There are certainly some things to like about DocuSign (NASDAQ:DOCU) and DocuSign stock. Its main product — which allows remote signing of contracts — saves users a significant amount of time and money. And DocuSign has developed products that help users prep contracts and search through previous deals.
Further, during the pandemic, DocuSign is becoming much more popular and valuable. In fact, in its fiscal first quarter, its revenue soared 39% year-over-year and its billings jumped 59% YOY. This makes sense as the novel coronavirus closes offices around the U.S.
Meanwhile, the company recently acquired Seal Software. Seal utilizes artificial intelligence to “automatically extract, analyze and compare contract terms and … identify areas of risk and business opportunity.”
In general, AI has become very powerful and useful, and contracts are often quite difficult to analyze. It’s difficult to know what provisions in a contract could create problems down the road.
Consequently, I can definitely see how this deal could be valuable. Finally, I must admit there is great potential for its overseas sales. In Q1, over 80% of DocuSign’s revenue came from American customers. But after acknowledging all of the pros, I still believe it’s time to sell DocuSign stock. Here’s why.
DocuSign Is Vulnerable to Competition
Through the years, I’ve become more aware of the importance of first-mover advantage. That’s because I once was pretty convinced that Amazon (NASDAQ:AMZN) and Netflix (NASDAQ:NFLX) would face tough competition that would meaningfully hurt their results.
But it took many years for such competition to materialize. And by the time Amazon and Netflix did face capable competitors, they were so entrenched that their results were largely unaffected by the new adversaries.
Relatively small companies, on the flip side, can lose a large amount of market share to new competitors. One example of that is Dropbox (NASDAQ:DBX).
From 2012 to 2016, the cloud storage company’s user base was rapidly growing. But in recent years, it has had to contend with free offerings from much larger companies, including Alphabet (NASDAQ:GOOG, NASDAQ:GOOGL) and Apple (NASDAQ:AAPL). As a result, its user growth slowed dramatically after 2016. And Dropbox is still not profitable.
Dropbox stock surged from $28.48 in March 2015 to nearly $40 in June 2018. By October 2018, however, it had tumbled to $21.70. In August 2018 it fell below $18. Today, it is trading around $23.
The Power of Network Effects
From its early days, Amazon benefited from a positive cycle known as “network effects.” Specifically, consumers started buying products from the website because thousands of merchants were offering products on it. Then, because more consumers joined the website, more merchants signed up. That cycle kept endlessly repeating.
A similar phenomenon played out for Netflix. It was able to use its cash to buy more movies and TV shows. And because it was able to offer a larger quantity of highly desirable content than its competitors, it acquired more users, giving it additional cash.
Further, both websites were very easy to use and were extremely effective at using data to suggest new products or content. Finally, once consumers became comfortable with Amazon and Netflix, it was difficult and uncomfortable for them to switch to a competing website. After all,their payment information was already stored on both websites, and the websites knew their likes and dislikes.
Conversely, Dropbox did not have any positive cycles. Its large user base did not attract other users. And it wasn’t hard for its users, most of whom were very proficient at using software, to switch to a competing service. Finally, it didn’t have any data about its users that would be difficult for a competitor to replicate, and it wasn’t difficult for competitors to develop services that were just as easy to use.
Is DocuSign an Amazon or a Dropbox?
So is DocuSign more like Dropbox, or more like Amazon and Netflix? DocuSign doesn’t seem to have any network effects. People who sign the same contract don’t have to have the same contract-signing software — there’s no peer angle here. It likely stores users’ emails, standard contracts and signatures, but most companies and law firms could easily transfer that data to another company.
And DocuSign doesn’t seem to use data collected over long periods of time to make invaluable recommendations to its users. Although Seal’s AI product sounds nice and could be valuable, it doesn’t seem like a “must-have” tool. I think a large tech company like Google or Amazon could easily develop a product with the same capabilities.
Similarly, I don’t believe that large tech companies would have much difficulty developing their own tools that facilitate the development of contracts and give users the ability to search previously signed deals. So I would have to conclude that DocuSign looks more like Dropbox than Amazon and Netflix.
The Bottom Line on DocuSign Stock
DocuSign stock has a forward price-sales ratio, based on analysts’ average 2020 sales estimate, of about 18. That makes the shares very expensive. Since the stock has a very steep valuation, and the company is vulnerable to competition, I would recommend selling the shares.
Larry Ramer has conducted research and written articles on U.S. stocks for 13 years. He has been employed by The Fly and Israel’s largest business newspaper, Globes. Larry began writing columns for InvestorPlace in 2015. Among his highly successful, contrarian picks have been Lyft, solar stocks and Snap. You can reach him on StockTwits at @larryramer. As of this writing, he did not own any of the aforementioned securities.
