnings, down from 30.4x today. This future PE is lower than the current PE for the US IT industry at 33.9x.
• Analysts expect the number of shares outstanding to grow by 1.07% per year for the next 3 years.
• To value all of this in today's terms, we will use a discount rate of 9.58%, as per the Simply Wall St company report.

DigitalOcean Holdings Future Earnings Per Share Growth

Risks

• The company's revenue growth for the fourth quarter was only 13% year-over-year, and revenue guidance indicates similar low to mid-teens growth for 2025, which could signal challenges in accelerating revenue significantly. (Impacts revenue)
  
• Although profitability metrics like the adjusted EBITDA margin remain strong, the need for substantial ongoing investment in AI and other growth initiatives could pressure net margins. (Impacts net margins)
  
• Gross margin fluctuations are expected in 2025 due to investments in the Atlanta data center and changes in server useful life, potentially affecting earnings. (Impacts gross margins and earnings)
  
• The shift in calculating ARR to a methodology that reduces volatility suggests potential concerns about consistency in growth projections, which may create market uncertainty. (Impacts market perception of revenue stability)
  
• Dependency on a small group of large customers (22% of revenue from Scalers+) means a loss of these customers or reduced expansion could significantly impact future earnings. (Impacts earnings)

Valuation

• The analysts have a consensus price target of $42.615 for DigitalOcean Holdings based on their expectations of its future earnings growth, profit margins and other risk factors. However, there is a degree of disagreement amongst analysts, with the most bullish reporting a price target of $55.0, and the most bearish reporting a price target of just $31.0.
• In order for you to agree with the analyst's consensus, you'd need to believe that by 2028, revenues will be $1.2 billion, earnings will come to $182.0 million, and it would be trading on a PE ratio of 29.3x, assuming you use a discount rate of 9.6%.
• Given the current share price of $27.86, the analyst price target of $42.62 is 34.6% higher.
• We always encourage you to reach your own conclusions though. So sense check these analyst numbers against your own assumptions and expectations based on your understanding of the business and what you believe is probable.