DigitalOcean’s IPO filing shows a two-class cloud market

This morning DigitalOcean, a provider of cloud computing services to SMBs, filed to go public. The company intends to list on the New York Stock Exchange (NYSE) under the ticker symbol “DOCN.”

DigitalOcean’s offering comes amidst a hot streak for tech IPOs, and valuations that are stretched by historical norms. The cloud hosting company was joined by Coinbase in filing its numbers publicly today.

DigitalOcean’s offering comes amidst a hot streak for tech IPOs.

However, unlike the cryptocurrency exchange, DigitalOcean intends to raise capital through its offering. Its S-1 filing lists a $100 million placeholder number, a figure that will update when the company announces an IPO price range target.

This morning let’s explore the company’s financials briefly, and then ask ourselves what its results can tell us about the cloud market as a whole.

DigitalOcean’s financial results

TechCrunch has covered DigitalOcean with some frequency in recent years, including its early-2020 layoffs, its early-2020 $100 million debt raise and its $50 million investment from May of the same year that prior investors Access Industries and Andreessen Horowitz participated in.

From those pieces we knew that the company had reportedly reached $200 million in revenue during 2018, $250 million in 2019 and that DigitalOcean had expected to reach an annualized run rate of $300 million in 2020.

Those numbers held up well. Per its S-1 filing, DigitalOcean generated $203.1 million in 2018 revenue, $254.8 million in 2019 and $318.4 million in 2020. The company closed 2020 out with a self-calculated $357 million in annual run rate.

During its recent years of growth, DigitalOcean has managed to lose modestly increasing amounts of money, calculated using generally accepted accounting principles (GAAP), and non-GAAP profit (adjusted EBITDA) in rising quantities. Observe the rising disconnect:

  • 2018: $36.0 million net loss, $39.5 million in positive adjusted EBITDA.
  • 2019: $40.4 million net loss, $55.2 million in positive adjusted EBITDA.
  • 2020: $43.6 million net loss, $95.9 million in positive adjusted EBITDA.

For the financially focused, depreciation and amortization, share-based compensation, interest costs and the “revaluation of warrants” were the key drivers of divergence.

DigitalOcean carries debt. This is expected given its history of raising debt and the fact that it paid millions in interest costs last year. Per its filing, the company has $261.4 million worth of long-term debts, including a term loan worth a little more than $166 million, a revolving credit facility with $63.2 million drawn and “notes payable” worth $31.4 million.

Our picture of DigitalOcean is coming together. The company’s growth is regular, including 25.5% revenue expansion in 2019 and 25% percent in 2020. Those figures are bolstered by rising adjusted EBITDA, which could entice public-market investors to provide the company with a comfortable revenue multiple. However, at the same time DigitalOcean is carrying a quarter-billion dollars in long-term debt and has lots of GAAP losses to eventually staunch.

In its favor is a history of generating positive operating cash flow; DigitalOcean’s regular operations more than self-fund on a cash basis. However, the company had negative investing cash flow of $115.5 million in 2020, thanks to what it describes as “primarily … a result of increases in capital expenditures to purchase property and equipment to support additional data center co-locations” amongst other expenses.

It’s not cheap to compete in cloud, in other words, if you have buy lots of hardware. And the sums that DigitalOcean is investing in its cloud infrastructure are a drop in the bucket compared to some of its larger rivals. This brings us to the competitive landscape of the cloud market.

DigitalOcean’s place in the clouds

When you look at the projected revenue of $300 million annually, it seems pretty solid on its face, but it’s actually quite small when you compare it to the Big 3 — Amazon, Microsoft and Google. Consider that the cloud infrastructure market reached $129 billion last year, with $37 billion coming in Q4. Of that, Amazon had over $12 billion, Microsoft $7.4 billion and Google $3.3 billion. It’s probably not fair to compare DigitalOcean to the biggest companies in the space, but even when you move down to fourth and fifth place with Alibaba and IBM, the two companies each surpassed a billion in revenue for the quarter.

John Dinsdale, chief analyst and research director at Synergy Research, a firm that tracks cloud infrastructure market share, points out that DigitalOcean is a small fish swimming in a big sea, accounting for a fraction of 1% of market share, but it is carving out its own niche.

“AWS and Microsoft Azure will not be losing too much sleep worrying about DigitalOcean, but it is not trying to compete head-on with them across the full spectrum of cloud infrastructure services. It has to be, and is, more focused on a subset of services and customer types,” he said.

Dinsdale says that a company like DigitalOcean can be an important piece of the cloud infrastructure ecosystem, especially for customers looking for choices beyond the usual suspects. “In many ways it epitomizes how smaller niche-oriented cloud providers can compete against the industry giants. Customers want choices and not everyone wants to go with AWS, Azure or Google Cloud Platform,” he said.

Perhaps that explains why DigitalOcean remains a favorite among developers as a cost-effective and easy to deploy and manage alternative. While it has a fair way to go to move anywhere near the billion dollar quarterly revenue goal, sitting at roughly $75 million a quarter at the moment, the company has a nice steady and growing source of income. The cloud infrastructure market as a whole continues to grow, and there is plenty of room for companies like DigitalOcean to make some significant revenue, even if it never approaches the top players in the market.

The IPO is a step on that journey, and the additional capital could help it push those revenue goals higher as it joins the ranks of public companies and continues to compete with giants in the cloud infrastructure market.