My thoughts on Digital Ocean’s Acquisition of Cloudways

Feature Image for Blog post on CLoudways and Digital Ocean. Amar Vyas
Feature Image for Blog post on CLoudways and Digital Ocean. Amar Vyas

Below is my “Gut feeling” take on the acquisition, read it as such.

Digital Ocean’s acquisition of Cloudways appears to be a defensive move to fend off hostile takeover or investor appeasement, that is, it is a finance driven investment rather than a strategic one.

BACKGROUND

In the last week, the following news story hit many tech blogs and financial news sites.

Headline: Digitalocean-to-acquire-cloudways-for-350-million

Digital Ocean (DO)is one of the services supported by Cloudways (CW), which provides a user friendly “front end” for server management.My hypothesis was, and is, that this is a defensive mechanism by Digital Ocean to prevent a hostile takeover. And an opportunity for Executive staff to earn a big fat bonus. Not to mention trim the fat (unfortunately lower level non tech roles) and improve operating margins.

The 350 Mn dollar 💵 IOU by Digital Ocean, makes them a more expensive company to purchase. This is a finance driven acquisition, not a strategic one.

Important questions that remain unanswered:

a. Will Cloudways drop support for Linode, Vultr, etc. since they are competitors to the new owners?

b. Will DO increase prices since they will pay the cost of acquisition out of operations and not debt or equity or reserves and surplus?

c. CW hired a few top level executives from AWS, Azure, etc. post acquisition, will Last In/ First out apply? i.e will they be let go?

Or did CW hire them to make themselves an attractive acquisition candidate?

Details:

Likely reasons for my hypothesis

a. Industry consolidation (Akamai’s purchase of Linode, similar but smaller company as DO.. possibly more to follow),

Now how many companies are sitting on atleast 10 Billoin dollars’  pile of cash? Some of it could be used to buy DO out. DO is an attractive candidate at current market cap and stock price (down nearly 70 percent over the peak). AS a defensive move, DO need to make Price tag expensive to make yourself less attractive (or more attractive to more suitable player, as the case may be).

350 Mn dollars may be a small outpost to hold off the marching horde of marauders, but it is still keeping the adversary engaged for some time.

Edit: I Came across this post after I posted the above:

b.Private Equity player / Investor taking company private

How many PE firms would want to buy DO, take it private, soup up the balance sheet and exit at a 3 x multiple 3 or 4 years later? If 2.5 years of that 3 or 4 year period is needed to digest CW, the DO is less attractive. CW topline expected to be about 52 Mn US dollars in 2022. So DO is buying them at 7X current revenues. Cheap maybe for tech companies, but expensive for many PE firms IMO.

c. Operational efficiencies

Borderline strategic, but if I were to go with a finance driven acquisition theory, then think about replacing higher salaried DO tech support + non technical staff with lower salaried CW staff.

Together, DigitalOcean and Cloudways will serve over 124,000 customers paying over $50 per month, representing approximately 84% of the pro forma company’s total revenue.

Let us look at the 350 Mn Price tag. Say 300 Mn of it is paid in 30 equal installments. Or 10 MN US dollar per month. DO will have to generate an additional 15-16 Mn US dollars per month to retain current margins, out of which they can expense off the 10.

Cloudways is expected to generate more than $52 million in revenue in fiscal 2022, representing a three-year compound annual growth rate in excess of 50%.” (Source and this source)

Assuming same set of growth, albeit YOY Instead of CAGR,

CW generates say 4 MN MRR currently. Assuming 50 % YOY growth, CW may reach 10 MN MRR by Mid 2025. Margins not known.

If DO is to finance the acquisition from operations, they will have to generate additional (bottomline) of atleast 7 to 8 Mn US Dollars per month. Some of which could come via operational efficiencies??

d. I also mentioned executive compensation and year end bonuses

When stock price is low, investors (possibly unhappy with stock price) may demand action, and topline growth may struggle with impending downturn….

Acquisition and mergers to improve topline growth are the oldest and tried and tested methods for CXOs to show growth and justify XMas bonuses.

Works both ways, btw- another tech company (or even a non tech company) could buy DO out for the same reason(s).

(Disasters like HP-Compaq, AOL Time Warner notwithstanding) _Above all are hypothesis. Without being a fly on the wall in the meeting room one can only speculate.

Notes

One more possible reason – and I do not have US specific data to support this- this could also be an investor driven (again, finance driven) acquisition. I see that a lot with Startups/ Unicorns now in India. Same set of investors across related or more probably unrelated businesses, making backroom deals to offload a weaker/ smaller company to a larger one, possibly one that is publicly listed.

e.g Naayka purchase of Little Black Book, Zomato purchase of grocery delivery service Blinkist

 

 

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