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Good Morning!

I hope everyone is having a great weekend!

As I am sure, many of you saw, my Cleveland Cavaliers’ season came to a difficult end this past week. On the bright side of things, I had the privilege of going to the Cavs vs. Celtics Game 2 in Boston and it was awesome — and the Cavs only win of the series!

Cheering on your hometown team in another city in a playoff environment was an incredible experience. I am also sorry to the city of Cleveland I was not able to make it to the other games during the series as I might just have been the team’s good luck charm.

Before we jump in, I just wanted to go on the record with a few Cavs predictions:

1. JB Bickerstaff will not be the coach of the Cavs next year

2. Darius Garland will be traded in the offseason

3. Donavan Mitchell will not be traded in the offseason

4. The Cavs will trade with the Nets and get Mikal Bridges or Cam Johnson

Enough sports. Let’s get down to business.

Showtime!

Three quick housekeeping announcements/reminders before we get started:

1. All opinions in The Crossover are 100% my own.

2. No Artificial Intelligence/ChatGPT is used in writing The Crossover. (Who needs AI when you have AL!)

3. The Crossover is not investment advice and is for education and entertainment purposes solely.

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DEEP DIVE

Digital Ocean: An Intriguing First Quarter

The News: Digital Ocean, the cloud hosting solution for growing technology businesses, recently shared their Q1 ‘24 earnings. The Company beat on analyst expectations both on the top & bottom line with revenue of $184.7M (representing +12% YoY growth) & Non-GAAP EPS of $0.43 versus expectations of $182.6M & Non-GAAP EPS of $0.38.

Some other key stats from the earnings release include:

• ARR of $749M vs. expectations of $737.5M (representing ~12% growth YoY)

• EBITDA margins of 40.2% vs. 37.3% expected

• Adj. FCF of $34M vs. $26M in Q1 ‘23

• ARPU of $95.13, an increase of 8% YoY

The Company also narrowed their guidance (positively) from $755M-$775M to $760M-$775M.

Finally, here is what CEO Paddy Srinivasan shared in a written statement along with the Q1 earnings press release:

“The first quarter was a strong start to the year as we position the company to be the leading cloud and AI platform for growing technology businesses,” said Paddy Srinivasan, CEO of DigitalOcean. “Our results demonstrate the solid performance of our core cloud and the exciting potential of our AI platform.”

Alan’s Angle:

DigitalOcean is a name I have written about on a couple occasions in the past. I love the rapidly growing space they operate in ($114B — $213B from 2024-2027 representing a 23% CAGR), the strong financial profile of the business (40% EBITDA margins), and emphasis on buying back stock/negating impacts of SBC (share count decreased from 118M in FY ‘22 to 103M in FY24E.)

While there are several question marks with the company including a new leadership team (CEO Paddy Srinivasan joined the Company in January), concerns around top line growth (only 12% growth YoY in Q1), an extraordinarily complex competitive landscape, I ultimately land on the bullish side of the equation.

Below I share just couple of the reasons why:

AI at a Reasonable Cost

I think it is clear to everyone that Artificial Intelligence is going to be a massive disrupter in all of our lives. How exactly? I don’t think anyone knows. However, what I do know is that I would like some exposure to the space without taking a risk on a company trading at a crazy multiple who probably won’t see profits for the next who knows how long.

DigitalOcean fits this bill. In July 2023, $DOCN acquired a company called Paperspace, a leading provider of cloud infrastructure as a service for highly scalable applications leveraging GPUs.

On the earnings call, Paddy shared very interesting color into how the Company’s AI solutions are performing (which I am assuming is attributed to Paperspace.). Specifically, Paddy stated:

“We're seeing strong revenue growth for our early stage AI solutions as we continue to ramp up our initial GPU capacity through the first part of this year. And our expectations are that demand will continue to outstrip supply for the foreseeable future demand outweighing supply.”

Demand being greater than supply is almost always a good thing. Additionally, just after these statements, Paddy shared that as of March the Company’s ARR grew to $19M, “most of which” is due to their platform-as-a-service offering. This growth represents 128% annualized increase from December 2023 in this space.

You can see Paddy’s full commentary on DigitalOcean and the Company’s AI push in the earnings call transcript here.

Customer Breakdown

The graphic above was shared by Digital Ocean in their Q1 Earnings Presentation. The chart shows on the left the breakdown of customers by segment/size and on the right the amount of revenue earned for each group during the quarter.

For background, here is a quick breakdown of each group and what they mean.

• Scalers spend more than $500 a month with Digital Ocean

• Builders spend between $50-500 a month with Digital Ocean

• Learners spend less than $50 a month with Digital Ocean and have been customers for more than 3 months

• Testers spend less than $50 a month with Digital Ocean and have been customers for less than 3 months

As you can see, more than half of the revenue comes from Scalers even though that is just ~2.5% of their total customer base. While the other customers are clearly important, I think there is a real opportunity to serve these higher paying, more concentrated group of customers and earn more wallet share for them. Specifically, on the call, Paddy mentioned how the Builders and Scalers love their “price to value” and that the customers have told them “they see opportunities to expand their business with Digital Ocean.”

Exactly what you want to hear.

If I recall correctly, CFO Matt Steinfort shared a similar sentiment in a fireside chat last year that there was meaningful pricing power from their customers.

(Side Note — Why do I not have the exact quote? Because I do not want to sift through a 45 minute webinar from last year to find it ;) ! I hope you can forgive me, and I hope I recall correctly!)

Also, importantly, the Scalers segment was the customer segment that also showed the greatest strength in the quarter growing customer count by 12% YoY & 2% QoQ as well as 16% ARR growth YoY.

I will be keeping a close eye on the Scalers moving forward and will be a critical component for the Company moving forward.

Growth & Wrapping it Up

70 times. That is how many times the word “growth/grow/growing” etc. was mentioned in the DigitalOcean conference call and for good reason. As I have mentioned earlier, the company has seen their top-line growth slow down represented by 12% YoY revenue growth in a tougher environment for SMBs.

A key question for the Company and stock is whether Paddy & Co. can reignite t growth. The mention of the root word “grow” 70 times shows that it is top a mind for the company and analysts alike.

I ultimately do think the Company will return to solid growth through their AI offerings, better serving their customers through an emphasis on product, and hopefully a less difficult environment for SMBs.

However, if there isn’t a return to growth, the stock will likely return to ~$20 a share. However, I still feel like the bullish case is the far more likely one.

Oh. And over 60 times.

That is how many times AI was mentioned on the $DOCN earnings call.

The Takeaway: I picked up a slug of Digital Ocean in the mid-high $30’s. Over the next several years, I think this company could be special.

BUFFETT WISDOM

Greg Abel is Up Next?!

A couple weeks ago, Warren Buffett and Berkshire Hathaway hosted their annual meeting in Omaha, Nebraska where Buffett shared updates on his business as well as his investment wisdom for several hours.

While I am sure you have seen many of the clips on X or YouTube, I wanted to share a quick excerpt that I particularly found interesting.

Buffett was asked during the event whether Greg Abel, the expected succeeding CEO of Berkshire after Buffett, would be responsible for making the company’s common stock investments or if that would fall to Ted Weschler & Todd Combs — two senior, prominent investment managers at Berkshire.

While Buffett shared that this decision will likely be made by a board when he is no longer around, he said that if it was up to him, he would leave the responsibility “entirely” with Mr. Abel.

Buffett’s reasoning was simple: “if you understand businesses, you understand common stocks.”

I think this is such a simple statement, but is so true. Over the past little while, I have often tried to put myself in the shoes of executives (of course as best as I can with information I have) and really think about the company’s challenges and opportunities from a perspective that this is a real business with real executives and employees.

This has been a very englighting exercise, and I love having Buffett’s quote to drive this idea home even further.

CHART OF THE WEEK

Shut Up and Wait?

A good friend of mine put the tweet/chart above on my radar, and I absolutely loved it.

As you can see, the chart is from 2017, in the years since? The S&P 500 is up over 100%.

The S&P 500 just continues to deliver decade after decade. Therefore, a question I ask myself often is “why do I put my money anywhere else?”

GOLDEN NUGGETS

1. Ipswich Returns to the EPL

2. Google’s Punches Back

3. Hubie Brown is the Real GOAT

MEME OF THE WEEK

There is Nothing Like Roku City…

Thanks for the read! Let me know what you thought by replying back to this email.

— Alan

Disclaimer: The Crossover is not a professional financial service. All materials released from The Crossover are for educational and entertainment purposes. The Crossover is not a replacement for a professional's opinion. Contributors to the Crossover might have positions in the equities mentioned in the newsletter.