DocuSign Shares Crumble: What Happens When the Earnings Growth Slows
Over the past year-and-a-half since the onslaught of the global Covid-19 pandemic, we’ve seen the share prices of a variety of companies skyrocket at an alarming rate. Companies such as Zoom Media, Teledoc Health, Moderna, Novovax and host of others have all had astronomical appreciation in their common stock due to a variety of favorable Covid-19 conditions: Work-from-home, telemedicine or vaccination products that have vastly increase their sales revenues and bottom-line earnings over the period.
Another such company that has recently benefitted from the work-from-home surge has been electronic signature company DocuSign. Many of us have used their extremely convenient and secure software for signing documents instead of using ‘wet’ signatures. Based in San Francisco with almost 6000 employees, DocuSign provides cloud based software with e-signature solutions that enable businesses to digitally prepare, sign, act on and manage agreements.
Earlier this month, DocuSign reported their quarterly earnings that were absolutely phenomenal, and that in fact, many even ultra-high growth companies would envious of. Year-over-year (to end of October 31, 2021) sales revenue catapulted 42%. Although still not a profitable company in terms of annual earnings (and may not be for another couple years), DocuSign did manage to significantly improve its annual earnings per share figure with a loss of only $0.03/share vs the $0.31/share loss that the firm reported in the previous year period. This significant earnings growth has propelled the price of its common stock from $78 at the beginning of 2020 to almost $315 earlier this summer.
However, following this earnings report, DocuSign’s share price declined by a monstrous 42.2% in just one day, erasing almost $19.4 billion dollars of company market capitalization. It’s a truly rare and even remarkable share price collapse for a company the size of DocuSign to drop by almost 50% in one trading session. Furthermore, this huge freefall was on the heels of massive trading volume of over 90,000,000 shares (the previous 3-month average trading volume was just over 3,000,000 shares/day).
So how can a company as large as DocuSign which has been growing at such a fast clip recently see their share price crumble by almost half in just one day?
In the case of DocuSign, the precipitous free-fall in stock price has nothing to do with what the company recently reported, but rather on what the company is forecasting to earn going forward. Although there are a variety of ways to value the common stock of a company, the main ingredient is how company earnings are expected to grow in the future that determines share value. This is the reason why DocuSign shares got clobbered after their recent earnings report: its earnings are expected to decrease significantly from their pandemic figures.
The key metric with DocuSign in their recent earnings report that shocked investors was what is called future ‘billings’. This billings figure is essentially future revenue that has not been recognized as revenue yet but regardless is included in the quarterly earnings report. In other words, what the company ‘expects’ in revenue in the future. Back in September, DocuSign predicted these third quarter software billings would be in the range of $585 million to $597 million dollars. However, in their December 2 quarterly earnings statement, the company reporting billings (future quarterly revenue) of just $565 million, a significant decline. Although this figure grew at a 28% clip year-over-year, it was down significantly from the 48% growth reported in the previous quarter.
CEO Dan Springer even confirmed in his post-quarterly earnings commentary that company sales are indeed slowing. He mentioned that customers ‘accelerated’ demand during the global pandemic with stockpiling digital signature capacity, but that this consumption has now returned to more ‘normal’ levels. To his credit, Springer did mention earlier that the company’s Covid-era pop in its business growth would slow, but clearly this guidance did not include the deceleration in billings that was not expected to occur so quickly.
As a result, the value of DocuSign’s shares have essentially had to be ‘re-priced’ to account for this reduction in future growth. A relatively straight-forward model analysts use to account for this drop-off in growth is what’s called a ‘price/earnings multiple reduction’. DocuSign’s share value was hit by a ‘double-whammy’ of sorts: the market has to now re-value the common shares to account for not only the company’s current lower earnings but also for what many analysts believe is a significant reduction in the rate of earnings growth in the future.
This two-pronged effect can been explained in the company’s price/earnings (P/E) multiple. Previously, DocuSign’s higher rate of earnings growth had resulted in a higher P/E multiple that Wall Street assigned to the share price. A higher P/E multiple is given to companies to account for their higher rate of future growth. However, now that growth is expected to slow, this P/E multiple has been compressed and when multiplied by the lower current rate of earnings, results in a significantly reduced stock price.
As a result, Wall Street analysts have been forced to bring their future price targets of the company down significantly. Before their recently quarterly earnings debacle, the average share price estimate on Wall Street for DocuSign was well over $300/share. But given the lower future earnings expected, it was recently slashed to $231/share, a drop of close to 50%. Investment bank Morgan Stanley even assigned a price as low as $163/share, not significantly higher than the current price of $150/share.
Is the incredibly high period of growth for DocuSign now over? The market certainly does seem to think so. Given the over 2000% increase in daily trading volume the day after earnings, a newer, much lower share price range is certainly in the cards. Instead of pricing DocuSign as a hyper-growth company with earnings expected to growth over 40% annually, it appears the collective action of market participants is now expecting the company to grow more in the area of 25% into the foreseeable future.
Does this mean investors should steer clear of committing investment funds to DocuSign? Certainly not. Growth in e-signature is still in its infancy and expected to bloom over 200% the next 3 years to a $6.9 billion business. Sales outside of the US accounted for just 23% of total global sales in the 3rd quarter and the company just increased its relationship with Salesforce to help facilitate agreements all around the world. Domestically, e-signature usage is just beginning to tap the area of government contracts.
DocuSign’s recent share plunge demonstrates how quickly business conditions can change for a company riding the coattails of a extraneous event (like the Covid-19 pandemic). Furthermore, it shows what happens when the market can price a company previously described a ‘high-growth’ to just ‘growth’. Although still the market leader in an area still in its infancy, DocuSign can be a great long-term company to hold, particularly with its potential growth outside of the US and in the new areas (government contracts in particular). However, investors expecting a 300% increase in share price that occurred over the one-and-a-half year period to mid-year 2021 will be badly disappointed.