DocuSign: Wait For Growth Inflection Point As Buy-Out Fantasies Fade

seekingalpha02-14

Despite the recent pull-back, DOCU is still up over 30% since October 2023 lows, driven by a combination of stronger-than-expected Q3 results and remaining takeover hopes.Revenue growth continues to ...

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20:57 GMT+8&nbsp;&nbsp;&nbsp;<a href=https://seekingalpha.com/article/4670081-docusign-wait-for-growth-inflection-point-as-buy-out-fantasies-fade><strong>seekingalpha</strong></a>\n\n\n</h4>\n\n</header>\n<article>\n<div>\n<p>Despite the recent pull-back, DOCU is still up over 30% since October 2023 lows, driven by a combination of stronger-than-expected Q3 results and remaining takeover hopes.Revenue growth continues to ...</p>\n\n<a href=\"https://seekingalpha.com/article/4670081-docusign-wait-for-growth-inflection-point-as-buy-out-fantasies-fade\">Source Link</a>\n\n</div>\n\n\n</article>\n</div>\n</body>\n</html>\n","isBrief":false,"type":0,"news_type":1,"symbol":"IE00BDCRKT87.USD","symbol_name":"PINEBRIDGE GLOBAL DYNAMIC ASSET ALLOCATION \"ADC\" (USD) 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rebound to double digits, DocuSign is fairly valued at around $50, with a fair value range between $35 and $70.hapabapa Founded in 2003, DocuSign (NASDAQ:DOCU) has become a global leader in facilitating secure and legally binding digital agreements, streamlining business processes and reducing paperwork. The company's cloud-based platform enables individuals and organizations to electronically sign, send, and manage documents, contracts, and agreements in a secure and efficient manner. DocuSign's services are widely utilized across various industries, including real estate, finance, healthcare, and legal, offering a reliable and convenient solution for businesses to digitize and automate their document workflows while ensuring compliance with legal standards. Thesis While DocuSign remains the uncontested leader in the eSignature segment, revenue growth continues to sequentially decline every quarter, with a new low of 6% growth expected for the fourth quarter of 2024, which ended January 31st. To justify its current valuation, DocuSign will have to prove it can reaccelerate growth to higher single digits in the future while expanding operating margins. Management intends to achieve this through a combination of accelerated international growth, new product launches, and better cost control. Separately, DocuSign has been looking for potential buyers since December. Private equity showed interest in the eSignature company, but following disagreement over a potential deal value of $13B (or $60 per share), interest has cooled off. Combined, this creates an unattractive risk-reward balance for the stock in the near term, which is why I do not recommend initiating a position now. I am giving the stock a hold rating due to its speculative short-term upside potential and its longer-term growth potential. Worth noting, the recent stock price momentum and EPS upward revisions make DOCU a Quant \"Strong Buy\", despite the unfavorable valuation grade. My assumption is that the Quant score will go down from here if a deal remains off the table. DOCU Ratings Summary & Quant Factor Grades (Feb 9, 2024) (Seeking Alpha) DocuSign is the leader in the eSignature space There is no doubt that DocuSign offered a great product at the right time when Covid hit and locked the workforce of many countries at home for weeks or months. DOCU reached an all-time high above $310 back in 2021, representing a market capitalization of over $60 billion. Later that year, the valuation got cut in half \"overnight\", as investors realized that growth rates were not going to be astronomic forever. As growth kept slowing down, the stock continued its slide throughout 2022, until it hit a low just under $40 in November 2022. Since then, DOCU has traded sideways, staying in a $40 to $60 range most of the time. Despite all that, DocuSign remains the uncontested leader in the eSignature space, owning about two-thirds of the market, according to Statista. Based on the company's TTM sales of $2.7 billion, this implies a total market value of just over $4.1 billion in 2023. DocuSign market share in digital signatures market (2023) (Statista) Given DocuSign's already high market share, revenue growth will have to come from growth of the overall digital signature market, as well as the expansion into adjacent segments including contract management. This growth will most likely be partially offset by market share erosion as more competitors enter the space. A report from Fortune Business Insights published in April 2023 forecasted an annual growth CAGR of 35% for the global digital signature market between 2023 and 2030, implying a $43 billion market size by 2030. However, this report expected the 2023 market size to reach $5.25 billion, which is well above the actual $4.1 billion implied by the latest Statista report. In fact, this means that instead of growing +34% as expected, the digital signature market may have only grown in the mid-single digits last year. Before modeling a few growth scenarios to inform our valuation assumptions, let's take a closer look at how well DocuSign is positioned to defend share, and what growth opportunities the company has from here. DocuSign's moat Bears may argue that DocuSign's moat is limited as many other providers now offer similar eSignature functionality. Let's take a quick look at the current key competitors:   Adobe (ADBE) offers Acrobat Sign as part of their PDF tool offerings, which are already broadly used and usually a preferred choice amongst large-scale businesses. Main downside is the comparatively high cost.  Xink offers a cloud-based platform allowing users to fill and sign documents electronically from various devices, while providing real-time document status tracking. You will find more information on the current common digital signature solutions in this research article.  Nitro is a popular alternative to Adobe Acrobat with more attractive price plans, catering to both individual users and large enterprises.  SignNow offers yet another alternative with advanced digital signature and client data collection features, aiming to simplify daily office operations.  Many more are emerging, but these makeup only 5% of the market. There is no doubt that anyone looking for an eSignature solution has plenty of options to choose from. The key question is: what matters most when selecting a digital signature tool, and what might set DocuSign apart? From a digital signature functionality perspective, user ratings published by Gartner indicate limited differentiations between the main providers listed above. All of them seem to be doing the job, with anywhere between 4.4-4.6 stars out of 5. Over time, leading providers like DocuSign and Adobe will most likely continue to be first movers on providing next-generation features, with others following to compete. Pricing-wise, each provider offers different plans, which are not always that easy to compare as they contain different features for the similar price levels. However, generally speaking, both Adobe and DocuSign have premium pricing, while newcomers like PandaDoc tend to offer the most attractive plans in an attempt to attract new users. Looking at the Gartner report, these solutions are more popular with individuals and small enterprises than with larger organizations, where the big players dominate. So, if the product offering is similar, how can DocuSign justify premium pricing and maintain its dominant position? Well, the functionality may be similar, but DocuSign's (and Adobe's) brand is a key differentiator. It stands for high-quality, trusted eSignature solutions, and has an entirely different level of acceptance both in the private and public sectors. A brand may not be as strong as a technical or economic moat, but combined with DocuSign's first-mover advantage that put the company in a dominant market position, I believe it is fair to assume that (unless taken over by Big Tech) the company will remain a dominant player in the eSignature space for the decade ahead and beyond. DocuSign's opportunity beyond eSignature While traditional eSignature is likely to remain DocuSign's main source of income at least in the mid-term, the company is actively looking to grow its business into adjacent segments, including eSignature add-ons and contract lifecycle management. According to DocuSign's own projections, it values its total addressable market (TAM) at $50B, of which half comes from \"traditional\" eSignature, and the other half comes from add-ons and contract lifecycle management (CLM) tools. DocuSign Total Addressable Market (DocuSign (Q3FY24 earnings presentation)) This is not too far off the $43B by 2030 from the Fortune Business Insights report referenced above, which again seems too optimistic to me based on the post-Covid growth trajectory. It is okay to keep this in mind as a \"blue sky\" scenario, but I would not take that at face value to determine the company's fair value. Here is an overview of DocuSign's current product offerings spanning traditional eSignature, eSignature add-ons, and CLM. DocuSign Product Offering (Stock Research Platform based on company website) The company does not report its revenue broken out by these products, which for the most part are up-sell features to the eSignature core product. What is clear is that by continuously expanding its platform with new services and features, DocuSign will generate incremental revenue by up-selling to existing digital signature customers at a low acquisition cost. In addition, DocuSign keeps building a contract management ecosystem that will make switching much harder for customers that adopt products beyond traditional eSignature, which should have positive effects on retention rates in the long term. Before taking a look at what this may mean for DocuSign's mid- to long-term growth prospects, let's review recent revenue performance and near-term expectations. Near-term growth outlook Quarterly revenue growth rates have \"crashed\" since early 2022, and company guidance suggests a further drop down to 6% in the fourth quarter of FY2024, which ended January 31st. For FY2025, analyst consensus currently sits at $2.91B revenue, or +6% over FY2024 estimated sales, suggesting a stabilization of growth in the mid-single-digit range. DocuSign quarterly growth rates continue to decline (Stock Research Platform) On a positive note, DocuSign is continuously expanding its customer base (+11% vs. PY in Q3FY24), with even faster growth in the enterprise and commercial customer segment (+15% vs. PY). However, the large customer base (above $300K in annual contract value) has been stagnant (1,051 in Q3FY24 vs. 1,052 a year earlier), which also partially explains why customer count has grown faster than revenue lately. DocuSign customer base trend (DocuSign Q3FY24 earnings presentation) Also, the dollar retention rate has consistently come down. If it falls below 100%, this would mean that on a year-over-year basis, DocuSign is getting less incremental sales from existing customers than it is losing sales from customers leaving or reducing their spend. DocuSign dollar net retention rates (DocuSign Q3FY24 earnings presentation) I am not surprised by this trend based on what I have seen a number of companies do post-pandemic. While very few of the companies I know are no longer using DocuSign, many have become more selective in how they use it and what they use it for. I remember during Covid times that almost anyone who said they needed DocuSign to get a document signed would get a license. Since then, the number of users has been under scrutiny, eliminating licenses for the occasional \"once in a quarter\" user, and pooling licenses with fewer power users instead. Since DocuSign charges for a set number of contracts per month/year in their regular plans, it makes a big difference for example to have 1 person issuing 100 contracts per year, or 10 people issuing 10 contracts each, the latter being 10x more expensive (i.e., 10x more revenue for DocuSign). Another change I have observed is that DocuSign was initially used quite broadly, including for simple internal document approvals. Admittedly, it's a really convenient way of signing. However, given the document limits on annual plans, it makes more sense to limit use to third-party contracts that will benefit from a simple, trusted, legally binding solution, while leveraging other alternatives for in-house sign-offs. For example, you can internally sign as many documents using Acrobat or Nitro as you want at no additional cost. My experience may be somewhat anecdotal as my sample of companies is not large enough to be representative, but it does offer some rationale for falling net retention rates and slowing revenue growth, all the while customer count continues to grow. The good news here is that if this type of transition to a more \"optimized\" use of DocuSign is a cause for slowing growth, an inflection point may be near, and should translate to a stabilization of net retention rates and a re-acceleration of growth. Long-term growth scenarios There is no doubt that the eSignature space will keep growing, driven not only by companies but also governments shifting more and more to electronic documents in the era of AI. However, the speed of growth remains uncertain. Before we get into actual valuation scenarios, let's take a look at possible market growth scenarios: the below chart shows the potential market size by 2030 based on different annual growth rates. Starting from a $4.1B market in 2023, a 5% annual growth would only take us to $5.7B by the end of the decade, while a 30% CAGR would catapult us up to over $25B. 2030 digital signature market size scenarios (Stock Research Platform) The yellow section of the bars indicates what DocuSign's revenue could look like in each case, assuming the company can maintain a 40% market share (down from 67% in 2023). This assumption allows for competitors to continue stealing share, while implying that DocuSign will remain the market leader by the end of the decade. I believe this is a conservatively reasonable assumption based on the company's dominant position and robust product innovation pipeline, as discussed earlier. This scenario modeling shows just how broad the spectrum of possible outcomes could be for DocuSign. If the market grows only 5% per year and DocuSign's share drops to 40%, their revenues by 2030 could actually fall from the estimated $2.7B in 2023 (fiscal 2024 for DOCU) to $2.3B. On the other side of the spectrum, if the market booms like many predict, DocuSign might secure a $10B revenue share in a $25B market. That is almost a 4x, representing a potential 21% average annual revenue growth. I personally do not believe in either of those extremes, but it is always good to know what could be when assessing risk and opportunity. The following tables show the different revenue scenarios for DocuSign based on both the market growth and the market share assumption. DocuSign Revenue Scenarios based on market growth and market share (Stock Research Platform) The market growth rate will largely depend on the speed of adoption of electronic documents and signatures in the private and public sectors, as well as any additional growth to come from adjacent services, including contract management services. While most publicly available predictions are ultra-bullish, with annual growth in the range of 25 to 35%, I believe that the mid-single digit growth we saw in 2023 challenges such an optimistic outlook. Electronic signature adoption got a major boost during the Covid lockdown period. Going forward, it is prudent to assume a more gradual growth rate. This is why I will be using a 15% market CAGR for valuation purposes. So finally, let's see how this all translates to a fair value for DOCU. DocuSign's fair value After looking into multiple revenue scenarios, let us briefly discuss a few other key variables in order to estimate DOCU's fair value. First, we need to talk margins. Second, we need to look at a few factors such as capital allocation (dividends, buybacks, etc.), stock-based compensation, and last but not least, the appropriate risk-adjusted discount rate. Let's start with margins. DocuSign's gross margins have been consistent around 78-80% over the past 12 quarters. I see no reason to deviate from this range for modeling purposes, as I do not see major catalysts for a change in margin profile. DocuSign Quarterly P&L highlights (Stock Research Platform, with data from Seeking Alpha) As for operating margins, DocuSign remains barely profitable on a GAAP basis. This is where I see significant potential for operating leverage at scale, i.e., a slower growth in selling, marketing and administrative expenses relative to revenue growth. The recently announced restructuring that will cut 6% of DocuSign's workforce is certainly a first step in this direction. To keep it simple, I will assume that over the next decade, operational expenses will grow at half the rate of sales, on average. This should drive operating margins to the low 20%s by 2033 (for reference, Alphabet (GOOG) has 28%, Adobe even 35%). Let's talk capital allocation next. DocuSign does not pay dividends, and based on the general assumption that it will maintain a focus on growth over the next decade, I will assume it won't start paying one within this time period. As for share buy-backs, the company has consistently bought back stock since 2019, but not nearly enough to offset the dilutive impact of its massive stock-based compensation (SBC). To get a sense of magnitudes, SBC in the trailing twelve-month period has reached $602M, a whopping 5.8% of the company's current market capitalization. Looking at the net of SBC and share buy-backs, the number of shares outstanding has grown at an average rate of 4.5% per year since 2018, albeit with a decelerating trend. DocuSign shares outstanding trend (companiesmarketcap.com/docusign) While DocuSign could technically use its expected FY2024 free cash flow (FCF) of $850M to fully offset SBC and avoid dilution, in the valuation I need to either \"discount\" the FCF for this non-cash expense, or I need to account for on-going dilution. I chose to do the latter, with an estimated range of 0.5% to 1.5% annual share growth, while setting FCF multiples to a range of 19-21x, right around the sector median. Finally, let's talk expected return, i.e., discount rate. For companies like DocuSign, which have a proven business model and robust balance sheet (DOCU has a net cash position of $900M), but high uncertainty on the revenue forecast, I usually apply a 12.5% discount rate. This above-market rate of return builds in a margin of safety in case my projections are too optimistic, despite my best efforts to set realistic expectations. So here we go: my base case scenario assumes a 7% revenue CAGR (corresponding to the scenario where the market grows 15% p.a. and DocuSign market share goes from 67% to 40% over time as a result of competitive pressures). Thanks mostly to operating leverage, this translates into an FCF growth of 10% annually. Based on our other assumptions, summarized in the table below, this gets us to a fair value right around $50. DocuSign Valuation Scenarios (Stock Research Platform) The low and high cases reflect a revenue growth range between 6% on the low end and 9% on the high end, translating to FCF growth between 8% and 12%. This range allows for a market growth between 12% (low) and 18% (high) or market share between 35% (low) and 50% (high). I believe these are plausible assumption ranges, leading to a probable fair value range for DOCU between $35 and $70 per share. Leveraged buy-out: Still an opportunity? Back in December last year, The Wall Street Journal reported that DocuSign started working with advisors to find a buyer. The rumor fueled speculations and temporarily drove the stock above the $60 mark. While tech giants like Microsoft (MSFT) could be possible candidates for taking over the eSignature company, the most probable scenario is a leveraged buyout by private equity firms like Bain Capital or Hellman & Friedman, who were said in January to compete for the acquisition, again pushing the stock above $60. Early February, a Bloomberg report stated that JP Morgan and Bank of America were in discussions to finance of as much as $8 billion for a potential $13 billion acquisition price, which roughly equates to $60 per share when accounting for restricted stock units and options. This was evidently a big disappointment, causing an immediate pullback of the stock price. Even worse, Reuters then reported that the deal may have cooled off over disagreements about the acquisition price, which is also supported by DocuSign's announcement on February 5th to cut 6% of its workforce. The key takeaway here is that unless a new stakeholder comes to the table, it seems unlikely that a deal will be struck, and certainly not above the $13 billion mark. CFRA analyst Keith Snyder may be right in saying that a potential deal, even around $60, would be the best option for shareholders given DocuSign's current growth struggles and limited catalysts to accelerate growth in the near term. However, I am not sure this would be the best option for long-term investors that have time and some tolerance for risk. Conclusion While the stock could pop to $60 overnight if a leveraged buy-out deal is announced after all, the probability of this scenario is a coin flip at best. On the other hand, if a deal is off the table for good, shares may stumble further and re-test resistance around the $40 level. Looking at the stock's fair value, it largely depends on the growth trajectory moving forward. My base scenario, which assumes a 7% revenue and a 10% FCF CAGR for 10 years starting FY2025, has a fair value of around $50. Considering the growth potential of the digital signature market, I consider this to be a plausible scenario, despite near-term growth headwinds. This means that at the current price, DOCU is fairly valued, which is why I am giving the stock a hold rating.  On the Stock Research Platform, I am looking for asymmetric low-risk, high-reward opportunities. DocuSign is a well-positioned company which I would not mind owning at the right price. I will wait patiently until the stock price approaches the lower end of its fair value range (sub-$40) before pulling the trigger. I may as well write put options with strike prices of $40 or below in case we see a sudden drop and volatility spike.","kind":null,"is_publish_news":null,"is_publish_highlight":null,"is_publish_live":null,"is_publish_wemedia":null,"editions":null,"symbols":[],"gpt_button":1},"commentList":[],"isCommentEnd":true,"newsSizeData":{"likeSize":0,"commentSize":0,"repostSize":0,"favoriteSize":0,"likeStatus":false,"favoriteStatus":false},"APP":{"userAgent":"Mozilla/5.0 AppleWebKit/537.36 (KHTML, like Gecko; compatible; ClaudeBot/1.0; +claudebot@anthropic.com)","isDev":false,"isTTM":true,"deviceId":"web-server-community-laohu8-v3","version":"4.22.4","shortVersion":"4.22.4","platform":"web","vendor":"web","appName":"ttm","isIOS":false,"isAndroid":false,"isTiger":false,"isTHS":false,"isWeiXin":false,"isWeiXinMini":false,"isWeiBo":false,"isQQ":false,"isBaiduSwan":false,"isBaiduBox":false,"isDingTalk":false,"isToutiao":false,"isOnePlus":false,"isHuaWei":false,"isXiaomi":false,"isXiaomiWebView":false,"isOppo":false,"isVivo":false,"isSamsung":false,"isMobile":false},"href":"/m/news/2411496305"}