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Investment Thesis
Heading into earnings on Thursday, I’m optimistic about DocuSign, Inc. (NASDAQ:DOCU). This is despite recent setbacks in its stock price and company performance. The company has established their leadership position in the electronic signature and agreement management sector over the past several years, especially during COVID, where the company used work from home policies to accelerate growth.
Post COVID, they are now more aggressive in expanding their product portfolio through their Intelligent Agreement Management platform and the integration of generative AI across their products to streamline complex agreement/contract compliance workflows. The integration of features like enterprise search within the platform help address key pain points in contract management and reduce dependency on extensive, expensive legal consultations and manual contract reviews.
The company’s recent $165-million acquisition of Lexion further expands its AI capabilities and will guarantee new market opportunities in contract lifecycle management—a sector that continues to demand more advanced technological integration. Even private equity firms, Bain Capital and Hellman & Friedman, have recognized the company’s value and growth potential that remains to be fully tapped, having previously discussed acquiring the company over the winter.
With this, I don’t think the market has fully recognized how the software layer of the AI revolution will help them in this area. The COVID-19 pandemic exposed the vulnerabilities in contract lifecycle management and enterprises swiftly realized that significant value and potential revenue are lost because of inefficient post-signature management, compliance monitoring, change management, and performance assessments online.
Despite their stock declining by over 73% from its peak, the company’s financial health remains robust in my point of view. The company’s revenue increased to $2.76 billion in the last financial year to transition from a loss-making position to profitability. The upcoming earnings are key, with projected revenue to reach $707.71 million for the most recent quarter.
I believe that DocuSign’s innovations through AI will put them in a more confident position in the industry and help bolster stock performance. I think earnings will show this. In my view, DocuSign, Inc. stock is a strong buy.
Background
DocuSign’s 73%+ stock drop over the past three years has been attributed to the post-pandemic normalization of the business environment and a deceleration in the company’s revenue growth. Initially, the company recorded a surge in demand and stock price during the early stages of the COVID-19 pandemic, when many enterprises adopted digital solutions to facilitate their remote operations. The company’s stock more than tripled from its pre-COVID levels by 2021 due to increased reliance on digital document management.
However, as pandemic restrictions eased and businesses adapted to new norms, these growth rates became unsustainable. In their 4Q FY 2024 report, revenue growth was approximately 8% year-over-year, which was significantly lower than its pandemic-era growth rates.
To respond to industry demand, DocuSign has been leveraging AI since 2018 to transform how businesses handle contracts from creation through management and compliance. They have expanded beyond basic electronic signatures to incorporate intelligent features that automate and optimize the contract signing process. AI-driven capabilities allow for auto-tagging dynamic fields in contracts, which facilitates preparation and signing processes much faster. DocuSign claims that contracts are prepared with accuracy to reduce the likelihood of errors and the need for rework to speed up the cycle of drafting to execution.
With this, the electronic signature apps market is projected to have a compound annual growth rate (CAGR) of 36.1% by 2030, driven by the growth in the adoption of digital processes and remote working models across various industries such as legal, finance, real estate, and healthcare even with many returning to office in this space.
Companies are finding that digital contract management software is key even in a post-COVID environment.
Software Companies Are Now Under Pressure
Salesforce’s recent earnings report highlighted a slowdown in software sales growth, which prompted scrutiny from investors who are increasingly concerned about profitability of the enterprise software industry as a whole. The company has faced pressures from activist investors to cut costs and improve margins, which had been overlooked in favor of rapid expansion. The reaction to Salesforce’s earnings had a ripple effect across the software sector, as growth prospects are being reevaluated by analysts amidst rising interest rates and more conservative corporate spending. Software companies, especially those that have yet to show consistent profitability, are reevaluating their positions.
In my opinion, the impact of Salesforce’s earnings has now become a bellwether for the industry, and companies are slowly adjusting their plans according to investor expectations. These companies appear to have lost the high margin aspects of their business model in an environment where AI makes it easier to code and increases capex costs with higher GPU costs. High-performance AI models, especially those involved in coding, require massive computational power that need expensive GPU-based hardware or cloud services. As such, these companies need higher capex to invest in hardware or expand their use of cloud-based AI services.
However, many of these software companies have no choice but to join the AI arms race that could strain resources and focus, or risk being left behind. In fact, AI code assistants, for example, are expected to be used by three-quarters of enterprise software engineers by 2028, up from just 10% in 2023. I believe that for them to succeed in this race, financial investments in AI technology, new business models and operational practices to integrate and maximize the benefits of AI are needed; however, these can risk other profit-driven initiatives.
DocuSign Is A Real AI Play
The global contract management software market size was estimated to be valued at $965.25 billion in 2021. This is expected to reach $2.94 Trillion by 2030, at a CAGR of 13.2% during the forecast period.
There’s a lot of value in AI in contract management, to say the least. According to recent research from DocuSign, corporate contract management is estimated to cost approximately $2 trillion globally (annually!), which highlights the immense financial burden that inefficient contract management processes can place on businesses. With this is the cost associated with legal services. Contract lawyers can range significantly, often between $300 to $1,000 per hour, and can climb even higher, up to $3,000/hr, for more comprehensive services like drafting and negotiation. Given that companies are already spending upwards of $500 per hour on attorneys, it’s not surprising why enterprises need AI to cut down on their costs.
As such, there’s so much potential in AI in the coming years. McKinsey reported that AI systems are now being trained to identify and flag high-risk clauses in contracts before they become problematic to prevent future disputes and legal challenges, and promote better compliance with relevant laws and regulations. I also believe that enterprises will find more value in AI’s ability to analyze and compare contract terms across a vast dataset to help better negotiate outcomes. With this, DocuSign has joined the bandwagon when they announced early this year that they will be using user data to train their AI model. I think this is one of those cases where AI integration will be most obvious. DocuSign has a clear value proposition here.
Earnings Expectations
DocuSign is set to report its Q1 FY 2025 earnings with an anticipated post-market announcement on June 6th. Market participants and analysts have projected an EPS of $0.79 for the quarter to record a year-over-year growth of 9.92%. Keep in mind that growth is accelerating from the 8% year-over-year growth in Q4 of FY 2024.
In Q4 2024, the company reported an EPS of $0.76, exceeding expectations by $0.11. The report also highlighted their $712.39 million revenue for the quarter, up by 8.01% year-over-year.
A significant highlight from the 4Q 2024 earnings call was the emphasis on AI-driven innovations, particularly in contract auditing and management. Allan Thygesen, CEO of DocuSign, announced:
We’re encouraged by [the] momentum across the business…organizations, large and small, continue to invest in DocuSign’s value proposition -Q4 Call.
I think AI will accelerate this.
For tomorrow’s call, I am keen on further details about the AI integration within DocuSign’s current offerings. Given the significant cost associated with traditional contract management and the high expense of legal services for contract review, the company’s solutions now present a compelling value proposition. I have high hopes for enterprise adoption, given the apparent value proposition (in my opinion)
Valuation
DocuSign’s forward non-GAAP P/E ratio stands at 16.40, below the sector median of 23.50. If their forward EPS were to converge with the sector median, this would represent an approximate 43.3% upside from its current levels. Keep in mind, their projected revenue growth of 9.78% year over year is far above the sector median revenue growth of 3.07%.
Adding to the traditional valuation metrics, there have been talks about potential buyout offers for DocuSign (as I mentioned in the investment thesis section). Although these talks have reportedly stalled, the speculative interest highlights the inherent value recognized in the company’s offerings and market position.
Risks
The biggest risk is growth, of course. DocuSign’s growth has moderated from the pandemic-era boom. In fiscal 2024, the company reported a revenue increase of 9.8% year-over-year, which decelerated from previous periods where double-digit growth was the norm. Many tech companies suffered from the broader trend post-pandemic after the surge in demand for remote and digital solutions have normalized.
The company’s restructuring efforts at improving growth have yet to fully convince the market of their efficacy, with the stock down the 73%+ I mentioned earlier. Their stock has reacted negatively to news of stalled acquisition talks. I believe this is the market souring on the prospects of the company operating independently. I think this is misguided.
Finally, while AI can be a disruptor, it can likewise also misinterpret complex legal language or fail to recognize context-dependent clauses. These costly errors mean serious legal consequences for DocuSign’s clients. Any inaccuracies in execution or outcome, as pointed out, can lead to unfortunate consequences. This includes the potential violation of privacy laws or inadvertently embedding discriminatory practices within the AI algorithms, as seen in other sectors where AI has led to unintended biases.
With this, I think the value proposition is clear. Quick contract checks before involved tedious tasks of skimming documents for key phrases and rereading language. As long as DocuSign states that their tools do not provide legal advice but rather simply help guide the users that would have skimmed their documents before to the right places, I think customers will see it as a value-add, without risking becoming too reliant on it.
Bottom Line
Heading into earnings, I believe that DocuSign is successfully expanding its capabilities beyond digital signatures to include comprehensive contract lifecycle management by employing AI-driven solutions.
The adoption of AI in contract auditing, although introducing new risks, is counterbalanced by rigorous safeguards that the company has put in place. As enterprises increasingly seek to reduce costs through automation, I believe DocuSign’s solutions offer a timely value proposition, which makes the stock a strong buy in my opinion.
