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Cornerstone Crumbs: DocuSign Debacle Still Requires A Little More Patience

"The Lord bless you and keep you;

The Lord make His face shine upon you,

And be gracious to you;

The Lord lift up His countenance upon you,

And give you peace."


Numbers 6: 24-26


Most investors interested in or already owning DocuSign, Inc. (DOCU) already know that today's after-hours action has been brutal. Unfortunately from my perspective, I think there's a little more pain to go before DocuSign becomes an intriguing mid- to long-term investment consideration.


I've owned DocuSign in the past with entries initially in the $40s and most recently last year north of the $150s. I didn't hold the position long-term from the $40s level as it was a small position, plus I've revamped my portfolio to focus exclusively on aggressive growth, which is why I re-entered DocuSign last year.


However, as I began to deconstruct DocuSign's Free Cash Flow, FCF, I soon realized that the company was in a state of Cash Burn with no clear end in site. This led to me selling the entire position in the low $200s. During 2021, DocuSign sold off hard during the mid-May aggressive growth-based drop, only to jump substantially north of $300 thereafter. Like many aggressive growth plays, DocuSign witnessed valuation multiple expansion during the pandemic. Most aggressive growth stocks are now in a multiple contraction environment (although schizophrenically). What I mean by schizophrenically is that there are many aggressive growth companies still sporting EV/Revenue and Cash Flow multiples in the 25-50 times and negative to hundreds levels respectively.


One by one though, they are seeing drops like what DocuSign is experiencing. Here's the good and the bad from my take on DocuSign.


The Good


The good can be summed up with DocuSign's robust Revenue growth through the first nine months of FY 2022. At the same time, the company is witnessing stronger Gross Margin, GM performance, declining Operating Expenses as a portion of Revenue, and corresponding increasing Operating Cash Flow, OCF margin. In fact, for the first time since FY 2018, DocuSign has witnessed positive FCF margin over the Last Twelve Month, LTM period.


I will reiterate here that investors need to recognize that DocuSign incurs Cash Flow outflows from Payments of Tax Withholding Obligation on RSUs, Etc. Over the LTM period, this amount was at nearly $450 million. With DocuSign's OCF margin approaching 25%, this equates to a just above 2% FCF margin after factoring for the RSU impact, Capex, and proceeds from stock options and stock purchase plans.


The Bad


The bad is noticeably DocuSign's guidance for their FY 2022 Q4 Revenue expectations. This came in slightly lower than average analyst estimates. Overall, DocuSign is expecting to generate FY 2022 Revenue just north of $2.08 billion. I initially modeled DocuSign to generate $2.1 billion in Revenue with a 25% OCF margin.


While the revision is extremely modest, Wallstreet is jumping the gun for FY 2023. I have modeled DocuSign to generate $2.7 billion in Revenue, with a mid-term FY 2026 estimate at nearly $5 billion. I expect DocuSign to see further OCF inflection towards 30% over this time, but it remains to be seen how much further the company can see its FCF inflect. The modest revised Revenue guidance to end FY 2022 will put next year's and mid-term estimates on pause as to whether DocuSign will continue to grow as expected.


Conclusion


I'm not overly concerned regarding the Revenue guidance miss, nor am I highly concerned regarding FY 2023 Revenue expectations. It's health to see the valuation multiples in contraction as I feel that DocuSign was overvalued. The key moving forward is having fair Revenue and Cash Flow estimates, combined with reasonable valuation levels. This is no easy task as we have just witnessed a multiple and expansion full-circle.


For me, if we assume DocuSign tracks towards $5 billion in Revenue by FY 2026 and a 30% OCF margin, I would feel comfortable with EV/Revenue and OCF/share valuation multiples of 15 and 55 times respectively, equating to a max SP of around $370. Seeing the SP drop in after-hours towards $160 is definitely tempting, but I believe that better risk/reward set-up is better suited towards $140.


There is no gaurantee that DocuSign will indeed generate $5 billion in Revenue, or achieve a 30% OCF margin by FY 2026. There is also no perfect clarity on whether the FCF margin will have significantly improved by then either. Depending on future growth, the valuation multiples will be impacted as well. Buying in at $140 affords a potential annualized 21% return in event DocuSign hits or exceeds estimates.


If an investor were to jump the gun and buy DocuSign at $160 tomorrow, and DocuSign were to only achieve $4 billion in Revenue, with the same OCF margin, and somehow still maintain the same valuation multiples, the SP would drop towards $300, affording only a possible 13% annualized return.


Markets are volatile and SPs are very erratic and with today's get-rich-quick mantra and skyrocketing asset prices (sometimes in only days), it's getting harder for investors to make sense of things. I like to keep it simple by using fairly conservative financial models (its hard to be entirely conservative while focusing on aggressive growth), while contemplating realistic valuation multiples. There is no perfect answer, especially as the future is uncertain, but as each quarterly result hits, there is a trend line that can be monitored towards these expectations. For DocuSign, I think there's a little bit more patience that may lead to a more ideal investment opportunity.




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