Dropbox Inc. (DBX, Financial) had a sizzling initial public offering last Friday, with the stock up 35% in its first day of trading. At market close, the market cap was around $12.54 billion with shares trading at nine times forward sales.
The IPO was priced at $21 per share. The company sold 36 million shares, including 9.2 million from existing private shareholders. The company raised around $641 million from the IPO after accounting for expenses. Salesforce (CRM, Financial) gained approximately 4.76 million shares of Dropbox through a private placement. The company now has around 440.3 million fully diluted outstanding shares.
Despite its popularity, the stock does not offer compelling growth at a reasonable price due to the slowing rate of subscriber growth, unfavorable enterprise prospects and increasing competition from big corporations, including Microsoft (MSFT, Financial) and Alphabet’s Google (GOOGL, Financial). It’s better to remain on the sidelines for now.
About the company
Dropbox is a technology company that develops application software. The company provides cloud file management and storage services to individuals and businesses. Addressable markets for the company include cloud storage, cloud collaboration and file and content management.
Dropbox touts itself as a global collaboration platform with more than half a billion registered users. The company competes with Google and Microsoft in cloud storage. In collaboration space, Atlassian (TEAM, Financial) is Dropbox’s direct competitor. The company also competes with Box Inc. (BOX, Financial) in cloud storage for enterprises.
The company was founded in 2007 and is headquartered in San Francisco.
Revenue
Dropbox’s revenue is growing at a double-digit pace as the company posted $1.1 billion in revenue in 2017, translating to a compound annual growth rate of 35.3% over the last couple of years. In 2017, 80% of the company’s annualized revenue came from paying users that renewed their subscriptions.
Average revenue per user is stable around $111 per user. The company registered growth in per-user revenue in 2017.
Market outlook
According to a report, the cloud storage market is expected to grow at a CAGR of 23.7% to reach $88.9 billion by 2021. Another report notes the cloud storage market will grow at a rate of 29.7% to reach $92.5 billion by 2022. Consumer cloud storage revenues, however, are only expected to reach $2.8 billion by 2025, according to Persistence Market Research. This doesn’t bode well for Dropbox as the company is a consumer-oriented company.
The cloud collaboration market, on the other hand, is expected to witness slightly lower growth going forward. The market is expected to reach $55.5 billion by 2023, translating into a CAGR of 13.2% between 2017 and 2023. Another report from marketsandmarkets forecasts the cloud collaboration market to grow at 12.7% p.a. between 2016 and 2021.
What are the red flags?
Crowded market
The cloud storage and content collaboration market is quite crowded. The storage market is flooded with big players, including Amazon (AMZN, Financial), Google, Microsoft and IBM (IBM, Financial). As a result, it will not be easy to get a share of the cloud storage pie. The content collaboration market is also flooded with competition as 66% of the industry's revenue was shared among the top 10 software vendors in 2016. Dropbox was the fifth-largest market share holder that year.
Moreover, the crowd isn’t subpar. Gartner named seven leaders in its 2017 magic quadrant of content collaboration platform, with Box leading the pack. Overall, there is some serious competition in storage as well as collaboration. Dropbox might find it difficult to maintain its growth trajectory.
Slowing pace of growth
Dropbox had around 11 million paying users as of year-end 2017, translating into a CAGR of 30.1% between 2015 and 2017. Around 80% of these users are using Dropbox for work. However, the rate of growth is slowing down, which isn’t a good sign for a growth company in its infancy.
Source: IPO filing
The graph depicts the fact Dropbox is having trouble keeping up the pace of paying-user growth. The growth rate dropped 10% (absolute terms) in 2017. Moreover, the company notes the following in its IPO filing:
“Our revenue growth rate has declined in recent periods and may continue to slow in the future.”
To review, slowing growth in the number of paying subscribers is one of the red flags for Dropbox going forward.
Price-driven competition
When it comes to public storage, large corporations like Microsoft and Google are more interested in user data than subscriptions. While we may see additional regulatory scrutiny due to Cambridge Analytica's misuse of Facebook (FB, Financial) data, that isn’t going to stop corporations from using this information for marketing purposes.
The point is Dropbox has to compete against the likes of Google and Microsoft with a subscription-based model. Cloud storage users are not willing to pay for subscriptions, which is evident from the fact only 2% of Dropbox’s registered users pay for its services. The company could turn to the enterprise market for refuge, but there’s already strong competition there. Microsoft recently launched a marketing campaign to lure enterprise customers into using One Drive. The company is offering customers of competing cloud providers free use of their service for a three-year period if they switch. This is indicative of a price-driven competitive environment in the cloud storage space.
Enterprise woes
On enterprise front, the company might face market penetration problems. Box, the company's main competition, is focused on serving the enterprise markets. Dropbox, on the other hand, is more involved in the individual and SMEs markets. Therefore, the company appears to be weak on the enterprise front. Moreover, enterprise market penetration requires a proactive marketing strategy. Enterprises aren’t going to deploy storage solutions based on word-of-mouth referrals. That’s one of the problems Dropbox notes in its IPO filing.
“Historically, our business model has been driven by organic adoption and viral growth, with more than 90% of our revenue generated from self-serve channels.”
Expensive valuation
*Lower PSG indicates cheaply priced growth.
Dropbox is expensive compared to Box. Dropbox is trading at a forward price-sales ratio of 9, which is almost double that of Box. Although the company registered more growth in the last quarter than its rival, it is still expensive.
On a free cash flow basis, Dropbox is priced at 35 times forward free cash flow, assuming the company generates $350 million in cash flow in 2018. Box, on the other hand, generated a mere $50 million in free cash flow over the trailing 12 months.
Nonetheless, a 35 times free cash flow multiple is high for Dropbox, given the company grew its paying user base by 25% in 2017.
Final thoughts
The jump in Dropbox's stock price has been a characteristic of tech IPOs lately. The positive reception doesn’t mean it will continue to rally. On the contrary, the stock might struggle to post gains going forward amid a slowdown in growth and quality competition. Long-term investors should remain on the sidelines for now.
Disclosure: I have no positions in any stocks mentioned and have no plans to initiate any positions within the next 72 hours.
