Cloud Consolidation Will Increase Costs And Crush Market Share

Key Takeaways

• Increasing competition from large cloud providers and the standardization of services are eroding DigitalOcean's pricing power, margins, and growth prospects.
  
• Heavy reliance on small business customers, combined with rising compliance costs and secular industry shifts, threatens long-term revenue stability and profitability.
  
• Rapid AI infrastructure demand, strong enterprise wins, and enhanced product innovation are driving higher customer retention, expanding revenues, and strengthening long-term financial flexibility.

Catalysts

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

• Cloud infrastructure consolidation and dominance by hyperscalers such as AWS, Azure, and Google Cloud is expected to increase, which will likely make customer acquisition for DigitalOcean more expensive and severely limit future market share expansion. Over time, this could directly constrain both top-line revenue growth and the ability to scale earnings efficiently.
  
• Being heavily focused on serving small and medium-sized businesses, DigitalOcean remains exposed to a customer base that is highly price-sensitive and prone to higher churn rates, especially during economic slowdowns. This structural reliance will likely pressure both recurring revenue and net margins long term as SMB cohorts churn or downsize cloud commitments.
  
• Advances in AI and automation are increasingly commoditizing basic cloud services, making it difficult for providers like DigitalOcean to maintain pricing power. As more features become standardized across platforms, the company could face prolonged margin compression and downward pressure on both gross profits and operating margins, especially if unable to differentiate offerings versus larger players.
  
• Expanding global data sovereignty and compliance regulations will disproportionately increase operational complexity and costs for DigitalOcean relative to larger peers, leading to rising SG&A and compliance expenses that erode net margins and limit earnings growth potential.
  
• The acceleration of low-code/no-code, serverless, and edge computing adoption threatens DigitalOcean's core infrastructure-as-a-service business model, risking both a slowdown in customer acquisition and shrinking usage among existing customers. This secular shift may result in decelerating revenue growth and compressing free cash flow conversion rates over time.

DigitalOcean Holdings Future Earnings and Revenue Growth

Assumptions

• This narrative explores a more pessimistic perspective on DigitalOcean Holdings compared to the consensus, based on a Fair Value that aligns with the bearish cohort of analysts.
• The bearish analysts are assuming DigitalOcean Holdings's revenue will grow by 13.9% annually over the next 3 years.
• The bearish analysts assume that profit margins will shrink from 15.2% today to 13.2% in 3 years time.
• The bearish analysts expect earnings to reach $162.9 million (and earnings per share of $1.36) by about August 2028, up from $126.4 million today. The analysts are largely in agreement about this estimate.
• In order for the above numbers to justify the price target of the more bearish analyst cohort, the company would need to trade at a PE ratio of 23.4x on those 2028 earnings, down from 23.8x today. This future PE is lower than the current PE for the US IT industry at 28.8x.
• Analysts expect the number of shares outstanding to decline by 1.11% per year for the next 3 years.
• To value all of this in today's terms, we will use a discount rate of 10.56%, as per the Simply Wall St company report.

DigitalOcean Holdings Future Earnings Per Share Growth

Risks

• Rapid acceleration in AI/ML revenue-with growth over 100% year-over-year and strong incremental annual recurring revenue-signals that DigitalOcean is successfully capturing secular demand in AI infrastructure, which could drive sustained top-line growth and revenue expansion.
  
• Enhanced product innovation, including over 60 new offerings in a single quarter, and widespread adoption of new features by top customers indicate increased customer engagement and stickiness, which may support higher net dollar retention and reduce churn, positively affecting recurring revenues and long-term earnings.
  
• The company's ability to win larger enterprise customers, as reflected by the increase in large multiyear deals and remaining performance obligations, provides greater revenue visibility and diversification, which could stabilize and enhance earnings.
  
• Consistently strong adjusted free cash flow margins and disciplined capital allocation, including managing share repurchases and convertible debt, suggest DigitalOcean can expand net margins and maintain financial flexibility even as it invests in growth.
  
• Ongoing momentum in new customer acquisition, migration from hyperscalers, expanding international reach, and increasing contribution of AI-related pull-through revenues may accelerate both revenue and profit growth, contradicting expectations of future share price decline.

Valuation

• The assumed bearish price target for DigitalOcean Holdings is $32.0, which represents the lowest price target estimate amongst analysts. This valuation is based on what can be assumed as the expectations of DigitalOcean Holdings's future earnings growth, profit margins and other risk factors from analysts on the more bearish end of the spectrum.
  
• 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 $32.0.
  
• In order for you to agree with the bearish analysts, you'd need to believe that by 2028, revenues will be $1.2 billion, earnings will come to $162.9 million, and it would be trading on a PE ratio of 23.4x, assuming you use a discount rate of 10.6%.
  
• Given the current share price of $33.05, the bearish analyst price target of $32.0 is 3.3% lower. The relatively low difference between the current share price and the analyst bearish price target indicates that the bearish analysts believe on average, the company is fairly priced.
  
• 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.