DigitalOcean (DOCN) – The Shopify of Cloud Computing

$200 Price Target

Citron – Learning from Our Mistakes

One of the greatest blunders we have made over the past 20 years of publishingCitron Research, is not realizing the power of Shopify when the stock was $100.At the time it seemed like another overpriced software company that allowedpeople to perform the simplest of tasks… making websites. What we failed torecognize and attribute enough value to was that:

1. Customers LOVED the product2. The Small and Medium Sized Business (SMB) market was a lot larger than

we anticipated and could work through its own churn3. The power of a passionate and dedicated developer network4. The ease of cross selling once a large customer base was established

Congratulations to everyone who owned Shopify through the years. Citron hasbeen waiting patiently for another company to come along with the same profile,hoping with fingers crossed that valuation would be investible… and it has finallycome to market.

Enter DigitalOcean – The Shopify of Cloud Computing

DigitalOcean (DOCN) is a cloud computing platform purpose-built for SMBs (i.e.,the Shopify of cloud computing or AWS for SMBs) at a fraction of the cost of largecloud providers.

The transformation to the cloud for large enterprises is obviously already on itsway. Just look at Amazon with Wall Street analysts estimating the value of AWS at$700-800 billion.

The next wave is the SMB transformation to the cloud and multi cloud.

We’ve seen this movie before and just like how Shopify and Square saw that SMBswere not far behind large enterprises in adopting ecommerce and digitalpayments, DigitalOcean is in the leading position to capitalize on this mega trend.

Keep It Simple Stupid

“Simplicity is the ultimate sophistication. It takes a lot of hard work to makesomething simple, to truly understand the underlying challenges and come up withelegant solutions.” – Steve Jobs

Simplicity has become the key to winning in the SMB market. While AWS sells aproduct that is not just expensive but also very difficult to use, DigitalOcean, likeShopify has created an easy solution for SMBs to embrace cloud technology.

Compare Shopify 2015 IPO Roadshow Presentation to DOCN Today:

Shopify 2015 IPO Roadshow Presentation

DigitalOcean Q1 2021 Earnings Presentation

https://s27.q4cdn.com/572064924/files/doc_downloads/shopify_overview_nov.pdfhttps://s27.q4cdn.com/619704647/files/doc_financials/2021/q1/Q1-21-DOCN-Earnings-Presentation.VF.pdf

Citron would argue that the SMB customer for DOCN is stickier than SHOPbecause a startup that needs cloud is more advanced than a drop shipper or smallentrepreneur.

***It is SO OBVIOUS to Citron what is about to happen to DOCN stock.

Look at the above chart at the growth of PaaS. As stated by management in lastearnings call:

“Roughly 90% of our revenue comes from the core compute network and storagesolutions that are typically called Infrastructure as a service. 10% are Kubernetes,our Database as a Service. And that piece of the revenue pie is growingsignificantly higher than our overall growth rate. And that reflects that fact wehave a growing customer who is building off their business”

https://seekingalpha.com/article/4426204-digitalocean-holdings-inc-docn-ceo-yancey-spruill-on-q1-2021-results-earnings-call-transcript

The PaaS part of the DigitalOcean business is the high margin and high growthpart of the business that will make DOCN the real AWS for SMBs.

The Shopify of Cloud Computing (i.e., AWS for SMBs)

When Citron initially published on Shopify, we were most surprised not by theenthusiasm of the shareholders, but rather the passion of the end users. Whogets so passionate over software???

After speaking with former employees, customers, and even the competition, wehave found that DigitalOcean’s customer base is even more passionate andevangelical than that of Shopify, which leads us to believe that DigitalOcean willbecome the dominant SMB cloud provider.

We were given the analogy during our calls with industry experts that using AWSis like operating a Boeing 747 (i.e., too many functions/switches/controls) whileusing DigitalOcean is like driving a car (i.e., relatively idiot-proof).

A customer who spends $500K annually with DigitalOcean told us thatDigitalOcean is his biggest cloud provider spend by far as it’s the easiest to useand on average is half the cost of the big cloud providers for the same service. Wesee a similar sentiment from DigitalOcean customer Parabol who moved overfrom Amazon’s AWS:

“The hosting option became DigitalOcean simply because the product was so easyand friendly to manage – all at the right price”

https://www.digitalocean.com/customers/parabol/

Below are some of the DigitalOcean’s positive customer testimonials:

● "What we really like about DigitalOcean is the keen customer focus. As acompany that serves developers, we want a partner that understands ourcustomers and has a shared purpose. DigitalOcean not only providesworld-class infrastructure but they truly get developers. This makes our jobeasier in terms of building management services for them.”

- Roxana Ciobanu, CTO of BunnyShell

● “With DigitalOcean, we get a low-cost option with great support andreliability.”

- Director of Education & Awareness, Molly Wojcik

● “We had been growing 10 to 20% a month. And every step of the way, DOhad tools that were exactly what it was right. We came for the simplicityand then, as we scaled, we were actually very pleasantly surprised by manythings on the platform”

- Daniel Ni, CEO & Founder of Scraper API

● “As a founder, I didn’t want to spend time micromanaging infrastructureand doing XML sit-ups. When the pandemic happened and traffic grewtenfold, the robust DigitalOcean platform allowed us to scale seamlessly,without any disruption to our operations, so we could continue to focus onrunning our business.”

- Jordan Husney, Cofounder & CEO of Parabol

Positive feedback from the developer community on DigitalOcean can also befound on YCombinator News:

● "I use DO because it's simple and easy. I got tired of dealing with AWScorporate-sized crap, all I want is to spin up several servers using terraformand get work done"

● "The company I work for solely uses DO. It has all the things you might wantthat won't get you cloud vendor locked. Plus their UI is actually useable,unlike my experience with AWS"

● "This. DO, imo, crushes AWS's pricing, documentation and ease of use foranyone but big enterprises"

● "AWS you need a math degree to understand the billing and even then youwill never know exactly what you will be billed until you are actually billed...This is not the case with DO and Linode"

● "On AWS and others: spin up a server that costs more in comparision toDigitalocean, and prepare to find costs on your bill you never thought youwould have: traffic, permanent storage, logging,..."

https://www.digitalocean.com/blog/building-a-developer-tools-business-on-a-developer-focused-cloud/https://news.ycombinator.com/item?id=26262830https://www.g2.com/products/digitalocean-droplets/reviews

The enthusiasm for DigitalOcean’s product has become almost cult like in thedeveloper community… something that we always want to invest in regardless ofvaluation.

Putting the Passion of DigitalOcean’s Customer in Perspective

DigitalOcean has been able to only spend 10% of revenue on sales and marketingyet is able to deliver consistent 30% top-line growth (i.e., customer acquisition isvery cost effective). As noted in the company’s S-1:

“Our developer-centric approach has helped us foster a large and loyal following.We attract approximately 5 million monthly unique visitors to our websites, hostwhat we believe is the largest hackathon in the world, and offer a comprehensivelibrary of high-quality technical tutorials and community-generated questions andanswers. Developers and SMBs especially value open source technology as itallows them greater choice, affordability and flexibility, and our platform isdesigned to take advantage of open source technology to provide our customerswith a much more efficient way to work. Our participation in and support of theopen source community further enhance the attractiveness, depth and scalabilityof our offering.”

https://www.sec.gov/Archives/edgar/data/1582961/000119312521055798/d898181ds1.htm

Comparatively, when Shopify was doing an equal level of revenue in 2016, thecompany was spending 33% of revenue on sales and marketing. Given thatDigitalOcean already has a great product and has not done much beyond Googleads and a $100 credit to sign up new customers, using the IPO proceeds toimplement a proper go to market strategy could drive a massive acceleration inrevenue.

With almost 600K SMB cloud customers and no real dollars spent on sales andmarketing, it is going to be really hard to screw this one up…. and they are not.

Ability to Move Up Market (Multi-Cloud)

Beyond the growing SMB market, DigitalOcean might have an easier time thanmost in moving up market and taking some low hanging fruit from AWS andAzure. It’s no secret that cloud computing pricing has become a hot topicrecently. Cloudflare CEO Matthew Prince has publicly blasted AWS that “theirmarkups are bonkers” and that AWS keeps prices “artificially high”.

For example, here is a Twitter post from last week. Note that Magesh Ravi is aSenior IT Recruiter at Cognizant, a $37 billion IT consulting firm.

https://twitter.com/mageshravi/status/1419211615107305473https://www.linkedin.com/in/magesh-ravi-a064539bhttps://www.businessinsider.com/cloudflare-ceo-matthew-prince-blog-amazon-cloud-aws-2021-7https://www.cnbc.com/video/2021/07/27/cloudflare-ceo-on-why-hes-calling-out-amazons-pricing.html

Not surprisingly, we are seeing an increasing number of companies adopt amulti-cloud strategy. As noted by Clay Magouyrk, executive vice president ofOracle Cloud Infrastructure:

“We’re seeing more and more customers adopt a multi-cloud strategy simplybecause some workloads run better or more cost-effectively on different clouds,”

This sentiment was echoed by Steve Mullaney, chief executive officer of AviatrixSystems Inc., a provider of networking software to help organizations to managetheir clouds across multiple vendors:

“Two and a half years ago, everything was AWS.” “Now everybody is multi-cloud.”

https://www.google.com/amp/s/www.wsj.com/amp/articles/battle-for-the-cloud-once-amazon-vs-microsoft-now-has-many-fronts-11627221600

It is not uncommon to read raving reviews on not only the obvious pricingadvantages of DigitalOcean vs. AWS but also on performance. Just look at thisrecent comparison from the development community:

https://www.bunnyshell.com/blog/aws-google-cloud-azure-digitalocean-vps-performance/

While DigitalOcean will never replace the complexity and intricacies of AWS, as alow-cost provider, DigitalOcean is well positioned to benefit from the multi-cloudmovement.

Investible Management Team

Starting at the top, DigitalOcean is led by CEO Yancey Spruill whose last role priorto joining DigitalOcean was CFO/COO at Sendgrid from 2015 to 2019 until thecompany was acquired by Twilio in 2019.

Under Spruill’s leadership, DigitalOcean has built out a top-notch managementteam. Below are some of the rockstar executives at the company:● Barry Cooks – Chief Technology Officer (former VP of R&D Cloud Operations

at VMware)● Carly Brantz – Chief Marketing Officer (former VP of Revenue Marketing at

Twilio)● Chris Higgins – VP of Infrastructure (former VP of Oracle Cloud

Infrastructure)● Raman Sharma – VP of Product Marketing (former Director of Product

Marketing at Microsoft Azure where he led Product Marketing for Platformas a Service, Serverless and Integration Products in Microsoft's CloudServices)

● Arif Kadir – VP of Revenue Marketing (former Senior Director of BusinessOperations at Twilio and Lead Analytics of North America Small Business atPayPal)

https://www.linkedin.com/in/barryjcookshttps://www.linkedin.com/in/carlybrantzhttps://www.linkedin.com/in/chrishighttps://www.linkedin.com/in/ramansharmahttps://www.linkedin.com/in/arif-kadir-48543a16

Follow Management’s Performance Based Compensation – We HaveSeen This Movie Before… Most Notably with Tesla

CEO Spruill is highly incentivized to get DigitalOcean’s stock price much higher. OnJuly 27, 2021, the board granted a RSU award to Spruill of 3 million shares if hecan get the stock above $280.50 as “measured based on the average of theCompany’s closing stock price over a consecutive ninety (90) trading day periodduring the performance period”. His first tranche is at $93.50.

https://www.sec.gov/ix?doc=/Archives/edgar/data/1582961/000162828021014704/docn-20210727.htm

Thursday Earnings for DOCN

DigitalOcean will report Q2 2021 earnings this Thursday before market open. Webelieve the setup into earnings is very attractive as:

1. DigitalOcean CEO beat revenue estimates every quarter during his time as

COO/CFO of SendGrid before the company was acquired by Twilio

2. Expectations are low. Wall Street consensus assumes Q2 2021 revenue

growth decelerated to 28% from 29% growth in Q1 2021, 26% growth in Q4

2020, and 24% growth in Q3 2020

3. Q2 2021 earnings reports from Amazon, Microsoft, and Google indicate that

the cloud computing industry saw a notable acceleration in growth this

quarter (see exhibit below)

4. DigitalOcean management met with Goldman Sachs who was a lead

underwriter on the IPO on 5/11 and analyst Christopher Merwin wrote in a

research note the following day that “top line growth acceleration” is a key

priority

5. DigitalOcean management will be participating in three investors

conferences on August 9th, 11th, and 12th shortly after reporting earnings.

We view it as a good sign when management teams want to meet with

investors shortly after reporting earnings

Below is a quote from CEO Spruill on the last earnings call which makes us believe

he is far from missing and could have a big beat in Thursday’s numbers. This really

describes where the company is and their trajectory. Note – this is from an

experienced tech CEO, not some SPAC promoter.

“I think we are just sitting down after the National Anthem, and we have our peryear and our first hotdog. And I haven't even gotten any mustard on my hands yet.So I think it's very early. And I think it's important to mention here, as Imentioned in the script, we joined less than 2 years ago. And a lot of theoperational changes that we've made. It's not unusual that after 18 months, youstart to see bear fruit.”

https://seekingalpha.com/article/4426204-digitalocean-holdings-inc-docn-ceo-yancey-spruill-on-q1-2021-results-earnings-call-transcript

Conclusion

This month is our 21st year of publishing Citron Research. In that time, this is ascompelling of an investment opportunity that we’ve come across. Thedevelopment community has spoken and we have listened.

With only 38% of revenue coming from North America and flush with IPO moneyto spend on sales and marketing, you just have to look at their hiring page to seethe company is about to hit a period of hyper growth.

In this report Citron initially had a list of everyone we believe could acquireDigitalOcean but we will save that for another time. Ironically enough, Shopify isat the top of the list. The reason we are not eager to include the analysis at thistime is because we believe this does not happen until the stock is at least $200.Until then…

Cautious Investing to AllThese reports have been prepared by either Citron Research (“Citron Research”) or Citron Capital, LLC (“CitronCapital”). Citron Research and Citron Capital are referred to collectively as “Citron” and each individually as a“Citron Entity.” Each report specifies the publisher and owner of that report. All reports are for informationalpurposes only and presented “as is” with no warranty of any kind, express or implied. Under no circumstancesshould any of these reports or any information herein be construed as investment advice, or as an offer to sell or thesolicitation of an offer to buy any securities or other financial instruments.Citron Research produces research reports on publicly traded securities, and Citron Capital is an exempt reportingadviser filed with the California Department of Business Oversight. The reports are the property of the applicableCitron Entity that published that report. The opinions, information and reports set forth herein are solelyattributable to the applicable Citron Entity and are not attributable to any Citron Related Person (defined below)(other than the Citron Entity that published the report).By downloading, accessing, or viewing any research report, you agree to the following Terms of Use. You agree thatuse of the research presented in any report is at your own risk. You (or any person you are acting as agent for) agreeto hold harmless Citron Research, Citron Capital and each of their affiliates and related parties, including, but notlimited to any principals, officers, directors, employees, members, clients, investors, consultants and agents(collectively, the “Citron Related Persons”) for any direct or indirect losses (including trading losses) attributable toany information in a research report. You further agree to do your own research and due diligence before makingany investment decision with respect to securities of the issuers covered herein (each, a “Covered Issuer”) or anyother financial instruments that reference the Covered Issuer or any securities issued by the Covered Issuer. Yourepresent that you have sufficient investment sophistication to critically assess the information, analysis andopinion presented in any Citron report. You further agree that you will not communicate the contents of reports andother materials made available by Citron to any other person unless that person has agreed to be bound by theseTerms of Use. If you access, download or receive the contents of Citron reports or other materials on your ownbehalf, you agree to and shall be bound by these Terms of Use. If you access, download or receive the contents ofCitron reports or other materials as an agent for any other person, you are binding your principal to these sameTerms of Use.As of the publication date of a Citron report, Citron Related Persons (possibly along with or through its members,partners, affiliates, employees, and/or consultants), Citron Related Persons clients and/or investors and/or theirclients and/or investors have a position (long or short) in one or more of the securities of a Covered Issuer (and/oroptions, swaps, and other derivatives related to one or more of these securities), and therefore may realizesignificant gains in the event that the prices of a Covered Issuer’s securities decline or appreciate. Citron Research,Citron Capital and/or the Citron Related Persons may continue to transact in Covered Issuers’ securities for anindefinite period after an initial report on a Covered Issuer, and such position(s) may be long, short, or neutral atany time hereafter regardless of their initial position(s) and views as stated in the Citron research. Neither Citron

Research nor Citron Capital will update any report or information to reflect changes in positions that may be held bya Citron Related Person.This is not an offer to sell or a solicitation of an offer to buy any security. Neither Citron Research nor any CitronRelated Person (including Citron Capital) are offering, selling or buying any security to or from any person throughany Citron research reports. Citron Research is affiliated with Citron Capital. Citron Capital is an exempt reportingadviser filed with the California Department of Business Oversight and is not registered as investment adviser in anyother jurisdiction. Citron Capital does not render investment advice to anyone unless it has an investmentadviser-client relationship with that person evidenced in writing. You understand and agree that Citron Capital doesnot have any investment advisory relationship with you or does not owe fiduciary duties to you. Giving investmentadvice requires knowledge of your financial situation, investment objectives, and risk tolerance, and Citron Capitalhas no such knowledge about you.The research and reports made available by Citron reflect express the opinion of the applicable Citron Entity as ofthe time of the report only. Reports are based on generally available information, field research, inferences anddeductions through the applicable Citron Entity’s due diligence and analytical process. To the best of the applicableCitron Entity’s ability and belief, all information contained herein is accurate and reliable, is not material non-publicinformation, and has been obtained from public sources that the applicable Citron Entity believe to be accurate andreliable, and who are not insiders or connected persons of the Covered Issuers or who may otherwise owe afiduciary duty, duty of confidentiality or any other duty to the Covered Issuer (directly or indirectly). However, suchinformation is presented “as is,” without warranty of any kind, whether express or implied. With respect to theirrespective research reports, Citron Research and Citron Capital makes no representation, express or implied, as tothe accuracy, timeliness, or completeness of any such information or with regard to the results to be obtained fromits use. Further, any research report contains a very large measure of analysis and opinion. All expressions ofopinion are subject to change without notice, and Citron does not undertake to update or supplement any reportsor any of the information, analysis and opinion contained in them.In no event shall Citron Research, Citron Capital or any Citron Related Persons be liable for any claims, losses, costsor damages of any kind, including direct, indirect, punitive, exemplary, incidental, special or, consequentialdamages, arising out of or in any way connected with any information presented in any Citron report. Thislimitation of liability applies regardless of any negligence or gross negligence of Citron Research, Citron Capital orany Citron Related Persons. You accept all risks in relying on the information presented in any report.You agree that the information in any Citron research report is copyrighted, and you therefore agree not todistribute this information in any manner without the express prior written consent of the applicable Citron Entity. Ifyou have obtained Citron research reports in any manner other than as provided by Citron, you may not read suchresearch without agreeing to these Terms of Use. You further agree that any dispute between you and Citron andtheir affiliates arising from or related to this report or viewing the material presented herein shall be governed bythe laws of the State of California, without regard to any conflict of law provisions. The failure of Citron Research orCitron Capital to exercise or enforce any right or provision of these Terms of Use shall not constitute a waiver of thisright or provision. You agree that each Citron Related Person is a third-party beneficiary to these Terms of Use. Ifany provision of these Terms of Use is found by a court of competent jurisdiction to be invalid, the partiesnevertheless agree that the court should endeavor to give effect to the parties’ intentions as reflected in theprovision and rule that the other provisions of these Terms of Use remain in full force and effect, in particular as tothis governing law and jurisdiction provision. You agree that regardless of any statute or law to the contrary, anyclaim or cause of action arising out of or related to Citron report or related material must be filed within one (1)year after the occurrence of the alleged harm that gave rise to such claim or cause of action, or such claim or causeof action be forever barred.