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DigitalOcean Has a Brilliant Growth Strategy — Here's What Investors Want to Know

2022 hasn't been a pleasant year for stock investors, and it's been especially brutal for investors in young tech businesses. DigitalOcean (NYSE: DOCN), a provider of cloud services, hasn't been an exception, as shares have tumbled about 70% over the past eight months.

Having said that, DigitalOcean is not like just any other young tech company. Its business is doing very well, and its carefully crafted land-and-expand growth strategy is laying the foundation for an even brighter future.

Not just another young tech company

DigitalOcean, a young public company that IPO'd in March 2021, is simplifying the adoption of cloud computing for small and medium-sized businesses, a relatively underserved segment.

Established cloud providers such as Amazon Web Services (AWS) and Microsoft's Azure do a great job of solving complex problems for their clients, typically mature enterprises with large IT staffs and budgets. DigitalOcean, however, has focused on building an easy-to-adopt platform that powers young upstarts to get their small businesses off and running quickly without spending a fortune.

Image source: Getty Images.

With the strong tailwinds of digital transformation and cloud adoption, DigitalOcean's business has been growing at a fast clip, similar to many other tech companies. In its recently reported first quarter of 2022, DigitalOcean's revenue reached $127.3 million, an increase of 36% over a year ago. That growth rate now marks the second year-over-year revenue acceleration, as revenue grew by 29% in the first quarter of 2021 and 25% in the first quarter of 2020.

But, unlike many young tech companies that took the path of "growth at any cost", DigitalOcean has been very intentional about its fiscally responsible execution. The company wants to get to $1 billion in revenue by 2024 and maintain 30%-plus revenue growth while producing plenty of positive free cash flow.

And DigitalOcean is backing itself up with results -- the company turned free cash flow positive in fiscal 2021 and now projects to grow the free cash flow margin from 6% in 2021 to 9% in 2022.

Also, as the company rewards its employees with stock-based compensation, it is repurchasing its shares to ensure that the shareholders are not getting diluted. For example, DigitalOcean repurchased $350 million of its own stock in 2021 and bought back an additional $300 million worth of shares in 2022. And the company announced in May 2022 a buyback of an additional $300 million of shares to be executed before the end of 2022.

Ultimately, the company wants to ensure that the share count doesn't expand unreasonably and its shareholders' returns are protected, as seen in the chart.

Data by YCharts.

DigitalOcean has matured way beyond its age, and its strategy of growing responsibly is very assuring to its investors.

Key customer metrics point to a great future

DigitalOcean's profitable growth is because of its superior product and its astute land-and-expand strategy, where DigitalOcean attracts software developers to its website to access an extensive library of technical and educational resources for free, introduces them to DigitalOcean's easy-to-onboard and simple-to-use cloud platform for a cost as low as $5 per month, and earns progressively more revenue as its customers grow and use more of DigitalOcean's products.

With a focus on continuously enriching its website resources -- organically as well as through acquisitions such as CSS Tricks, another learning website -- DigitalOcean's website has grown its average unique monthly visitors from 3.5 million per month in the first quarter of 2019 to 9.4 million in the first quarter of 2022. This is really impressive.

The company refers to its early-stage subscribers as "Learners," whose focus is to explore new technologies and test out some initial ideas. As the Learners find success and begin to adopt DigitalOcean's platform, they progress into what the company refers to as "Builders,'' typically young start-ups that are ready to develop their digital footprints by adopting more of DigitalOcean's products and services.

"Builders" eventually graduate to "Scalers," DigitalOcean's largest category of customers, who are ready to take their offerings to broader markets. Many Scalers use many DigitalOcean products and are the highest-paying customers.

DigitalOcean has done a great job of carefully designing its customer acquisition and growth blueprint. The company has simplified the customer experience every step of the way, from education and onboarding through product adoption.

The company offers personalized support to its partners. As customers grow, DigitalOcean actively seeks their feedback on the needs and development of future products. Overall, along with its superior product, the masterful execution of its land-and-expand strategy is at the heart of the company's growth.

What lies ahead?

According to IDC, 16 million new developers are expected to enter the global workforce by 2025, and 500 million new applications are expected to be developed by 2023. There are about 100 million small businesses around the world, a number growing by about 14 million per year.

These are massive tailwinds for DigitalOcean, and the company projects its overall market opportunity to grow from $72 billion in 2022 to $145 billion in 2025. Even a small sliver of that opportunity would lead to a really bright future for the company.

DigitalOcean's patient, responsible, and profitable growth strategy, centered around its smart land-and-expand framework, is establishing a tremendous foundation for the company to continue to capture a larger share of a growing market. However, with the current pullback in its share price, now may be a good time for investors to consider a small position in this promising business.

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John Mackey, CEO of Whole Foods Market, an Amazon subsidiary, is a member of The Motley Fool’s board of directors. Kaustubh Deshmukh (KD) has positions in Amazon, DigitalOcean Holdings, Inc., and Microsoft. The Motley Fool has positions in and recommends Amazon, DigitalOcean Holdings, Inc., and Microsoft. The Motley Fool has a disclosure policy.


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