To The Moon

Summary

• DocuSign stock is down -8.7% YTD, opportunity to buy at a fair valuation with strong cash flow and balance sheet.
• Second quarter earnings to be reported on September 5, potential for stock gains.
• DocuSign's new IAM platform could be a game changer, unlocking revenue growth and providing management updates on IAM revenue in subsequent quarters.

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DocuSign (NASDAQ:DOCU) is down around -8.7% year-to-date and I see this as an opportunity to buy at a fair valuation with a strong cash flow and balance sheet.

Second quarter earnings coming soon

DocuSign is slated to report its second-quarter earnings on September 5 and this is a good time to analyze the potential for stock gains.

The company reported its first-quarter earnings on June 6 and the stock suffered due to concerns over its gross margins and guidance. For the quarter ending in April, DocuSign earned adjusted earnings per share of $0.82, with analysts expecting $0.79 per share. Revenue also beat expectations with a 7% increase year-over-year to $709.6 million against expectations of $707.4 million.

Investors were disappointed with sales guidance for the full year, which is expected to be in a range of $2.92B to $2.93B, which was largely priced in.

DocuSign Annual Revenue and Profit (Seeking Alpha, Author)

One of the concerns about DocuSign is slowing growth, but on an annual basis, gross profit is keeping pace with revenue. Growth is obviously slowing, which means we need to view this more as a value stock, and this is the basis of my investment thesis.

Margins stalled but still very strong

Gross margins at the company had risen to 83% in the third quarter of 2022. One of the recent concerns had been a stalling in margins at 82%. This is still a very strong margin, and a fall in margins of 1% can be attributed to seasonal issues.

DocuSign Metrics (Seeking Alpha)

According to Seeking Alpha data, DocuSign saw its billings slip in the first quarter of 2022 and 2023. We are likely to see a rebound in the second quarter, which may bring that number back to 83%. But I would not be overly stressed about the number.

DocuSign Margins (Seeking Alpha)

Despite the stickiness in gross margins, the company's operating margin is on an upward trend, recently hitting 29%.

DocuSign Subscription Revenue (Seeking Alpha)

If we remove the seasonal element from the Q1 results, then subscription revenue is still climbing.

IAM segment could be a gamechanger

Following the company's Q1 results, DocuSign also announced two new executive hires as it embarks on a new growth area.

The company unveiled DocuSign IAM, an Intelligent Agreement Management platform, available for customers in the U.S., Canada, and Australia on May 30, 2024. That landed days ahead of the first quarter earnings release, and the company could start to see revenue growth on the back of that in coming quarters.

New President and Chief Revenue Officer Paula Hansen said the new AI-assisted product was, "one of the largest remaining white spaces left to tackle in SaaS."

"Poor agreement management and outdated systems cost businesses time, opportunity, and nearly $2 trillion in global economic value every year. DocuSign IAM will help change that — driving real business impact for DocuSign's customers, in a way that wasn't possible before."

IAM requires a subscription upgrade and can help unlock value across organizations in areas such as sales and procurement. The platform will be rolled out to a wider range of countries in late-2024 and 2025 and could be a game changer over that period.

Subsequent quarters will provide management updates on IAM revenue and could see a revaluation in the stock.

DocuSign is a cash flow king

One of the strongest reasons to own DocuSign stock is its ability to generate free cash flow. As an asset-light business, it is also a stock that could weather a market downturn more than others.

The company has almost no capital expenditure to worry about and has a levered free cash flow margin of almost 40%. Looking at the operating income, it has been improving greatly on an annual basis. However, the company is also spending heavily on research and development, so the cash picture could be even better.

DocuSign Financials (Seeking Alpha)

Management has forecast sales to be in the range of $2.92-2.93 billion for the year. The company produced a free cash flow yield of 32.7% in the first quarter ($232.1 million FCF/$709.6 million in sales).

As the company continues on its albeit slower growth path, this cash flow yield can continue to add upside to the stock. As noted, R&D costs have been a drain on cash flow, but this can normalize as the company launches its AI-related products. Another area of drain on the company's cash has been in debt financing.

DocuSign had $1.79 billion in total long-term liabilities at the end of the most recent quarter. Net cash from financing activities during the first quarter was -$169,874.

Adding to the cash flow yield picture is the fact that management increased their stock buyback program in Q1 to an additional figure of up to $1 billion.

So, even if growth is slowing down, there are reasons to believe that the stock is undervalued.

Seeking Alpha data shows that a forward price/cash flow ratio of 11.60 is almost half the sector median of 20.93.

I believe the downside risk to the thesis is limited because of the strong cash flow picture. Growth could slow further and hurt the stock, but I believe there is significant underlying value that provides a margin of safety.

Conclusion

DocuSign stock has traded around -8% year-to-date, and I believe the stock is undervalued on its cash flow. Although growth has slowed, the company is generating significant cash flow and there are hidden items that are distorting this figure further. The coming quarter could be a game changer for the company if its new IAM SaaS platform provides additional revenue upside. The first quarter results had a seasonal drag, and we could see a bounceback in margins, with the potential for new IAM revenue growing emerging through 2025 as the product is rolled out. Investors should ignore the slowing growth story and see that it is still trading at a low valuation for a company that is very asset-light and producing significant cash flow.