When news of the Pfizer vaccine broke out, and subsequently broke markets (temporarily), I thought that the news-reported "rotation" out of stay-at-home and tech stocks into value stocks provided an immense opportunity to trade some of the popular tickers. In fact, I suspected that the FOMO people felt from missing out on the run following the election was replaced with a skeptical, contrarian viewpoint that life may return to pre-COVID times and stocks return to pre-COVID valuation levels.
I believe the skepticism around the rise of tech is an honest mistake. The effects of COVID on financial markets are not the result of temporary government measures, but likely of permanent regime changes. Let me roll with this as an assumption; you are already probably familiar with the concepts of MP3, rising anti-capitalist populism, a rotation out of cities, large stimulus measures, and a strengthening challenge from China against the dollar as a reserve currency. For those who recognize that 2020 is a regime change and not a temporary boost (or decline, depending on industry), there are plenty of plays worth discussing. I am intentionally going to ignore the discussion around hype stocks, like those in the EV and cannabis craze. Instead, I'm going to focus on a lesser talked about stock, that is still "big tech" related, in a high growth phase, and not as speculative as far as valuation is concerned. A stock like that, which does not get a lot of attention, has its moments. This week could be one of those moments, where being in it before a new wave of investors rush in might pay off nicely. Let me share the analysis I have done so far on Docusign ($DOCU).
Notable Company Features
DOCU's self-declared TAM is $25 billion just for the eSignature space, in which they are obviously the top player, and they also have efforts underway for a whole Suite solution, expansion (importantly, into international markets), and vertical integration. They're projected to bring in under $2 billion of that this year, so they are very much still in high growth phases, spending a lot of sales/marketing and R&D. It's not hard to see DOCU making tens of billions of dollars of revenue down the road, and this week could cement people's belief that a higher valuation is due to come sooner.
Employees also really like working at the California-based company. It ranks as one of the best companies on Glassdoor, with over 95% of people recommending the company and giving CEO approval. This piece of metadata is often very useful; great companies attract great talent.
Based on my analysis and my limited experience with financial statements, I think that the most important metric to look out for when DOCU reports earnings is going to be revenue, and how that feeds into year-over-year gross profit growth. I looked at different revenue and expense scenarios, and there wasn't much sensitivity around the consensus net loss per share estimate, of minus 32 cents. However, the year-over-year Q3 growth is estimated to be between 40 – 50% (reverse-engineering their guidance and consensus estimates gets me 42%), and my calculations show it's likely to beat the 50% mark, which I assume to be psychologically significant because growth has stayed at around 40% for over the past year.
In the past two years, DOCU has experienced revenue growth of around 10% quarter-over-quarter. It's maintained an incredibly stable gross profit margin (everything is presented on a GAAP basis) of about 75%. The company's guidance for this quarter shows only a 5.5% growth in revenue against prior quarter, which looks to me like it's extremely conservative, just like the consensus estimate for Zoom in their earnings this week. Notably, both companies have beaten every quarter's revenue estimates in the past two years.
My "base case" for revenue growth is 13%; that's a little less than the 15% from last quarter, and keeping gross profit % flat as well, nets a gross profit growth of 52% year-over-year. I think it's probably likely that we will see gross profit growth of around 50%. Cost of revenue grew 22% last quarter; that was unusual, and I suspect it's related to the free trials. If true, then we should expect cost of revenue to go back to trend, growing in line with actual revenue and keeping gross profit margins neutral.
My "bad case" and "good case" call for gross profit growths of 38% and 61%, respectively. They use lower/higher growth rates for revenue, keeping gross profit margins flat as well. I also tweaked some operating expense assumptions in the second half of the table (see Appendix), in which I calculated a net loss per share. The consensus estimate on net loss per share looks a bit more optimistic. It is 32 cents, and my base, bad, and good case call for 34, 47, and 30 cents respectively.
Overall, I expect DOCU to comfortably beat revenue earnings by several percentage points, but the downstream impact into the final net loss per share value is unlikely to surprise.
With only about 1% of shares trading hands on an average day, DOCU looks like a stock primed to win. It's been in a very tight trading range for almost the past 5 months, which followed a big rally. Looking at the volume by price indicator, it has done a lot of mean-reverting to the $215 level. More recently, it has tried to escape, getting bought up at $195 and sold at $235 more than once. That's $20 in either direction. Notably, the straddle on next week when it reports earnings shows a $22 move. DOCU's earnings is after-hours on Thursday, which follows just three days after Zoom reports its earnings. This means that we will have a good sense ahead of time of whether DOCU, which is a direct beneficiary of the COVID-era like Zoom, can maintain their explosive growth.
Looking at the broader market, the dollar is sitting at a multi-year low, and it is currently on a downward trend, which just needs a reasonable catalyst to start a lower leg down. That would presumably raise equity valuation levels. In addition, the Nasdaq is "only" around 25% higher than its high from February; some names gained far more than others. If you believe in the regime change from physical to virtual, all the new monetary/fiscal mechanisms to support financial markets, the democratization of investing through commission-free trades drawing in new investors (a majority of which buy and hold, raising demand), existing mania around the markets, a changing administration that will be less likely to provoke markets with tweets, and the general desensitization of the average investor, then you probably have an optimistic view like me.
Docusign reports earnings this week. Zoom reports a few days earlier, giving us an early read. Because DOCU has relatively stable finances, I think Zoom will provide key insights into what to expect. Technical indicators are strong. Revenue is likely to beat, and gross profit margin growth could impress. DOCU is an underdog in terms of hype stocks, but has all the characteristics needed to get a lot of attention. And the product that they sell is extremely well received, and they clearly have attracted a lot of talent. All said, a new leg up in DOCU's valuation looks like a real possibility.