Dropbox (DBX, Financial), the provider of cloud storage for consumers and corporations, reported stellar second quarter results Thursday, beating both the top line and bottom line consensus of the Street.
The cloud storage company reported revenue of $339.2 million, up 27.2% year-over-year while beating the analyst consensus by $8.3 million. Non-GAAP net income more than doubled during the quarter to reach 11 cents a share; the Street was modeling for earnings per share of 7 cents.
Paying users – the key operating metric of Dropbox – increased 20% to reach 11.9 million. Paying users stood at 9.9 million during the same quarter last year. Average revenue per user (ARPU) also increased to $116.6 during the quarter, compared to $111.9 during the same period last year.
For the third quarter of 2018, Dropbox is expecting to report mid-point revenue of $351.5 million, an upside of around 3% sequentially. The guidance is also ahead of analyst consensus of around $345 million. Regardless, the cloud storage company is trending downwards and the stock company has lost around 6% of its market cap since its earnings release yesterday.
What does Dropbox do?
The company operates in the cloud storage and collaboration market. It serves consumers and enterprise customers in cloud storage and file management while competing with the likes of Google (GOOG, Financial) and Microsoft (MSFT, Financial) on the consumer side. On the enterprise front, the company is competing with Box Inc. (BOX, Financial). Atlassian (TEAM, Financial) is a direct competitor of Dropbox in the cloud collaboration space.
Why is the market punishing the stock?
Although Dropbox posted double-digit growth alongside decent guidance for the quarter, the stock price is under pressure. This primarily relates to the pre-mature end to the lock-up expiration period of Dropbox. The lock-up period was set to end on Sept. 19. The period will now end on Aug. 23. (The lock-up period refers to the post-IPO time span in which executives and large shareholders aren’t allowed to sell their shares.) A reduction in lockup period usually entails negative price action, which is probably the cause of Dropbox’s post-earnings drop in stock price.
Here are some other red flags
1. Slowing sequential growth
The growth in paying users is slowing down, which might have put investors off too. During the second quarter of 2018, Dropbox’s paying users increased merely 3% sequentially.
While paying users are growing, the rate of growth is slowing down. During the second quarter of 2017, Dropbox grew its paying subscribers 6% sequentially. However, this growth has slowed down to only 3% during the second quarter. The following chart will make things perfectly clear.
Dropbox managed to add 400,000 paying users during the second quarter of 2018. This slow down is also being reflected in the third quarter revenue guidance, which is calling for grow of 3% sequentially in contrast to 7% sequentially in previous quarters.
Put differently, Dropbox might not be able to sustain its over-20% yearly growth in revenue going forward. The growth is likely to fall between 10-15% as the cloud collaboration market is projected to grow at 13.2% to reach $55.5 billion by 2023.
2. Price-competition in consumer cloud storage
Google and Microsoft are not exactly bidding up prices on the consumer side of cloud storage. Google’s 2-terabyte package is priced similar to Dropbox’s 1-Terabyte plan while Microsoft is also offering 2 TB space for $6.99, which is around 40% cheaper than Dropbox. In short, big internet companies will put pricing pressure on Dropbox in order to lure consumers toward their services.
3. Differentiated competition in enterprise cloud storage
Box is ahead of Dropbox by quite a margin in enterprise storage. Gartner – in its latest vendor analyst report – ranks Box ahead of Dropbox both in term of vision and ability to execute. “It extends content collaboration through intelligence, enhanced user experiences and enterprise-oriented governance, protection and oversight,” said Gartner about Box Inc. in its 2018 magic quadrant for content collaboration platforms.
Although Google and Microsoft lag behind Dropbox in terms of vision to enhance content collaboration, they both are ahead of Dropbox in their ability to execute, according to Gartner.
In short, pricing competition on the consumer side and quality offerings of Box on the enterprise side will certainly keep Dropbox on its toes in upcoming quarters.
4. Then, there’s valuation
Dropbox is priced quite expensively as far as relative valuation in concerned.
The price-sales ratio is astonishingly high given that the company is growing its sales at around 25%. Given that growth is expected to slow in near future, it will take around three to four years before the price-sales ratio comes to a reasonable level. Assuming 15% growth in sales from 2019 onwards, it will take almost five years for Dropbox to push its price-sales below 5.
Moreover, the stock is priced around 70 times its 2019 forward earnings, which is quite high for a company that is expected to grow at a rate of 15%.
Bottom line
While Dropbox reported fabulous second quarter results, quarter-over-quarter growth is slowing down. As subscriber growth slows, it will become increasingly difficult for Dropbox to justify its lofty valuation. Add competition from Google, Microsoft and Box to the mix, and staying on the sidelines begins to seem like a really good idea.
Disclosure: I have no positions in any stocks mentioned and no plans to initiate any positions within the next 72 hours.
