Dropbox: This Forgotten Unicorn Is Worth Buying At The Current Price

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About: Dropbox, Inc. (DBX), Includes: CRM
by: Innovative Investor
Summary

While investors are right to be cautious about Dropbox, this article will explain reasons why I believe that this is an ideal period to invest in the company.

The reasons are its impressive revenue, premium user, and ARPU growth, its valuation, the balance sheet, and the ownership of the company.

Dropbox is still led by its CEO, who owns a significant portion of the company and it could be an acquisition target by the likes of Salesforce.

As of this writing, Dropbox (DBX) stock is trading at $25, which is just $4 above its IPO price. While investors are right to be cautious about the company, this article will explain reasons why I believe that this is an ideal period to invest in the company. The reasons are its impressive revenue, premium user, and ARPU growth, its valuation, the balance sheet, and the ownership of the company.

Why the Stock Has Underperformed

The reasons why the company’s stock has underperformed are clear and easy to understand. First, the company has continued to ramp up losses and investors are worried whether it will ever be profitable. Indeed, in 2018, the company had a loss of more than $494 million, up from $117 million in the previous year.

Second, the company operates in an industry that is very competitive. It competes with the likes of Amazon (AMZN), Apple (AAPL), Microsoft (MSFT), and Alphabet (GOOG). These companies have a higher financial might than DBX and they have incentives to lure users in their cloud platforms. For Apple and Google, iCloud and Google Drive comes preinstalled in their operating systems while for Microsoft, OneDrive comes loaded with the Office 365 package. This competition makes it difficult for the company to raise prices.

Third, investors are worried that DBX is essentially a one-product company. Its other products such as Dropbox Paper and the recently-acquired Hellosign have no major revenue.

Finally, because of the competition point mentioned before, investors are concerned that the company will not dominate the corporate segment, which is usually more sustainable than the consumer-facing segment.

While each of these points is valid, I will now explain why it makes sense to invest in the company at the current valuations.

Impressive Growth and a Path to Profitability

Dropbox operates using a freemium model, where it offers a free package and premium versions of its products. As a result, the company has accumulated more than 500 million account holders and more than 13.2 million premium users. Therefore, for it to succeed, DBX needs to convert its free customers to premium members. On this, the company has continued to see impressive growth. In its S1 filing before the IPO, the company said that it had more than 11 million paying users. In the most recent quarter, the company announced that it had more than 13.2 million users. The customer growth has also led to an increase in average revenue per user (ARPU) growth, which has risen from $114 a year ago to $121.

In terms of revenue growth, the company had an annual revenue of more than $1.39 billion in 2019, up from the previous $1.1 billion. This year, investors expect the company to have annual revenue of $1.6 billion. The mean analysts' estimates for 2020 and 2021 are $1.88 billion and $2.13 billion respectively. In the most recent quarter, the company’s revenue increased by 22% on YoY basis. At the same time, the operating margin has increased from -48% in April last year to just -3.38% in the MRQ.

This growth implies that there is a path for the company to be profitable on a GAAP basis. On a non-GAAP basis, the company’s operating income turned positive in 2017, when it reached more than $60 million. In FY’18, its total non-GAAP operating income was more than $170 million. As mentioned, analysts expect the company’s revenue to grow to $2.1 billion in 2021. In a hypothetical situation, with $2.1 billion in annual revenues, and the company is able to slash its expenses, it would have an operating margin of more than 30%. That is above the operating margin of other GAAP companies like Microsoft and Adobe. This means the company would have a GAAP operating income of more than $700 million.

Obviously, the path to profitability might take some time as the company continues to work hard with the goal of attracting corporate customers. As single-product company, DBX has a difficult task selling the product to companies, who prefer to have a single vendor of such SAAS products. For example, instead of a company opting for DBX for cloud storage, it can subscribe to Microsoft’s Office 365 and get free cloud storage solutions. Therefore, the HelloSign acquisition could help the company gain more corporate customers from the likes of Docusign (DOCU), which is also a single-product company.

Valuation

Dropbox is currently valued at more than $10 billion on annual revenues of more than $1.4 billion. From the topline numbers, this valuation does not seem quite ridiculous considering how other SAAS companies are valued. Using the topline and the current market valuation figures, DBX is valued at 7.14x 2018 revenue and 5.5x the estimated FY’19 revenues. This is a reasonable valuation considering other SAAS companies like Shopify (SHOP), Okta (OKT) and Adobe are trading at 17x, 21x, and 12x their FY’19 revenue.

Looking at the company’s valuation based on the enterprise value and the EBITDA, the company’s valuation is not ridiculous as well. The EV to EBITDA ratio of 21, is much smaller than that of Box, Shopify, and Adobe, which have a ratio of 45, 551, and 26 respectively.

To some extent, these valuations are understandable because DBX has a relatively lower growth rate than these peers. However, the current growth of more than 20%, the increasing free cash flow, and the low customer churn rate means that the growth can support this valuation.

Other Reasons to be Bullish

While the valuation and the journey to profitability are the most important reasons to buy the company, there are other reasons why it makes a good investment. First, the company is still led by its founder, who retains a significant portion of the company. Research shows that companies that are led by their founders tend to do well. In addition, Salesforce (CRM) owns a significant portion of the company. In recent years, Salesforce has moved to acquire companies that it has stake on such as its acquisition of Quip. Recently, the company acquired Tableau, which it had a small ownership. While no deal has been announced yet, there is a possibility that CRM could make a bid for DBX.

Conclusion

Dropbox is a great asset-light company with an annual growth rate of above 20%. The company trades just 4 points above the IPO price. While the company faces a huge challenge on competition, I believe that investors should own a small part of the company. There is a strong path to profitability, it has excellent cash flow, its churn rate is low, the ARPU is increasing, and its valuation makes sense. Further, it is still led by its CEO, who owns a significant portion of the company and it could be an acquisition target by the likes of Salesforce. It also has a strong balance sheet, of almost $1 billion in cash and no debt.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.