May 15 2020 - DocuSign: Not Too Late To Join The Train

DocuSign has rallied alongside other cloud stocks playing into the WFH theme.

DocuSign's strong brand image, growth factor, partnerships, and opportunity to improve margins via its land and expand strategy will continue to uphold the stock.

Valuation appears oversubscribed. Bullish investors should either adopt a long-term investing strategy or anticipate a pullback.

Source: Hedgeye

DocuSign (DOCU) is a niche SaaS platform with strong growth and margin expansion potential to play the Work From Home (WFH) theme. Financial, legal, tech, insurance, and real estate services are some of the top industries that will require the need for DocuSign's solutions to seal agreements. This trend will drive the adoption of DocuSign's solutions while reducing its customer acquisition cost as the need to adopt its solutions become expedient. While the market has priced in near-term growth catalysts, DocuSign's leadership position in the eSignature space, added capabilities, and strategic partnerships will continue to drive strong growth.

Demand (Rating: Bullish)

Source: Author (using data from Seeking Alpha)

Market Opportunity

We estimate that our total customer base of over 585,000 customers represents 1% of the estimated enterprises, commercial businesses, and VSBs in our current core target market worldwide.

DocuSign's total addressable market represents a B market opportunity. eSignature alone represents a B market opportunity. Demand is strong in the financial sector (loan processing), services (legal), real estate, government, and tech industry. It has also expanded its TAM into the CLM (contract lifecycle management) space. It generates a significant portion of its revenue outside the US. This highlights its global scope.

Potential

DocuSign is expanding its product offerings to drive average revenue per user. While revenue has largely been driven by its flagship eSignature product, added capabilities in CLM, AI, and analytics will drive faster and sustainable growth. This will be supported by the growing usage of eSignatures as companies complete their digital transformation projects. DocuSign is on target to record strong double-digit revenue growth this year. Data from Okta's app usage report shows a 20% growth in logins from DocuSign's users between February and March.

Management is guiding for revenue growth of 30% in FY'21. This assumes growth in demand for agreement cloud and a decline in professional services revenue. Going forward, professional services are expected to be handled by system integrators.

Given these strong near-term tailwinds, DocuSign will continue to outperform in the near term.

Business/Financials (Rating: Neutral)

Source: Author (using data from Seeking Alpha)

Products

DocuSign agreement cloud. This is a platform of records for organizations to manage agreements. The platform provides flexible options for enterprises to eliminate paper-based transactions by conducting all business agreements in the cloud.

DocuSign CLM. This product comes from the acquisition of SpringCLM. It integrates with Salesforce (CRM), which is expected to growth-hack the usage of the solution. The product positions DOCU in the leadership space of Gartner's magic quadrant for contract lifecycle management solutions. Gartner anticipates that companies with CLM solutions have a better handle on revenue management and cost savings when handling contracts. This CLM space has a lot of players, and it is projected to face a lot of consolidations in the coming quarters.

DocuSign intelligent insight. This comes from the acquisition of Seal software. It helps to reduce document review and processing time by providing actionable insights using AI.

Professional Services. DocuSign plans to hand over professional services to GSIs. Since GSIs are better structured to handle integration and consulting, it frees up manpower and cost to ensure DocuSign can fully focus on product development and research.

DocuSign will need to work on smooth internal and external product integration before it enjoys the full gains it's projecting from its new acquisitions.

Financials

The expectation is for expanding usage and cross-sell to drive operating margins. DocuSign's recent M&A activities suggest it needs to keep strengthening the capabilities of its products to add more value to customers. Near term, gross margin will continue to reflect investments in facilities to strengthen its global reach. Operating margin will continue to improve as it cross-sells its products.

Cash flow has been boosted by deferred revenue, capitalization of deferred contract cost, and stock-based compensation. The expectation is that large enterprises will continue to drive large annual commitments.

DocuSign has enough liquidity to weather a near-term economic recession. Though its balance sheet is laden with goodwill and intangible assets from its recent acquisition, its working capital has been positive, and it has enough cash on its balance sheet to keep running its operations.

Macro/Competitors (Rating: Neutral)

Competitors

DocuSign's biggest competitor in the eSignature space is Adobe (ADBE). The total addressable market is still under-penetrated, which means there is enough to go round in the near term. Reviews from Capterra show DocuSign has more visibility in the eSignature space. Its branding and niche strategy mean consumers continue to choose DocuSign over competitors even if they match it on pricing.

There is a decent level of congestion in the CLM space, though DocuSign is still ranked as a leader. The CLM space is expected to converge in the coming years.

Macro

Source: Google

DocuSign recently completed the build-out of private data centers to penetrate the Fed vertical after acquiring FedRAMP certification.

Management didn't hint at a massive disruption of business activities induced by COVID-19. Regardless, I expect enterprise greenfield wins to be impacted as companies struggle to deploy offline sales teams to go after fortune 500 companies.

Investors/Valuation (Rating: Neutral)

Source: Author (using data from Google Finance)

Investors

Investors have been bullish about the stock in recent quarters. It now trades at 18x P/S ttm. Though, analysts are less optimistic with an average price target at .

Valuation

Source: Author (using data from Seeking Alpha)

DocuSign's valuation is less risky, given the rapid global adoption of cloud-based contract management software that will ensue after COVID-19 drove enterprises to adopt remote work tools. My experience handling legal and paper-based contract signing gives me the conviction that eSignatures are the future. The load of productive time that can be saved from digitized contract and agreement processes more than justifies the ROI to be expected.

The downsides to the growth factor are minimal. Churn will be inline while there remains no formidable competition in sight to impact margins expansion.

Risks

The top risks include EPS dilution risk from the SBC required to improve the products and drive new growth.

The sector oversubscription risk suggests investors are overweight most tech equities. This might put a hard cap on multiple expansion in the near term.

Conclusion (Overall Rating: Hold)

DocuSign remains a long-term hold. Risk-averse investors can acquire a little position and add on further dips. DocuSign will continue to enjoy a lot of demand-side tailwinds, including the acceleration of global digital transformation projects, the rapid adoption of remote work tools, usage growth as enterprises move more workloads to the cloud, and strong cross-sell from new products.

Investors are already paying a lot for future free cash flow. This makes the stock oversubscribed. Regardless, DocuSign remains a compelling growth play.