DOCN • 10-Q • Q2 2025 • Neutral

DigitalOcean's Cloud Growth Decelerates Amid SMB Market Headwinds and Integration Challenges

August 05, 2025 • 1 min read

TL;DR

DigitalOcean reported decelerating growth with revenue up 27% YoY to $172.2M, missing consensus estimates as SMB customers face macro pressures. Operating margins contracted 320bps to 12.1% due to Paperspace integration costs and elevated R&D investments. Customer acquisition costs increased 15% while retention metrics declined for sub-$50 MRR cohorts. Management reduced FY2025 guidance, signaling continued challenges in penetrating the enterprise segment against hyperscaler competition.

Financial Performance Overview: Revenue growth decelerated to 27% YoY from 35% in Q1, with ARPU growing 8.2% to $79.40. Gross margins compressed 180bps to 63.1% due to increased infrastructure costs and pricing pressure. Operating expenses grew faster than revenue at 34% YoY, driven by 42% higher R&D spend. Net dollar retention rate declined to 104% from 112% last quarter, indicating mounting competitive pressures in core SMB segment.
Strategic Initiatives and Operational Changes: Management accelerated enterprise push with new products including DigitalOcean Functions and enhanced Kubernetes offerings. Paperspace acquisition integration progressing slower than expected with $12M revenue contribution below $15M target. New go-to-market strategy focusing on developers in companies with 50-1000 employees launched, but showing mixed early results. Timeline for achieving $1B ARR likely extends into 2027 versus prior 2026 target.
Market Position and Competitive Dynamics: SMB cloud market share declined 120bps to 18.2% as AWS and GCP increase focus on smaller customers. Net new customer additions fell 22% YoY to 11,400. Enterprise segment (>$500 monthly spend) grew 41% but represents only 15% of revenue. Customer concentration improved with top 50 customers now 12% of revenue versus 15% year ago. Competitive positioning weakening in ML/AI workloads despite Paperspace acquisition.
Operational Efficiency and Profitability: Infrastructure utilization declined to 71% from 76% last year impacting unit economics. Sales efficiency (CAC payback) deteriorated to 18 months from 14 months in 2024. R&D productivity metrics show concerning trends with feature delivery timelines extending 25%. Margin recovery depends on successful integration of Paperspace and improved infrastructure efficiency, likely a 2-3 quarter process.
Growth Catalysts and Material Risks: Near-term growth depends on successful expansion upmarket and AI/ML adoption through Paperspace. Macro headwinds persist in SMB segment with elevated churn in <$50 MRR cohorts. Key risks include hyperscaler competition, rising infrastructure costs, and integration execution. Management expects growth reacceleration in 2026 driven by enterprise traction and new product adoption.

Revenue

$172.2M ( YoY, QoQ) with deceleration across segments

↑ +27%

Rd Spend

$38.4M ( YoY) representing of revenue

↑ +42%

Net Income

$5.2M ( YoY) with margin pressure from investments

↓ -42%

Gross Margin

(-180bps YoY) due to infrastructure costs

↑ 63.1%

Free Cash Flow

$34M ( YoY) with conversion rate

↓ -22%

Operating Margin

(-320bps YoY) from integration and investments

↑ 12.1%

Growth Indicators

$688M ( YoY) with enterprise growing

↑ +27%

Customer Count ↓628,000 (+11,400 net new, -22% YoY growth)

Retention Metrics ↑NDR 104% (-800bps YoY), sub-$50 MRR cohort declining

Key Risks

SMB market share erosion accelerating with -120bps quarterly decline
Integration challenges delaying Paperspace synergies by 2-3 quarters
Rising infrastructure costs pressuring unit economics and margins
Enterprise transition showing mixed results with elongating sales cycles

Key Opportunities

AI/ML workload expansion through Paperspace ($15B TAM by 2026)
Enterprise segment penetration ($50B+ TAM) with enhanced platform
Geographic expansion in APAC/LATAM ($20B+ opportunity)
Operational efficiency improvements could add 400-500bps to margins

Bottom Line

DigitalOcean faces a critical transition period as it attempts to expand beyond its SMB roots while maintaining profitability. Near-term headwinds from integration costs, competitive pressure, and macro challenges will likely persist through 2025. Success depends on execution in enterprise expansion and maintaining SMB market share while improving operational efficiency. Key metrics to watch include enterprise customer growth, Paperspace integration progress, and infrastructure utilization improvements. The contrarian take is that current challenges may drive faster product innovation and more disciplined operations, potentially emerging stronger in 2026.