DigitalOcean focuses on profits as growth slows

Cloud computing customers of all stripes are looking for ways to save money. DigitalOcean (DOCN -0.70%), a small developer-focused cloud computing platform, is not immune to this trend. While DigitalOcean’s fourth-quarter revenue rose 36% year over year, the company is forecasting growth of about 23% for 2023.

Adjusting the timeline

DigitalOcean had a goal of achieving $1 billion in annual revenue by 2024, along with a free cash flow margin of at least 20%. The company is pushing back the first part of that target while pulling in the second half. Given the challenging economic environment beyond the company’s control, DigitalOcean now expects to reach its $1 billion revenue goal by 2025.

There’s little the company can do to accelerate that, so it’s instead focused on cutting costs and accelerating free cash flow generation. DigitalOcean now expects to hit a 20% free cash flow margin this year.

Part of the plan includes layoffs, which are becoming increasingly common in the tech industry. DigitalOcean announced along with its earnings report that it would be reducing its workforce by approximately 11%. The company also plans to move some positions “across a broader geographic footprint,” likely to lower salaries. This plan is expected to save around $60 million annually when completed.

At the same time, DigitalOcean is laying off employees and the company is investing in share buybacks. After spending $600 million on share buybacks in 2022, the company has approved an additional $500 million for the same purpose this year. Notably, it announced that it expects to use up to 125% of its free cash flow in 2024 to buy back shares.

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making progress

Even as DigitalOcean faced headwinds in 2022 as customers began to withdraw, the company significantly improved its profitability. Free cash flow more than tripled for the full year to $77.8 million, about 13.5% of revenue. Based on its revenue guidance, the company should generate about $140 million in free cash flow this year if it hits its 20% free cash flow margin target.

DigitalOcean’s frugality was a big reason for this blazing free cash flow. The company’s customer acquisition strategy relies largely on word of mouth and helpful content to attract potential customers. DigitalOcean spent just 14% of its revenue on sales and marketing last year, a small fraction of what some tech companies spend.

The company will continue to rein in spending this year as it copes with a weaker growth rate, even as it invests in initiatives aimed at accelerating growth over the long term. Storage is a significant opportunity. Storage services make up just 10% of DigitalOcean’s revenue, and the company believes it can double that percentage. The recent acquisition of SnapShooter backup tool should help matters.

With small and medium-sized businesses spending around $98 billion annually on cloud infrastructure, DigitalOcean has a tremendous long-term opportunity. But now, as these small businesses look for ways to lower their own costs, DigitalOcean needs to shift its focus to profitability and efficiency while weathering the storm.