DocuSign: Upgraded to Buy based on growth, net cash and share repurchases (NASDAQ: DOCU )

It’s finally time to upgrade Document Signing Company (NASDAQ: DOCU)Buy. The e-signature company’s growth rate has plateaued, although management continues to warn it could face further pressure due to the following reasons. The macro environment is grim. Still, after a period of marked underperformance, DOCU trades at an attractive valuation that positions it to be profitable even if growth continues to slow. The company has a net cash balance sheet and is actively repurchasing stock.

DOCU’s growth story may not be what it once was, but it doesn’t have to be – DOCU is a deep value opportunity in the tech space. I rate the stock a Buy given the valuation, but note looming risks from its largest rival.

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Even after big gains in tech sector, DOCU The price is still trading more than 80% below its all-time high. I don’t think the stock will get close to that target in the short term, but the decline is enough.

I last covered DOCU in March, when I explained why I downgraded the stock to hold from buy due to the failure of the growth story. There are still some issues with the growth thesis here, but after underperforming the market by 25%, the valuation becomes even more compelling.

DOCU Stock Key Indicators

In its most recent quarter, DOCU’s revenue unexpectedly beat expectations, with revenue rising 11% year-over-year to $688 million, ahead of expectations for revenue of $679.

International revenue grew faster, up 17% year-on-year, and accounted for 26% of total revenue. Technology companies are having trouble adding new customers amid a tough macro environment. Still, DOCU has been able to sustain some customer growth.

E-signatures are proving more cyclical than expected, as DOCU’s net dollar retention rate continues to compress, hovering at 102% last quarter. Similar to the “cloud optimization” reported by other cloud companies, DOCU found that customers showed greater scrutiny when using the product.

Billings growth is expected to rise sequentially to 12%, marking the end of continued losses.

That could spark some optimism that the worst is over, but management said on the conference call that Billings’ strength was largely due to an increase in “on-time renewals,” while reiterating that the near-term outlook remains challenging.

Like many of its tech peers, DOCU is trying to offset slowing revenue growth by expanding its profit margins. DOCU displays solid operating leverage, particularly in sales and marketing.

DOCU achieved impressive margin growth, with non-GAAP operating margin expanding 700 basis points. DOCU generates free cash flow margins of 27%, which exceeds operating margins from prepaid revenue.

DOCU ended the quarter with $1.5 billion in cash and $725 million in debt (convertible notes). The company repurchased $30 million worth of stock during the quarter and also increased its stock repurchase authorization by $300 million, for a total of $500 million. I expect the company to carry net debt over the long term, with cheap shares providing an easy target for excess capital.

Looking ahead, management expects third-quarter revenue to grow as much as 7% year-on-year to $691 million, with non-GAAP operating margins falling to 23% quarter-on-quarter. Management raised full-year guidance to $2.737 billion (up from $2.725 billion), but that would mean fourth-quarter growth of just 5.6% year-over-year.

Management outlined plans to add a wallet feature that “will enable frequent users to save their profiles, increasing efficiency and convenience.” The functionality and value proposition sound similar to PayPal’s (PYPL) checkout functionality, although I suspect users may find it less relevant. Signing your name seems more cumbersome than entering your billing information, and I think users will generally want to read the contract.

Management expects U.S. dollar net retention to continue its downward trend in the third quarter, which would seem to imply that U.S. dollar net retention will become negative at some point in the near future, if we’re not already at that point. Management still expects growth to re-accelerate at some point, likely due to an improving macro outlook, but noted they still “have work to do” to make such progress.

Is DOCU stock a buy, a sell, or a hold?

DOCU helps advance the digital age by moving agreements from paper processing to electronic signature processing. An agreement goes far beyond a lease contract and forms the basis for conducting business.

DOCU provides an end-to-end platform to manage the entire electronic signature process.

I’d go so far as to say DocuSign has almost become a verb, but that certainly hasn’t helped stop growth from decelerating.

While the growth story appears to be under pressure, the stock trades cheaply, most recently trading at less than four times sales.

On a non-GAAP basis, the stock currently trades at less than 20 times earnings, and operating leverage is expected to contribute to solid earnings growth in the coming years.

Based on long-term net margins of 30%, DOCU’s implied valuation is approximately 12.3x long-term earnings. I think this valuation is too cheap considering the company is likely to sustain at least mid-single-digit revenue growth over the next decade and still maintain a net cash balance sheet. I think the stock trades at a P/E ratio of around 15x, which implies potential upside of over 20%.

What are the main risks? Competition, especially from Adobe (ADBE), is arguably the biggest risk. ADBE has been a serious competitor in the electronic signature space, seeking to add electronic signature capabilities to its already popular PDF document product. This leaves open the possibility that even if the macro picture improves, DOCU may still face difficulty growing revenue due to strong competitors from ADBE (as well as others). I believe the market is large enough to support both companies’ growth ambitions, and note that these two stocks are at opposite ends of the valuation spectrum. A similar risk is that electronic signatures could be seen as a commoditized market. This is obviously reflected in the stock valuation, but could have a negative impact on the company’s future growth rate and unit margins. Finally, it’s unclear how generative AI will impact companies. Will it enable it to enhance its product offering? Or will this help increase competitiveness?

DocuSign, Inc. isn’t a blockbuster, but its valuation is cheap enough to warrant an upgrade. I rate the stock a Buy due to its low valuation, net cash balance sheet, and aggressive share repurchase program.