Is It Finally Time to Dump DocuSign Stock?
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Disruptive tech companies usually follow the same journey. It starts with strong revenue growth which represents something being disrupted and market share being captured. Then, they establish some gross margin cadence which reflects the future potential for profitability. Finally, they start realizing positive operating cash flows which pave the way from growth to value. A company with high gross margins (80% or higher) and positive operating cash flows that sells products/services to over a million clients is very attractive. Why? Because they’re a sustainable franchise with established sales channels that can be used to upsell and cross-sell. That’s the appeal of today’s company, DocuSign (DOCU).
Problems With DocuSign Stock
You cannot have disruption without strong revenue growth. What’s strong? We consider double-digit growth to be a minimum, which is why DocuSign has us worried. It’s been almost two years since we published a piece titled, Is It Time to Worry About the Slowdown in DocuSign Stock? That was followed by more concerns voiced last year around dismal SaaS metrics, three of which we said were most important to watch. From last year’s piece:
- Revenue growth: Later this year DocuSign will announce next year’s guidance, perhaps at the same time they release this year’s actuals. Any disappointments here will underscore our concerns.
- Net retention rate: Has now dropped for eight quarters in a row. This is our biggest concern – existing customers find increasing spend with DocuSign as optional.
- # of Clients over 300K: Large clients are spending less, and there should be a correlation between this number and the net retention rate.
We concluded, “If they can’t improve two out of three by the end of this year, we’ll have to look for LegalTech exposure elsewhere.” Here’s what happened.
Terrible Horrible SaaS Metrics
Let’s review each of the three metrics which we’ll use to decide if DocuSign should stay or go.
1) Revenue Growth
DocuSign saw nearly 10% revenue growth last year which beat guidance of 8% (good) but they’re guiding to a midpoint of 5.8% growth this year (bad). Even hitting the high end of their tight guidance range means just 6% growth which points to a clear decline. DocuSign’s quarterly revenues show the growth trend will be broken for the first time, even if the company hits the top end of this coming quarter’s guidance.
One reason revenues aren’t growing is because existing customers are spending less over time.
2) Net Retention Rate
Gross retention is a metric we use to see if clients are moving to the competition. We’re told in Q1-2024 that the company doesn’t provide this metric, then most recently, we’re told “gross retention was flat year-over-year in Q4 across the direct book of business.” Not overly useful information. Moving to net retention rate (NRR), we’re told it’s now 98% which means clients are spending less over time – a big red flag.
The company tries to paint a prettier picture. “We’re encouraged that the pace of year-over-year decline slowed substantially,” whatever that means, and the coming quarter, they expect NRR to be “flat to down slightly.” What we need to see is an NRR that’s above 100% which shows that they’re successfully upselling and cross-selling.
With their average contract having a life of 19 months, it means they’re likely negotiating contract renewals at less than what they received before. Typically, salespeople will talk up new and added features to justify a price increase. In this case, clients are probably pointing to reasons why they should pay less. Since eSignatures clearly add value, they’re probably finding cheaper alternatives from competing solutions. This should start putting pressure on DocuSign’s gross margins, but they seem fine for now, hovering around 82-83%.
We fully expected that DocuSign would be using all the startups they’ve invested in to find new avenues for growth. Mainly, we’d like to see them cross-selling adjacent offerings – like AI contract negotiations – and then breaking these out in revenue segments so we can see progress. Instead, they seem focused on profitability metrics and point to international revenues (27% of total) as a key growth area going forward. Unfortunately, that’s muted by the decreasing spend in the United States, which brings us to our last metric.
3) # of Clients over 300K
Having clients spending less over time helps explain why the # of clients spending over $300,000 dipped as seen below.
This metric appears to be resuming its upward climb, though it needs to clear the previous high (1080 clients) before we put this matter to rest (and resume the upward climb, of course). In the latest earnings call, we’re told “Q4 bookings for customers with total contract value over $1 million increased by more than 50% year-over-year.” Without benchmark numbers this information doesn’t mean much. How many customers are spending over $1 million, and is this number – not bookings but the actual number – increasing over time?
Revisiting Our Original Thesis
Just over four years ago, we visited Estonia’s Pactum AI to learn about their AI algorithms that negotiate contracts with 96% of the process being automated. One of their investors, DocuSign, claimed that “DocuSign Analyzer” was capable of the same thing, making us wonder if DocuSign was using their own technology or Pactum’s. Our follow-up piece titled A Pure-Play LegalTech Stock for FinTech Investors looked at how DocuSign had a 70% market share in eSignature functionality with Adobe trailing behind at 20%. That leadership position along with their rapid growth and apparent usage of AI made us decide to move out of the Global X Fintech ETF (FINX) and into DocuSign. We hoped their growth would continue while they upsold their 1.5 million clients additional AI-powered services. Metrics tell us this isn’t happening.
ARK exited their DocuSign position in 2022 and shortly afterwards began the relentless decline in net retention rate. Did ARK see something we didn’t? The main problem is that existing customers are spending less money. Assuming they’re not bailing entirely (we don’t know because we’re not given gross retention rates), they’re probably renegotiating contracts for a platform that offers a commodity service – eSignatures. DocuSign should have been developing adjacent offerings to shore up their offering which is what all that AI fuss was about. Their recent acquisition of Lexion – an agreement management company – seems like too little too late. It’s been three years since we read about all the things they were doing with AI, but revenue growth tells us a different story.
There’s a temptation here to look at DocuSign’s large customer base, cash flow generation potential, and healthy gross margins as a support level. Surely the stock price won’t crater that much because some private equity firm will swoop them up. (Rumors have been circulating.) It’s the same sort of hopium needed to believe there’s some great turnaround story waiting to happen. DocuSign might be the only firm left out there blaming their shortcomings on COVID, and we suspect that isn’t the real problem.
Conclusion
With an earnings call days away, it’s important to have our ducks in a row. Is there any reason to believe next year will see a resumption of double-digit growth when key metrics imply otherwise? The rapid acquisition of Lexion in time for earnings seems like a Ginkgo move. Look, we’re doing AI now! Problem is, we’ve been expecting DocuSign to have been using AI for a while. Whatever they’re doing, it’s not cross-selling and upselling. Unless we see a dramatic change in these trends, it’s hard to see a good reason to keep DocuSign in our portfolio. They seem to have switched from being a disruptor to being disrupted themselves.
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The novelty of their offering wore off years ago. One trick pony.
That’s why selling adjacent offerings is so important.