DocuSign (DOCU) Q2 Recap

DocuSign announced Q2 FY2021 earnings on September 3rd. The results were strong, with large beats on both revenue and EPS. Additionally, they raised Q3 and full year revenue estimates by a wide margin. In spite of this, DOCU stock dropped about 11% the next day, as the market was likely hoping for an even larger beat following a spectacular earnings report from ZM. On the earnings call, the leadership team spoke to the significant opportunity for DocuSign beyond eSignature, highlighting international business growth, future customer expansion into the full suite of contract lifecycle management products and the upcoming roll-out of notary services. In this blog post, I review DocuSign’s Q2 earnings, customer wins and other business updates that occurred during the quarter. I also analyze product enhancements, acquisition updates and the competitive landscape. For additional information on the DocuSign investment thesis, interested investors can read my past quarterly updates and original deep-dive.

Headline Financial Results

• Q2 FY2021 Revenue was $342.2M, up 45% year/year. This compares to the consensus estimate for $318.5M, which would have represented growth of about 35%. Q1 Revenue growth was 39%, so Q2 represented a nice acceleration.
• Q2 Non-GAAP EPS was $0.17 vs. $0.07 expected, representing a beat of $0.10. This compares to $0.01 in Q2 FY2020. Q1 EPS was $0.12. Non-GAAP net income was $35 million in the second quarter, compared with $2 million in the second quarter of last year.
• Q2 Non-GAAP operating income was $33.7M, representing an operating margin of 9.8%. This compares to an operating loss of $0.6M, for an operating margin of -0.2%, in the prior year. Q1 operating margin was 8%.
• Q2 FCF was $99.8M for a FCF margin of 29.2%. This compares to FCF of $11.9M in Q2 FY2020 for a FCF margin of 5.0%. In Q1 , FCF margin was 11%.

• Q3 Revenue estimate of $358-362M, representing growth of 44.3% year/year at the midpoint. This compares to the consensus revenue estimate of $335.1M, for 34.3% growth. This represents a raise of about 10% as compared to the next quarter raise of about 7% in Q1’s report.
• Q3 Non-GAAP estimated operating margin range of about 5-9%.
• FY2021 Revenue guidance of $1.384-1.388B, representing growth of 42.3% at the midpoint. This compares to the consensus revenue estimate of $1.316B for 35% growth. This represents a raise of about 7% on annualized revenue. This raise is on top of the 6% raise in Q1.
• FY2021 Non-GAAP operating margin guidance of 6-10%.
• Ended the quarter with cash, cash equivalents, restricted cash and investments of $740.6M.

Other Performance Indicators

• Q2 billings were $405.7M, up 61% year/year. This compares to the consensus billings target by analysts of $340M, for 35% growth, and the company’s own estimate in Q1’s report for $338M at the midpoint. This represent a pretty significant beat of 26%. In Q1, billings grew 59% year/year, so billings growth accelerated slightly. Billings is a useful measure for providing insight into future revenue streams.
• Q3 billings guidance is $380-390M, which would represent annualized growth of 43% at the midpoint over Q3 FY2020 billings of $269.4M. While on the surface, this appears to represent a deceleration, we should keep in mind that it is higher than the 35% estimate for Q2 and we can expect a beat (maybe not to Q2’s 26% magnitude, but only 18% beat is needed to match Q2). Also, on the earnings call, the CFO stated that “We guide what we can see. We don’t guess.”, which implies that billings projections are more influenced by what has been booked quarter to date versus what is anticipated.

• Subscription revenue was $323.6M, up 47% year/year. Professional services makes up the other $18.6M in revenue and didn’t grow as quickly as subscription revenue (which is fine).
• Non-GAAP gross margin of 78%. This is inline with the rate from a year ago. Q1 gross margin was 79%. The full year target is 78-80% gross margin. In the earning call, the CFO mentioned “Margins were impacted by our Seal acquisition, as well as by investments we made in our data center capacity, particularly for hosted services, to ensure our ability to meet significantly higher transaction volumes. ”
• Breaking down Q2 Non-GAAP expenses by category, we see nice year/year reductions in relative percentage of S&M and G&A. R&D spend was roughly inline.
  • S&M = 45% (versus 51% in Q2 FY2020)
  • R&D = 14% (versus 15% in Q2 FY2020)
  • G&A = 9% (versus 13% in Q2 FY2020)
• Ended the quarter with 5,008 employees, an increase of 44% over Q2 of last year. This is encouraging, as some software companies slowed down hiring during after COVID-19 hit. The management team also clarified that “a substantial amount” of the hiring growth was in their go-to-market organization.

Customer Activity

• Total customer count increased to 749K at the end of Q2, representing 39% annualized growth and 13.3% sequential growth. This compares to 661K total customers in Q1, with 30% annualized growth and 12.2% sequential growth.
• DocuSign has added more total customers in the first half of this year, than they added in all of last year. They added 88k new customers in Q2 and 68k in Q1, as compared to 27k a quarter on average for the prior year.
• Enterprise and Commercial customers (which represents those with over 10 employees and landed outside of the self-serve channel) grew by 10k to 99k total for 55% annualized growth and 11% sequentially. In Q1, DocuSign added 14k customers of this size, for 48% annualized and 19% sequential growth.
• DocuSign has added more large customers thus far in 2020 than in all of 2019 so far as well.

On the earnings call, DocuSign’s CEO talked about how the heightened demand trends that emerged in Q1 continued through Q2. These have primarily been focused on the core eSignature product offering. Growth has been driven by both customer adds and expansions of existing customers into new use cases, departments and countries.

• Q2 DNER ticked up to 120%, driven by strong eSignature expansions and upsells. DNER was 119% in Q1 and 117% for the two quarters prior, and 113% in Q2 FY2020. The combination of strong customer adds and DNER should drive high sustained revenue growth. On the earnings call, the CFO stated that he expects DNER to remain at this higher level.
• Customers with ACV greater than $300K grew 41% year/year to a total of 520 customers. This compares to Q1 with 473 of these customers and 46% growth.

While eSignature still remains the primary product sale, DocuSign’s leadership team expects gradual expansion into the Agreement Cloud suite as well. This prioritization by customers makes sense, as the COVID-19 situation would elevate enabling digital signatures to an immediate priority for many enterprises. The DocuSign sales team was happy to accommodate, streamlining customer on-boarding for eSignature. At the same time, they set the stage for future engagement around the broader contract lifecycle management opportunity.

And if we look at our growth, it’s been more significant in the traditional aspects of our business than any other part. And we’re very clear when we go to our field, we say that you have to — when you talk to customers and you talk to prospects, you start off every conversation with DocuSign’s Agreement Cloud company, let me tell you how we’re going to help you prepare, sign, act on and manage your agreement. And if that individual says to you, “Yes, I’d like to buy some eSignature to get started right now,” the only appropriate answer is, “Yes, sir” or “Yes, ma’am. I’m happy to sell you some eSignature.” And that’s what we’re going to continue to do through this period of time.

We want to really support what the customers are needing. But at the same time, as I mentioned upfront, we’re seeing a lot of people saying the concept of the Agreement Cloud is really something they’re embracing. And they’re saying, “We’d love to figure out a way to broaden the relationship with DocuSign.” We believe that things like DocuSign CLM, which is with the SpringCM product that we’ve turned it into here, will continue to be strong. We see a lot of demand.

We’re building a lot of pipe for it. And the customers that we’re bringing in right now, those 88,000 new customers, many of those will be prospects for CLM in the future, but we believe that the sales cycle there will always be a little bit longer. They’re more complex. Usually, there’s a services component. Right? So it has to be a statement of work calculated and done. And a lot of times, I think we’re seeing CIOs and CFOs that are our customers today are saying, “I want to do that. But right now, I need to get these signature pieces enabled. Let’s do that now.” And as we get later into the year and more settled and settled down in their company is where I think we’ll see increased demand and pull-through of those other components.

DocuSign Q2 FY2021 Earnings Call

Management further clarified that they expect these expansion opportunities to take hold in the second half of 2021, as new customers added this year pass their one year anniversary. After about 12 months, customers typically experience proven ROI on eSignature and are open to an engagement review. At that point, they think customers will be ready for discussions to expand eSignature to more use cases and begin Agreement Cloud adoption planning for the mid-market and enterprise customers.

This expansion motion was highlighted in some of Q2’s customer wins and upsells.

• DocuSign’s largest retail customer runs a network of healthcare clinics. When COVID-19 hit, the company accelerated plans to provide telehealth services using DocuSign eSignature to handle consent and other paperwork remotely. This is a great example of COVID-accelerated demand that they see as lasting. While telehealth services will remain after COVID-19, these digital processes will likely get applied to in-person clinic visits as well to replace paper forms and clipboards. This is because the efficiency gain and better user experience was made clear during remote visits. 
• Another example is from a large financial institution that has been a longtime DocuSign customer. The company already used eSignature. When COVID-19 hit, they accelerated their plans for further rollouts. DocuSign helped them activate 11 new lines of business for digital signature. This illustrates a pattern where established customers bring eSignature to new divisions, departments, and regions.
• Finally, DocuSign leadership provided a few examples from the public sector. To date, they have held a strong competitive position at the local, state, and federal levels here in the United States. This quarter, they built on that basis with a healthy mix of eSignature and multi-product Agreement Cloud deals, including DocuSign CLM and Identity. They helped a major city deploy a digitized workflow to handle applications for housing assistance. They also enabled a federal agency to capture applications and distribute relief funds to healthcare providers on the front lines of coronavirus response. 

Economic headwinds did cause some customers to request relief in certain sectors. That was more than offset by the increased demand overall. As the COVID-19 situation clears, we could expect these sectors to recover.

International

For a company as large as DocuSign, international business makes up a small percentage. In Q2, revenue from sources outside the U.S. ticked up from 18% to 19% of total revenue. From the CEO’s perspective, this is too small. He discussed this opportunity at a couple of analyst events in September, including the D.A. Davidson Software Conference and the Jefferies Software Conference. The CEO views international as DocuSign’s largest untapped growth opportunity.

This view makes sense, as international revenue grew by 59% in Q2 to $67M (versus $342M of total revenue). This represents an acceleration from Q1’s growth of 46% for $55M. The sequential growth of $12M or 22% is particularly impressive. Interestingly, on the Jefferies call, the CEO discussed how the majority of the international growth came from Europe. This is where leadership focused their preliminary efforts to expand international. This implies that actual annualized growth in Europe was higher than the 59% for all of international.

A lot of that success is being attributed to DocuSign’s CFO, Mike Sheridan. According to the CEO, Sheridan saw an opportunity to grow the international business and has been spearheading a trial effort in Europe since the beginning of the year in an informal “GM of Europe” role. Given the success of this exercise in Europe, Sheridan is being promoted to President of International. His CFO role is being back-filled by board member Cynthia Gaylor, previously CFO at Pivotal and former leader of corporate development at Twitter.

With Sheridan leading all international efforts, the plan is to duplicate the process improvements he instituted in Europe. These were primarily around creating efficiencies in operations and facilitating coordination between go-to-market teams. Also, they are optimizing digital channels to bring in more self-service customers and re-aligning the sales team to focus on larger direct customer sales.

These initial organization and process improvement tactics are the first step. As part of his new role, Sheridan will review the full portfolio of countries and assess where new or incremental opportunities exist. Finally, the CEO thinks the international team could eventually be structured into business units along regional lines, each with their own aggressive growth targets and autonomy to achieve them.

Part of the explanation for DocuSign’s lower international revenue mix is driven by the varied legal requirements by country. These are primarily grouped into common law countries and civil law. The common law countries are generally the historical descendants of Great Britain and follow a standard set of expectations for validating an agreement. These are the U.S., Canada, the UK, Ireland, Australia and New Zealand. The civil law countries have different expectations, which can vary by country. For DocuSign currently, these are Germany, France, Brazil and Japan. This difference makes the roll-out of civil law solutions more methodical, based on how easily the core DocuSign product suite can be modified to meet each country’s requirements. DocuSign leadership is confident that the platform now provides the flexibility to address these variances efficiently.

Along these lines, international expansion will be a dual-pronged effort. First, DocuSign will better organize the go-to-market team and refine sales processes in the common law countries. These should drive quicker wins. For civil law countries, they need to assess the suitability of the product for each and compare to the opportunity. On the Davidson call, the CEO discussed how they would focus direct sales efforts on their “core 8” markets initially, and then branch out into other countries. The core 8 are the U.S., Canada, Brazil, Germany, France, UK, Australia/New Zealand and Japan.

The DocuSign leadership team thinks the international business could eventually be as large as the domestic. On the earnings call, the CEO commented “it’s similar to what DocuSign was about five years ago when I joined DocuSign. At that time, DocuSign was also a very rapidly growing organization.” This growth will be important for investors to monitor going forward, as accelerated revenue growth internationally will help offset any future deceleration in domestic business, as the COVID-19 surge normalizes.

Government

DocuSign has been enhancing its product capabilities and go-to-market focus to enable the transformation of government processes to their digital equivalent. By DocuSign’s estimates, government agencies spend almost $39B supporting paper-based, manual processes to provide services to citizens and workflows for their employees. Imagine if all of these processes could be digitized.

To address this, DocuSign built a dedicated Agreement Cloud for Government. This is physically separate from the hosting of the private sector Agreement Cloud. This cloud environment runs on dedicated servers that only house government data, including access keys and agreement envelopes. This high-security environment is meant to minimize risks by segregating government data from private sector and consumer data. DocuSign has achieved DoD IL4 certification and FedRAMP authorization at the Moderate level (Adobe Sign is at the lower Li-SaaS level). Its services are available to government agencies as listed on the FedRAMP Marketplace.

DocuSign already has thousands of local, state, federal, and international public sector organizations as customers. Examples include Covered California for on-boarding insurance brokers, the state of North Carolina for citizen services, Nashville public schools, the City of San Francisco and numerous federal agencies. Some federal agency customers are the Department of Education, Health and Human Services, Energy, Federal Student Aid, GSA and Medicare & Medicaid Services.

Analyst Reactions

Following DocuSign’s Q2 earnings results, 13 analysts provided updated coverage ratings. Of these updated ratings, all but one analyst raised their price targets. Five analysts kept a Buy rating and 7 have a Hold equivalent. Most analysts without an outperform bias commented that the quarter was strong, but expressed concern over valuation after the stock had more than tripled for the year prior to earnings. The average price target for these updates is $258, representing a 19% increase from the closing price after earnings of nearly $216 on September 4th.

Date	Analyst	Rating	Price Target
9/2	Oppenheimer	Outperform	Raised from $200 to $300
9/4	Deutsche Bank	Buy to Hold	Set at $225
9/4	JMP Securities	Outperform	Raised from $233 to $261
9/4	Morgan Stanley	Equal Weight	Raised from $187 to $260
9/4	Wedbush	Outperform	Raised from $240 to $270
9/4	JPMorgan	Overweight	Raised from $150 to $271
9/4	Evercore	Inline	Raised from $210 to $250
9/4	RBC	Outperform	Raised from $230 to $275
9/4	Piper Sandler	Neutral	Raised from $140 to $235
9/4	Goldman Sachs	Neutral	Raised from $200 to $229
9/4	DA Davidson		Raised from $161 to $270
9/4	Wells Fargo	Equal Weight	Raised from $180 to $210
9/4	BofA	Neutral	Raised from $165 to $300

Following the earnings report, RBC issued the highest price target of $275. Analyst Alex Zukin provided the following commentary.

RBC Capital analyst Alex Zukin raised the firm’s price target on DocuSign to $275 from $230 and keeps an Outperform rating on the shares. The company’s Q2 earnings results were “very strong” with a beat on billings of over 20%, the analyst tells investors in a research note. Zukin adds that the quarter affirms the bullish thesis of his prior “Work 2.0 report”, suggesting that two-thirds of survey respondents indicated that eSignature technologies were critical to their day-to-day jobs.

TheFly.com, September 4, 2020

Deutsche Bank was less optimistic for the near term and downgraded DocuSign to Hold based on valuation concerns.

Deutsche Bank analyst Taylor McGinnis downgraded DocuSign to Hold from Buy with a $225 price target following the company’s Q2 results. The analyst sees no growth slowdown “in sight,” but believes this dynamic is already reflected in the shares at current valuation levels.

Thefly.com, September 4, 2020

Product Development Activity

The DocuSign product and engineering teams were busy during the last several months. They are executing along two vectors. The first is absorbing recent acquisitions into their core platform, which by itself delivers significant incremental capabilities. The second is continued extension of features to meet new customer use cases. I’ll review the past acquisitions first and then highlight new product feature additions.

In July 2018, DocuSign announced the acquisition of Spring CM, which helps companies generate, automate, manage and store documents in their secure cloud. Customers can use their tools to create documents from pre-approved templates and populate them with data imported from outside systems. Then, they can automate the distribution and approval of these documents. Once documents are received, Spring CM tools facilitate red-lining and negotiation. Finally, after the documents are signed, they provide a central repository for document storage and retrieval.

All of these tools formed the foundation for DocuSign to extend its functionality beyond electronic signature into a new category called Contract Lifecycle Management (CLM). According to Gartner, CLM enables enterprises to automate the process of authoring, negotiating, approving and storing business contracts. It also facilitates contract compliance by making executed contracts easy to search, track and monitor over time for changes to terms.

The term “contract life cycle management” refers to applications used for managing contracts from initiation through ongoing management and eventual renewal or termination. CLM solutions manage any legal documents containing obligations that affect an organization.

Gartner, Feb 2020

This led to the launch of the Agreement Cloud in March 2019. This was an enormous release. It formally expanded the DocuSign offering from just eSignature to the full agreement lifecycle. DocuSign segments the agreement lifecycle into four steps, with groups of product offerings under each – Prepare, Sign, Act and Manage. The release also included three new product offerings – DocuSign Gen, Click and ID Verification. To align it with the broader ecosystem of enterprise tooling, the Agreement Cloud release included the hundreds of integrations with other enterprise systems.

The diagram below illustrates the various steps that are part of the full lifecycle of a typical contract. As you can see, signature is just one step in this process. The Agreement Cloud automates all of these steps.

This broader platform of tooling to address every step in managing agreements is important for investors to consider. This illustrates why DocuSign is not “just an e-signature company” and represents an important competitive advantage. While the majority of new business starts with e-signature, mid-market and enterprise customers eventually broaden their adoption of DocuSign products to include more and more of these tools to automate the full lifecycle of agreements.

Competitors who focus only on the signature step might appeal to SMBs that just need to move document signing online. However, they don’t address the broader opportunity. CXOs at large companies will value knowing that these additional capabilities are available to them after adopting e-signature and will select DocuSign in competitive consideration for this reason. This ensures DocuSign will continue to win business for these more lucrative enterprise deals.

To further bolster their capabilities in the Manage step, in Feb 2020, DocuSign announced the acquisition of Seal Software. The Seal platform uses AI/ML to add intelligence, automation and visualization capabilities to enhance the contract management process. Technologies from Seal have been incorporated into the DocuSign platform to power the Intelligent Insights product offering.

For agreement search and location across multiple document storage tools, DocuSign offers its Total Search feature. Document locations can span multiple DocuSign eSignature accounts within an enterprise as well as external document storage resources, like Box, Dropbox and Sharepoint. Document search goes to the full text level, making it easy to find a past agreement using a couple of keywords.

Total Search can also index scanned documents using OCR technology. Search queries can utilize keywords, phrases, wildcard characters, proximity matching, boolean logic, etc. Indexed content includes both the full text of the agreement and its metadata, like execution date, location, parties, etc. The indexing process applies search best practices, like de-duplication, grouping, stemming and synonyms.

The Intelligent Insights product layers AI capabilities over agreements to automate the monitoring of terms and conditions over time. This replaces the manual, scheduled review process often employed by sales and legal departments to check contract status. Intelligent Insights allows for modeling and categorization of individual clauses within agreements, like renewals or SLAs, as discrete data elements with measurable values. This way, teams can generate conditional triggers to flag compliance issues, send events to outside systems or surface upsell opportunities.

Comparable clauses between agreements can be displayed side-by-side for review. This can highlight inconsistencies in older agreements that need to be updated. Finally, data gleaned from agreements can be categorized into relevant business concepts and then visualized into useful summaries. These technologies provide the basis for future capabilities around smart contracts and observable agreements.

As part of the Agreement Cloud 2020 Release 2 on July 6, Intelligent Insights was formally integrated into the Agreement Cloud platform. In addition, DocuSign introduced Insight Accelerators. These are add-on modules that use pre-built AI models to target specific use cases, like Brexit, data privacy and LIBOR.  They also have a Catastrophic Event Accelerator that can help locate Force Majeure clauses. Here are some examples of Accelerators:

• Catastrophic Events (including pandemics)
• Procurement
• Mergers and Acquisitions (M&A)
• Data Privacy (GDPR, CCPA, data security)
• LIBOR, QFCs & Credit Agreements
• Non-Disclosure Agreements (NDAs)
• Brexit

As you can see, the two acquisitions of Spring CM and Seal Software added substantial new capabilities to the DocuSign Agreement Cloud and significantly evolved DocuSign’s product offering beyond digital signature execution. In addition to absorbing these two acquisitions, DocuSign made a number of other improvements to the product suite over the course of the quarter:

• Added more functionality to DocuSign Gen for Salesforce to support complex quote generation.  The core feature allows salespeople to generate a simple quote for customers within Salesforce. This agreement can then be distributed to customers for digital signature, which is managed behind the scenes by the DocuSign system. The new functionality supports customized tables and formatting. It also includes the ability to create quotes for multi-year subscriptions, automatically formatting currency based on the user’s locale and insertion of documents into a quote, based on Salesforce business rules. 
• Added Workflow Templates to the Agreement Cloud. These templates allow users to configure common agreement workflows and activities, like approvals, red-lining, signature placement and routing.  For agreements that share these common workflows, the user is saved from recreating them on each agreement generation.
• Improvements to ID Verification, which allows users to automatically verify a signer’s government issued ID.  In this new release, senders have the option to manually verify the user’s identity, if the automated process fails.  Also, signers can be allowed to verify their identity only once when signing multiple documents, without having to re-submit their ID for each. 
• Built a new integration with Workplace from Facebook. This new integration allows Workplace users to quickly access DocuSign eSignature within the Workplace interface. A DocuSign chatbot built into Workplace provides the ability to access a standard document sending workflow, generate documents that require signature and distribute them to signers. The signers are notified within Workplace and prompted to enter the eSignature flow to sign the documents. Once executed, the sender receives confirmation that the signature process is complete. This integration is very useful for enterprises using Workplace internally. As an example, a new employee document agreement process from HR could be automated in this way.  
• Redesigned the DocuSign mobile app for IoS and Android. The team focused on ease-of-use to give new app gives users all of the same tools and features, but improving the overall experience to enable seamless signing and sending of documents from a mobile device. The app supports the primary steps in generating an agreement and getting approvals. These include uploading a document, leveraging a template, adding tags, assigning signers and customizing your own signature.

DocuSign Analyzer

On September 30, DocuSign announced a new product offering called Analyzer. This builds on the advanced ML/AI capabilities gained through the Seal Software acquisition. Analyzer focuses on the pre-execution phase of agreements. It streamlines the analysis and negotiation of new agreements when a company first receives them. This product is an extension of DocuSign Insight, which allows companies to search, analyze and understand the agreements they already have.

DocuSign Analyzer offers the following core capabilities:

• AI-based clause analysis for incoming agreements. Analyzer’s purpose-built contract AI capabilities break agreements down into their core components, delivering an interactive list of clauses for fast, easy review and analysis of agreements based on the legal concepts they contain.
• Risk scoring of contract content to guide faster action. Analyzer provides shareable, easy-to-understand “red-yellow-green” scorecards calling out terms of interest, based on the organization’s legal and business policies. Teams can configure multiple scorecards to address a range of use cases.
• Analyzer can deliver its functionality via a Microsoft Word sidebar, enabling teams to easily review and edit agreements without leaving Word. Analyzer is also compatible with Word Online for cloud-based review.
• Analyzer makes it easy to edit existing contract text with pre-approved language from an organization’s legal team. Clicking in the sidebar adds recommended primary or fallback language from the clause library to the agreement text.
• Workflow and routing integration with DocuSign CLM. Analyzer both enhances and benefits from the robust workflows of DocuSign CLM, enabling intelligent routing to the right stakeholders based on risk analysis. Key Analyzer functionality can also be accessed directly within the CLM document preview.

DocuSign Analyzer was in a private beta with a set of existing customers prior to this release. Beta customers reported “saving thousands of dollars per agreement” due to efficiencies in document review, red-lining and negotiation. Over many agreements processed by a large enterprise, this tool could drive substantial savings, in addition to risk mitigation and better customer experience.

One of those beta customers was UnitedLex, a technology and legal services company. Their EVP provided the following testimonial.

Technology and legal services company UnitedLex has seen the value Analyzer brings to legal teams firsthand. According to EVP of Corporate & Commercial Services Dan Hendy, DocuSign Analyzer is helping with smarter execution and more cost-effective outcomes in its own contracting process.

“As a major collaborator on the industry’s largest deployment of AI within pre-signature commercial contracting, we’re leveraging Analyzer across a team of 250+ global transactional attorneys,” explains Hendy. “We’re seeing the impact that integrated AI tools can deliver: reducing human review time and ensuring consistency of response, all while mitigating risk. This optimizes the contract negotiation process and means legal departments can deliver an even better service to their business.”

Docusign Analyzer, Press release, Sept 2020

Following the beta testing period, DocuSign Analyzer is now available as a formal product release in the US, UK, Canada and Germany. It is currently an extension of the DocuSign Insight product. Later in 2020, DocuSign will offer it through bundled pricing with DocuSign CLM as well. 

This represents an exciting addition for DocuSign, which further extends the capabilities of the Agreement Cloud and full lifecycle of contract management. It underscores the competitive advantage that DocuSign is accumulating through a deep build-out of capabilities around agreement management and analysis. These are time-consuming processes that legal, procurement and sales departments in large enterprise customers allocate substantial resources to address through mostly manual, non-automated review. By making this process more efficient, DocuSign is creating significant value for enterprises. This goes far beyond facilitating digital signatures.

Liveoak Acquisition

In addition to the Spring CM and Seal Software acquisitions in the past, DocuSign announced the acquisition of Liveoak Technologies in July for $38M in stock. The Austin-based start-up facilitates remote online notary and other assisted agreement types. Their platform leverages web-based videoconferencing, rich collaboration features, identity verification and other tools to help complete an auditable transaction remotely. Primarily, this enables remote notary-verified agreements. DocuSign previously had a solution to support notarized digital agreements through its eNotary offering, but it still required visual proximity. Liveoak’s solution enables a fully remote agreement process that meets the stringent legal requirements for notarization.

DocuSign had a working integration in place with Liveoak’s platform prior to the acquisition, so minimal incremental development work is required to enable this capability as part of the Agreement Cloud. This will be launched as a new product called DocuSign Notary with its own pricing structure. It will focus on remote online notarization (RON)—where audio-visual technology is used to complete a notarial act when the signers and the notary public are in different places. The product is already in private beta, with plans to offer an open beta in a couple of months.

In the D.A. Davidson Software Conference, DocuSign’s CEO mentioned that he expects “meaningful volume” from the new product to hit in Q1 2021. This product launch has the advantage that Liveoak has a set of existing customers, including some of the world’s largest financial institutions. Similarly, several DocuSign enterprise customers were immediately interested in this new product once announced and are already participating in the private beta.

The first phase of RON will be for “first-party” notarized transactions. This is the case where the enterprise customer employees the notary and simply needs to bring that person online in order to execute the transaction. This phase is easier to spin up, as the customer is providing and authorizing the notary. DocuSign’s CEO estimates that this first-party business has about a $1B TAM and that he expect DocuSign to capture a large share of it.

After launching first-party transactions, DocuSign would expand to third-party notary agreements. This market is much larger, but would be more involved logistically, as DocuSign would need to line up a stable of notaries by state and verify them. These could then be made available for any organization or consumer that needs a document notarized, similar to the process one might use at a local FedEx or UPS office. The CEO expects to have this available for roll-out in the second-half of 2021.

On the earnings call, DocuSign leadership used the example of a large bank, like Bank of America, which is a DocuSign customer. Account openings often require a notarized signature for certain types of transactions. With branches closed, banks need to consider how to facilitate the notary process remotely. They already have account managers who are public notaries, but they can’t meet in person. The first-person notary product would plug right into that demand.

Even in a post-COVID world, DocuSign leadership contends that banks could offer this service as a competitive advantage. Customers wouldn’t need to travel to a branch to open an account. That process could be handled remotely from the branch or even a call center. This would also appeal to newer online banking services that are moving away from maintaining expensive physical branches. Finally, DocuSign leadership believes this capability would appeal to customers in other sectors, like health care or telecom, where a higher level of legal agreement has been desired, but hasn’t been easy to facilitate with the overhead of notarization.

DocuSign leadership believes that DocuSign Notary will do for notarization what eSignature did for signing. It will enable a dramatically better experience for everyone involved from wherever they may be. They view this as a natural extension of their eSignature business. Like with digital signatures, once customers and end consumers use remote online notarization, they don’t expect them to return to the legacy process.

While a total TAM of $1B for first-party notary services is smaller than DocuSign’s current annual run rate of about $1.4B, if DocuSign can rapidly roll out the service to existing enterprise customers and capture a large share, it could become a meaningful revenue contributor in 2021 and beyond. The larger opportunity of third-party notary services would of course add to this over the next 2-5 years.

Competitive Activity

DocuSign broadly defines their addressable market as transforming the “foundational element of business – the agreement.” While this leaves a lot of room for interpretation, I think it is a fair characterization. DocuSign’s opportunity goes far beyond the replacement of paper-based signatures. If this were the investment thesis, the opportunity would be mediocre. However, DocuSign’s Agreement Cloud is addressing a large swath of opportunities, essentially covering any use case that requires contractual agreement or consent between two parties. They can fairly argue that most functions of business are based on that foundation.

DocuSign took a first pass at estimating the total addressable market in their S-1, published in March, 2018. They initially sized the market at $25B. As part of the DocuSign Agreement Cloud announcement in March 2019, they doubled their estimate of the TAM to $50B, based on the expansion of their product offering and integration with other system of record applications like Salesforce and SAP. The CEO reiterated this estimate at a recent analyst event, sizing eSignature at $25B and all the tooling around contract lifecycle management at another $25B.

The CEO acknowledged that eSignature represented the majority of DocuSign’s revenue at this point, but that CLM would steadily grow and eventually catch up. Given that DocuSign’s revenue estimate for this year is about $1.4B, they would represent about 3% share of this expanded TAM.

Complete Solution

This separation of TAM into eSignature and CLM also underscores what I think is DocuSign’s advantage relative to competitive solutions. The comprehensive nature of its Agreement Cloud platform is really important. DocuSign is building a suite of capabilities to facilitate the full process of agreement preparation, negotiation, orchestration, risk management and compliance monitoring. This is the enterprise play, that goes far beyond electronic signature. While it is true that many individuals and SMB’s likely just need a digital signature product, I think DocuSign is wisely positioning themselves for enterprise spend, which arguably is the larger opportunity.

This is why investor comparisons to competitive offerings need to be passed through the lens of the target customer. I agree that for the simple use case of digitally affixing a signature to a static document, many alternatives exist to DocuSign eSignature. A small team of devs could probably duplicate this functionality in a few weeks. However, for any business processing hundreds or thousands of such contracts, a one dimensional electronic signature solution quickly becomes limiting.

This is illustrated if we consider the buying decision for the CIO/CTO at a large company, like a financial institution, manufacturer, retailer or health care provider. Let’s assume they need to move their paper-based processes for managing contracts into a digitally enabled workflow. While electronic signature would be on their checklist, they would also be interested in other aspects of a vendor’s full offering that allow their organization to efficiently manage all the steps in executing and managing an agreement.

• How does the agreement get prepared? Are tools available to facilitate seamless workflows for contract assembly, negotiation with multiple parties and internal approvals through hierarchical levels?
• Are agreement generation steps and workflows deeply integrated with the business systems that other departments use, like CRM, HRM, procurement, etc?
• Can developers easily incorporate agreement workflows into the company’s online applications through complete and well-documented APIs?
• Does the vendor’s system have the ability break down the agreement into its contextually relevant clauses and conditions, with associated numerical values?
• Can triggers be set to monitor these values against external inputs (renewal dates, SLAs, interest rates, etc.)?
• Can the system ingest new third-party contracts that require review, break them down in component clauses, compare those to accepted terms and highlight areas of risk, all in a fully automated process?
• Once the agreement is signed, is it placed in a storage repository that is highly available and secure?
• Can a user easily search all agreements for specific terms, numerical values, conditionals, tags, or other meta-data? This should go far beyond simple text based search.
• If some types of documents need to be notarized, does the same system facilitate notary as an integrated step in the process, where successful notarization is automatically updated in the workflow?
• If my agreement requires collection of payment or transfer of funds, can the system integrate with a payment processor and include payment receipt as part of the approval workflow?
• Once the agreement is executed, can the system programmatically trigger actions in other external systems, like fulfillment or manufacturing?

DocuSign is the only solution on the market that can address all of the use cases above. I think this is critical to appreciate the larger opportunity, particularly within the enterprise and even mid-market space. Digital signature is just one small step in the overall workflow. Providing automation and intelligence for processing agreements for an enterprise that generates thousands or millions of them a year will become a real driver of operational efficiency.

In addition, all of these capabilities are available both through a user interface and programmatic APIs. The DocuSign CEO often cites a metric that over 60% of all interactions with the DocuSign system are executed through an API interface, not a UI. The fact that this is so high is a testament to the completeness and quality of DocuSign’s API offering and appeal to developers. To date, developers have created over 100k sandboxes on the platform and DocuSign completed a major update to their Developer Center in May, which made the experience even better. DocuSign claims that thousands of businesses have integrated with their agreement platform through APIs, including T-Mobile, loanDepot and Alameda County, CA.

Procore Technologies provides a great example of API integration . They are a provider of SaaS applications for the construction industry, which allows customers to manage all aspects of a construction project. One important part of the platform is a customer hub for processing service contracts, change orders and purchase orders. All of these need a legal agreement between the parties, as they involve financial commitments. Procore was able to use the DocuSign APIs to embed electronic signature functionality within their application. This allowed Procore’s construction project managers to quickly create, annotate and distribute these agreements for signature from sub-contractors. For each agreement, the project manager can track progress with a helpful status bar that turns green when all parties have reviewed and signed the contract.

Complete tooling for all steps in the agreement lifecycle and a programmable API to enable third-party integrations provide a deep moat and competitive advantage for DocuSign in attracting enterprise customers. While SMB will be a level playing field for electronic signature focused competitors, the mid-sized and enterprise markets will generate the majority of spend.

And DocuSign’s lead will only increase from here, as a consequence of their size and focus. Their R&D spend will exceed $200M this year, all focused on the agreement lifecycle. They are continuing to refine and expand their product suite, both through aggressive internal development and thoughtful acquisitions. This focus on a single enabling technology with a huge TAM will provide DocuSign with a long tail of growth for years.

Industry Analysts

Objectively analyzing the competitive landscape, we have a couple of data points from industry analysts. In terms of DocuSign’s full Agreement Cloud offering, Gartner defines this as the Contract Lifecycle Management (CLM) market. The Gartner Magic Quadrant for CLM from Feb 2020 puts DocuSign in the Leaders category, validating the position of the Agreement Cloud. Their two largest eSignature competitors (Adobe and Dropbox) weren’t even included in this category. This underscores the competitive advantage that DocuSign enjoys with large enterprise customers, as CXOs in those organizations would like to know they could tap into broader agreement management capabilities after digital signature adoption.

The other two companies in the leader’s quadrant, Agiloft and Icertis, are privately held and don’t seem to be expanding their market share.  In my full analysis of DocuSign, I identified the two publicly traded competitors to monitor as Adobe and Dropbox. Each had entered the e-signature market by acquiring a competitor to DocuSign.

The DocuSign CEO has discussed on past analyst calls his perspective on the competitive market. He cites Adobe Sign and Dropbox as the other two with meaningful penetration in electronic signature. He contends that DocuSign is 6-7x the size of Adobe Sign and that Adobe Sign is another 6-7x bigger than Dropbox. He doesn’t dismiss Adobe. He just points out that Sign makes up a small percentage of revenue for Adobe and therefore will never get the same focus in product development that DocuSign’s core suite of products will. To underscore the point, he estimates that DocuSign spends more on R&D (Q2 GAAP R&D spend of $64M) than Adobe Sign generates in revenue.

We know that Adobe is not sitting still and highlighted rapid growth for Adobe Sign in their most recent Q3 earnings report. I imagine they see the large opportunity in digital signature as well, with the COVID situation, and will continue to invest in the product. They also employ various bundling schemes where Sign is made available for a discount to large customers with significant spend in other areas like Creative Cloud and Experience Cloud.

Nonetheless, as I outlined above in the typical use cases for a CIO at an enterprise looking to streamline their company’s full process of agreements, I think the DocuSign Agreement Cloud suite of services will always remain one step ahead due to their laser focus on agreements. The advanced ML/AI features introduced with DocuSign Insight and Analyzer are evidence of this. Breaking agreements down into their contextually relevant clauses, terms and conditions and then intelligently comparing those to industry best practices and screening for risk requires a deep knowledge and focus on contract law. Any large, horizontal player, like Adobe, is unlikely to invest the resources necessary to build differentiating features in this domain. Notary will be yet another example of this differentiation. If a signature for a document requires notarization, is the vendor going to bounce the customer out to a third-party system or offline process to facilitate it? These questions matter for enterprise spend.

With that said, let’s take a look at DocuSign’s major competitor. In past DocuSign analysis, I have examined the two players Adobe Sign and Dropbox HelloSign. Of these two, I will provide updates on Adobe’s execution. As I discussed last quarter, I don’t see meaningful movement in the Dropbox solution. This continued in the most recent quarter.

Adobe Sign

Adobe offers electronic signature through its Adobe Sign product.  Adobe Sign is part of the Adobe Document Cloud product line, along with Acrobat, Reader, Send, PDF Pack and Scan. On September 15, Adobe reported their Q3 FY2020 earnings results (June – August). Document Cloud as a whole generated revenue of $375M in the quarter, up 22.1% year/year. This compares to $360M in revenue in Q2, which represented 21.6% annualized growth. Document Cloud made up 11.6% of Adobe’s total revenue of $3.22B in Q3.

Adobe doesn’t break out revenue contribution at the product level, so we don’t have exact numbers for Sign. However, for comparison, DocuSign generated $342M in revenue in their most recent quarter (May – July), with an annualized growth rate of 45%. Given that Sign is one of eight product lines in Adobe’s Document Cloud, we have to assume Sign’s revenue is much smaller than DocuSign’s revenue from electronic signature.

In Adobe’s Q3 earnings call script, they provided several updates on the performance of Document Cloud and the Sign product.

• Document Cloud revenue grew to $375M, with $98M of net new ARR. Experienced strong growth in gross new ARR coming from the Adobe Reader funnel.
• Significant momentum with Adobe Sign, which grew enterprise bookings of more than 200% year/year.
• Announced that Adobe is planning to pursue FedRAMP Moderate status for Adobe Sign (DocuSign already has Moderate level)
• Launched Adobe Document Cloud Resource Hub for Education. This provides a destination with information outlining how Document Cloud can help facilitate remote learning.
• Highlighted strength in other segments of the Document Cloud outside of Sign, primarily with Acrobat.

One analyst on the earnings call asked for more color on the growth of the Sign business in particular. Adobe’s CEO answered as follows.

Document Cloud really had a very strong business. And at the macro level, the strength of Acrobat, all the verbs that we have including Sign, the frictionless Acrobat web and the platform APIs, we’re really convinced we have the right platform for document creation, sharing, signing, exporting and scanning. I mean, scan also, the number of installs of scan, what we are seeing on mobile, so across all of our PDF solutions. When we are talking about the business as it related to Sign, Sign actually grew faster than the Document Cloud business. And the 200% statistic that we gave has to do with Sign standalone. The way we are going to market, we introduced Sign also in the channel just very recently. So, while that’s early, we’re seeing good traction with Sign in the channel.

The primary route to market is either through Acrobat for individuals or through the enterprises. In the enterprises, we are seeing two forms of traction. The first is where people are using Sign as the core sign solution for all of their business processes. I think, some of the partnerships that we’ve announced as well with Microsoft as well as with ServiceNow, we expect to see that continue to grow. And in addition to that, we’ve actually seen some really good traction with our document experience — experience document sellers also demonstrating how the combination of Adobe Experience Manager, which is the core website, plus what you can do around forms and signs for business processes, how that’s growing. So, across the board, we saw some really good strength in that business.

Adobe, Q3 Earnings call, Sept 15, 2020

Separate from earnings, Adobe made some other product announcements related to Sign during the quarter:

• Several announcements at Microsoft’s Ignite conference.
  • Adobe Sign for Teams – Live Signing. This enables a new face-to-face signing experience – directly within Microsoft Teams video calls.
  • Adobe Sign powering Microsoft Approvals. Extending Microsoft’s new Approvals platform, Adobe will enable users to add the security and audit trail of e-signature to their Approvals requests.
• The Foundation for California Community Colleges (FCCC) signed an Enterprise Term License Agreement (ETLA) with Adobe, giving the state’s 116 community colleges affordable access to Adobe Sign and Adobe Acrobat Pro. 
• New advancements in Adobe Sign that include readiness for industry standards in digital documents and e-signatures in healthcare and life sciences. This is especially important for companies that need to comply with the US FDA regulation, 21 CFR Part 11, which oversees the use of digital documents and e-signatures in healthcare and life sciences. 

With the earnings report and product announcements, Adobe is clearly generating some momentum with Sign and continues to see it as a growth opportunity going forward. I think this will encroach on some of DocuSign’s market share. The primary use case would be for simpler agreements where the the document is prepared in a separate word processing (MS Word) or document creation (Acrobat) tool and needs a digital signature. This workflow is a replacement for the previous process of printing, signing and scanning a paper document. The completed document would then be stored in a cloud-based document store.

This workflow, however, represents a subset of the capabilities in DocuSign’s full CLM product. It doesn’t provide the same level of tooling to prepare the agreement, beyond the editing features in the document creation tool itself. It also wouldn’t provide the same level of sophistication for monitoring completed agreements. They could presumably be tagged with some basic metadata for retrieval, but wouldn’t break down the agreement into its component parts.

It is this data modeling and intelligence layer that DocuSign applies over all agreements which provides the level of sophistication needed by large enterprises with thousands or millions of contracts to manage. DocuSign’s solution structures the agreement into a data model, with its various clauses, terms and conditions broken down into individual values. This provides the benefit of making the agreement programmable. The user could set up automated checks and triggers with conditional logic for each value within a contract. For example, if a contract guarenteed a certain SLA value or delivery time, it would be very easy to programatically retrieve the contracts affected if the value were exceeded. The user could even trigger automated responses to be sent to an external system, like generating a refund. Without this data model for each agreement, all of these triggers have to be monitored and acted upon manually. Large enterprises employ teams that spend enormous time manually tracking contracts for these triggers.

Additionally, the agreement data model and new AI capabilities from the Seal Software acquisition add intelligence to the contract review process. Since contract terms and conditions are broken down into typical legal clauses (IP ownership, termination, enforceability, etc.), DocuSign’s new Analyzer product can run algorithms against these to categorize each clause by risk level and provide suggestions for improvement.

The legal industry publication Artificial Lawyer covered the release of Analyzer. They state that this capability would appeal to corporations with large legal, sales and procurement departments. They even go on to speculate that DocuSign could expand this capability to consumer contracts in the future.

Built NLP models that can handle most mainstream commercial contracts that big companies use with a high level of accuracy: that can identify key clauses, compare them to what is in a company’s playbook, show the risk level from High, Medium, to Low, and also suggest improved contract language as a response.

Artificial lawyer, Sept 30, 2020

The other interesting consideration with the Adobe Document Cloud platform is that is hinges on the Acrobat product and its output of documents into the PDF format. Per Wikipedia, the “Portable Document Format (PDF) is a file format developed by Adobe in 1993 to present documents, including text formatting and images, in a manner independent of application software, hardware, and operating systems.” The Acrobat ecosystem, and hence the Document Cloud, primarily exists to facilitate the creation of documents with unique formatting requirements, with combinations of text, images, tables, etc., so that they can be shared universally across different display devices. It is has also been popular as a means to ensure visual accuracy when printing documents.

Adobe Sign was naturally added to this product ecosystem, as it facilitates the ability to affix a digital signature to a digital PDF document. This was a logical extension of the fact that Acrobat and the PDF format have commonly been utilized to prepare and exchange legal documents, like business invoices, proposals and other contracts.

However, in a world that is moving away from printing paper and migrating common business practices into online workflows that don’t involve a single document, one has to wonder how relevant the PDF format will be in the future. As an example, an image on the Adobe site shows how Acrobat could be used to create an invoice for a business.

Yet, most of these proposal and invoicing solutions are moving to SaaS-based services like Salesforce and NetSuite. While both DocuSign and Adobe Sign have integrations with these types of tools, I would argue that DocuSign’s foundation in an agreement data model allows these integrations to go very deep. Further, the legal contract intelligence capabilities discussed above could be injected back into the sales negotiation process within Salesforce.

Other Potential Entrants

Investors and analysts often ask what prevents another major software company from entering the electronic signature or agreement management space. This is a fair question to raise, as the large software and cloud companies are always on the look-out for incremental revenue opportunities.

The DocuSign CEO has an interesting perspective on this, which may help explain why Adobe is the only major player that has launched a directly competitive solution. The CEO discussed this at the D.A. Davidson Software Conference in September. He said that many of the large software vendors were major investors in DocuSign when it was private, before the IPO in April 2018. These included Microsoft, Google, Salesforce, SAP and Intel. So, their investments create a disincentive to compete.

Further, the CEO contends that if any one of these players launched a competitive signature solution, then the others would likely react by shutting out integrations to their product. For example, if Google launched a contract signature product, then Salesforce might not cooperate to provide a deep integration with their CRM tools. This lack of integration from one solution to the other major software systems would immediately kneecap the enterprise growth potential for that product. Of course, anything can happen, but this explanation seems plausible.

Of these, Microsoft would be the most obvious candidate to launch a competitive solution, but the DocuSign CEO pointed out at a past analyst event that Microsoft is a major customer of DocuSign already, with over 300 use cases for DocuSign internally. Also, earlier in DocuSign’s history as mentioned above, Microsoft was a large investor, so they benefit from DocuSign’s success. Finally, Microsoft and DocuSign struck a long-term strategic partnership in 2014 to bring electronic signature capabilities to Office 365. They have a similar agreement with Adobe Sign. I assume these include some sort of revenue sharing.

Future Opportunities

As the business contract moves from a single paper document to a data-driven, fluid agreement system, the concept of a “smart contract” becomes achievable. In the future, we will likely see the paper agreement go away. We can conceive of future agreements simply becoming a collection of the inputs that adhere to basic contract law – an offer, terms, consideration, intent and acceptance. These don’t necessarily have to be structured in the paper document that we are all used to. These elements of a contract could be decomposed into a more fluid process of creating, negotiating and acknowledging an agreement. Moving beyond canned contract templates, future agreements could be “assembled” from a database of contextually relevant terms and conditions.

DocuSign’s Agreement Cloud is well positioned to capitalize on this trend, particularly with the addition of the contract lifecycle management capabilities surrounding the electronic signature. These components provide the basis for agreement assembly, negotiation of terms, legal execution, electronic distribution and storage. The Insights and Analyzer products recognize discrete contract clauses and use AI to scan agreements for risks or opportunities.

Once a business agreement has been executed that stipulates certain future terms or conditions, humans have to periodically check on the contract status and manually notify parties if terms are not being met. Automating these checks would be very helpful and save a lot of time. A parallel can be drawn to observability solutions in application monitoring (like DDOG). In this case, we are applying “observability” (monitoring with context) to legal agreements. This could be a huge future opportunity for DocuSign, as more of this agreement execution workflow is pushed online, decomposed and automated. Providing a full featured development environment for managing “observable agreements” could be the next stage of the Agreement Cloud.

As discussed above, the Liveoak acquisition positions DocuSign perfectly to supplement their existing electronic signature solution with notarization when an agreement rises to that level of authorization. DocuSign is already testing a solution for this with existing customers, where the enterprise has the notary employed by the company. This is estimated at a $1B TAM.

However, beyond this, DocuSign has plans to expand the solution to the consumer market later in 2021. This would fulfill the use case where an individual needs a document notarized and would normally visit their local UPS or FedEx Kinko’s store to get that executed. Instead, they could simply use DocuSign online for that requirement. The market for third-party notary has been estimated at $30B annually with over 1B documents requiring physical notarization in 2016. There are a handful of small players in this market, like Notarize. With DocuSign’s brand and cross-promotion from eSignature, they would likely grab a large share.

Finally, the AI-driven contract review and scoring capabilities enabled through the Analyzer product could be extended to the consumer market. This will require much further refinement and development than that available with Analyzer’s largely corporate focus now, but it is conceivable that DocuSign supplements the function of contract review that is normally handled by one’s personal attorney (if you can afford one). This potential was raised by the Artificial Lawyer article referenced earlier.

But, the real prize in the future will be to take this to the point where everyone who finds themselves with a contract can run it through an Analyzer-type filter as part of DocuSign’s suite of applications and get the same useful results, such as: maybe don’t sign that apartment lease because of the terms in paragraph six about the landlord’s rights to evict; or maybe don’t sign that freelancer’s agreement because of the bit on the last page about how they co-own copyright of any content they produce.

Artificial Lawyer, Sept 30, 2020

DocuSign Take-Aways

Probably the most exciting aspect of DocuSign’s performance is the acceleration of revenue growth. Granted, a good portion of this is due to COVID-19 and the impact of social distancing requirements. At the D.A. Davidson Software Conference, DocuSign’s CEO discussed how eSignature experienced tailwinds from COVID-19, but the Agreement Cloud products faced headwinds, as those require a larger investment with an extended timeline and application of system integration. Therefore, while the surge in eSignature adoption may level out as COVID-19 clears, we can expect pick-up in larger deals associated with enterprise adoption of the full CLM suite.

Focusing on revenue growth, we have favorable projections for the remainder of this year. Given the substantial beat in Q2, it is conceivable that Q3 revenue growth lands near or just past the 50% mark. Similarly, with two more cycles of beat and raise, Q4 and full year revenue growth could possibly do the same.

Q2 Revenue Growth:           45%   (10% beat)
Q3 Revenue Estimate:         44%   (10% raise)
Q4 Revenue Implied:          41%   
Full Year Revenue Estimate:  42%   (7% raise)

While revenue growth is accelerating, profitability is also improving. Operating margin jumped to 10% in Q2, up from about break-even a year ago. FCF margin hit a new high as well, jumping to 29% in Q2 versus prior year of 5%. DocuSign is experiencing operating leverage as they scale. Sales and Marketing expense decreased by 6% year/year and G&A costs reduced by 4%.

Growth in billings supports these future revenue projections as well. Q1 billings grew 59% year/year and Q2 ticked higher to 61%. For Q3, billings growth is projected at 43%, but the Q2 estimate was beat by 26%, so at least matching Q2’s growth in actuals for Q3 is feasible. Billings growth is an important indicator of future revenue recognition. Having billings growing at a higher rate than revenue implies that high revenue growth is sustainable for several quarters.

On a Rule-of-40 basis, DocuSign is performing exceptionally. With FCF margin of 29% and revenue growth of 45%, its Rule of 40 value is 74. That puts them inline with some of the best SaaS businesses, more impressive for a company with a revenue run rate over $1B a year.

Customer expansion has been very strong in 2020 and also supports future revenue growth. DocuSign added more customers in both the total and large customer category in the first half of 2020 than in all of 2019. For Q2, total customer count surged by 88k, representing 39% annualized and 13% sequential growth. Enterprise and commercial customers (with 10 or more employees) grew 55% over Q2 of the prior year. With a DNER hitting 120%, its highest rate in the past year, these new customers should provide a nice boost to future revenue.

The big question will be how sustainable revenue growth will be for 2021 and beyond. Due to outperformance in 2020, comps will be higher. However, there are a few factors that should come into play. First, eSignature expansion is likely to continue. In many cases, new adopters of eSignature in enterprises apply it to a couple of use cases or a single department initially. After proving the ROI, they expand it to address more workflows. As an example, the DocuSign CEO previously mentioned that Microsoft has over 300 use cases for eSignature, while most large customers start with just one.

Next, as enterprise IT spend recovers and can be applied to digital transformation and automation projects, we should see the eSignature adopters shift to considering the automation of their full lifecycle of agreement management. This is where the Agreement Cloud product suite would be harnessed. Customers can leverage more DocuSign tooling to help them prepare, manage, store, search and monitor their agreements in one platform. These types of engagements tend to represent greater spend than eSignature by itself. They also have longer sales and implementation cycles, which explains why they were de-prioritized in favor of eSignature when COVID-19 first manifested.

The new notary service offerings have major potential. In the D.A. Davidson Software Conference, the DocuSign CEO discussed how the Live Oak acquisition cloud be quickly incorporated into DocuSign’s product offering. He expects “meaningful volume” in Q1, as the initial use case of first-party notary services is already being tested with existing customers. While the TAM for first-party notary is estimated at $1B, DocuSign could rapidly absorb a lot of this. Third-party notary is targeted for second half of 2021 and would address an even larger TAM.

Finally, international represents a big opportunity. DocuSign only generates 19% of its revenue from outside of the U.S. That is surprisingly low and the CEO even acknowledges this. With 59% revenue growth internationally in Q2, but only at a $200M run rate, international expansion could provide sustained high revenue growth for many years. The CFO has driven this growth as a side project in Europe since the beginning of the year, as he thought this would provide a good experiment for international potential. He is now being promoted to run the entire international operation.

The competitive landscape remains favorable for DocuSign. They continue to dominate the market for both eSignature and CLM services. Adobe Sign is experiencing high growth, but is several times smaller than DocuSign’s revenue run rate. Similarly, on the CLM side, Gartner recently confirmed DocuSign’s leadership position on a product basis following the integration of Spring CLM into the Agreement Cloud.

DocuSign’s revenue growth should continue to translate into profitability over the long term. On the earnings call, the CFO reiterated their operating margin target of 20-25% within four years. Given that they just hit 10% operating margin, this seems realistic. At the same time, management plans to continue to invest in the business to continue driving expansion and revenue growth.

As a parting thought, Okta CEO Todd McKinnon recently posted a tweet highlighting the opportunity for identity solutions (which Okta provides) as a consequence of the broader growth in digital migration. He points out various online interactions that require some form of identity as a baseline.

I would echo Todd’s sentiment, highlighting that the same argument can be made for the general concept of agreements and consent. As the leading provider of systems of agreement, DocuSign stands to benefit substantially over a long period of time as offline business processes upgrade into the digital ecosystem.

Investment Plan

When I initiated coverage of DOCU stock in April, it was trading at $100. Expecting growth, but in a tough economic environment, I had set a 5-year price target of $245. In early September, prior to earnings, DOCU shot up to $290 and recently settled back into the $220 range. The stock is now up almost 200% for the year (3x its price on 12/31/19 of $74.11) and briefly cleared my initial price target. While I don’t think this velocity of share price will continue next year, I am still optimistic that DOCU will appreciate meaningfully through 2024.

Therefore, I am increasing my prior 5-year price target to $610. This is based on assumed revenue growth of 49%, 40%, 35%, 30%, 30% for calendar years 2020 through 2024, generating an exit revenue rate of $4.5B in 2024. To get a reasonable P/S ratio for 30% profitable growth, NOW provides a good comparison. NOW currently enjoys a P/S of 25 on revenue growth of 28% and TTM revenue of about $4B. Target gross margin and operating margin would be comparable. A P/S ratio of 25 on $4.5B of revenue in 2024 yields a target market cap of $112.5B for DOCU. With today’s market cap of $40B, that represents an expansion of 2.8x over the next 4+ years for an exit share price target of $610 from the most recent close of $218. I realize this is rough and doesn’t account for share dilution, but I think provides a fair top-end target by early 2025.

Given this optimistic view for DOCU, I have allocated an oversized 17% share in my personal portfolio. It is currently my third largest holding, falling slightly behind TWLO as a result of the recent surge in that stock. I plan to maintain this level of investment to DOCU and will continue to provide quarterly updates as the year plays out.

NOTE: This article does not represent investment advice and is solely the author’s opinion for managing his own investment portfolio. Readers are expected to perform their own due diligence before making investment decisions. Please see the Disclaimer for more detail.