Dropbox: Long Overdue For A Rebound

May 07, 2022 7:00 AM ETDropbox, Inc. (DBX)6 Comments8 Likes

Summary

  • Shares of Dropbox rallied modestly after the company posted strong Q1 results.
  • Revenue grew at 10% y/y, beating the high-single-digit target that Wall Street had set.
  • Meanwhile, operating margins continue to tick upward while free cash flow expansion is settling into high gear.
  • Dropbox is substantially undervalued at ~3x forward revenue.
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Dropbox Debuts On Nasdaq Exchange

Drew Angerer/Getty Images News

Amid market volatility and a general disdain for growth and tech stocks, there's never been a better time to focus your portfolio on the value portion of the tech sector. Certain names, in particular, have continued to turn out exceptional fundamental performance even while their stocks have continued to slide - and sitting at the top of this list is Dropbox (NASDAQ:DBX), the well-known file sharing platform used by millions across the world.

Now, year-to-date, Dropbox's ~13% decline is better than the decline in the S&P 500 and dramatically better than the 40%+ crashes that many of its SaaS peers have seen. But that's because Dropbox started correcting earlier than most tech stocks: the company has really been in a downtrend since last summer, where it reached a peak above $32 per share.

The causes for the decay in Dropbox stock were the usual suspects: concerns over growth deceleration and heightened sensitivity over the competitiveness of the file-sharing space. Yet I think where the focal point of Dropbox's appeal lies is in its expanding profitability and cash flow - which should make it a very investable play in a market environment that is heavily concerned about safety and the bottom line. It's a good time, in my view, to assess buying the dip on Dropbox.

Chart
Data by YCharts

Revisiting the bullish thesis for Dropbox

I remain staunchly bullish on Dropbox and consider it a long-term hold in my portfolio. For investors who are newer to this stock, here's a refresher on what I believe to be the key bull case drivers for the company:

  • Dropbox isn't just trading on a pie-in-the-sky future projection, but on real free cash flow today, singling out from other SaaS stocks in this risk-averse environment. Growth and paying premiums for growth stocks is out; value is in. The fact that Dropbox has routinely dangled a target of hitting $1 billion in annual FCF by FY24 while continuously raising operating margins quarter after quarter is a big draw for investors. Note that in FY21, Dropbox already hit north of $700 million in free cash flow, so I think it's highly likely that this original $1 billion target gets replaced with something more aggressive.
  • Consumer upsells. More and more freelancers have emerged from the pandemic, untethering themselves from a corporate lifestyle and building brands and businesses of their own. Tools like Dropbox have become necessary infrastructure, and one with very low barriers to entry and ease of setup. Accordingly, Dropbox has differentiated itself from Box by appealing to these professional solo acts and small businesses, which is reflected by Dropbox's greater upsells to premium paid plans.
  • Enterprise market opportunity. Dropbox's traditional strength has always been in smaller/consumer users, though it has started ramping its enterprise efforts lately. There's still plenty of opportunities for Dropbox to take market share from Box here.
  • E-signature opportunity. The addition of an enterprise tool like DocSend will further flex Dropbox's muscles in the enterprise space, helping it catch up to its rival Box (the latter of which has long touted superior security capabilities). DocSend also makes a welcome addition to Dropbox's growing portfolio of collaboration tools, alongside HelloSign (a direct competitor to DocuSign (DOCU)). Like the rest of Dropbox's product portfolio, DocSend has a range of plans and pricing for users of various budgets and levels of sophistication, giving it immediate cross-sell applicability to all segments of Dropbox's customer base.
  • Buyback boost. On February 11, Dropbox's board approved another $1.2 billion in share buybacks, which is a great way for the company to capitalize recent share price declines. This authorization covers a whopping ~15% of Dropbox's current market cap.

Cheap valuation against both revenue and cash flow

Unlike many other software stocks, Dropbox's valuation today can easily be justified by both top and bottom line metrics. At current share prices near $21, Dropbox trades at a market cap of $8.21 billion. After netting off the $1.50 billion of cash and $1.37 billion of debt on the company's most recent balance sheet, Dropbox's resulting enterprise value is $8.08 billion.

For the current fiscal year FY22, meanwhile, Dropbox has guided to $2.32-$2.33 billion in revenue, consistent with its prior outlook, as well as $760-$790 million in free cash flow (a 33-34% FCF margin, versus a 33% margin in FY21):

Dropbox guidance update

Dropbox guidance update (Dropbox Q1 earnings deck)

Against this outlook, Dropbox trades at:

  • 3.5x EV/FY22 revenue
  • 10.4x EV/FY22 revenue

Either multiple, in my view, stresses the case that Dropbox is quite substantially undervalued and is overdue for a rebound.

Q1 download

Let's now go through Dropbox's latest Q1 results in greater detail. The Q1 earnings summary is shown below:

Dropbox Q1 results

Dropbox Q1 results (Dropbox Q1 earnings deck)

Dropbox's revenue in Q1 grew 10% y/y to $562.4 million, beating Wall Street's expectations of $559.1 million (+9% y/y). The company continues to grow its user base and its ARR as well.

As shown in the chart below, total paid users rose 8% y/y to 17.09 million at the end of Q1. In addition to that, the average revenue per user also grew incrementally to $134.63, driven by the increased popularity of premium plans. Dropbox's ARR also grew 8% y/y to $2.29 billion - we'll also remark here that this $2.29 billion in locked-in ARR already represents nearly 100% of the company's $2.32-$2.33 billion annual revenue guidance for the current year, implying some room for upside.

Dropbox user metrics

Dropbox user metrics (Dropbox Q1 earnings deck)

Here's some helpful commentary from CEO Drew Houston's prepared remarks from the Q1 earnings call, detailing the company's strategic priorities for the year:

I want to quickly remind you of our 2022 initiatives that we outlined in February. First, we're continuing to evolve our core FSF business to improve retention drive monetization. Second, we're expanding into workflows beyond FSF around documents with HelloSign and DocSend and rich media content to better serve creators and freelancers.

Finally, we remain focused on operational excellence as we continue to balance growth and profitability as Tim will discuss further. So we'll start with our efforts around retention. I'm pleased with our progress here as we continue to see our churn rate come down as a result of improvements we've made to the user experience. Last quarter, we further improve the sharing experience by giving users the ability to send Shared Links with edit permissions. In the past recipients of Shared Links could only view content and weren't able to edit or collaborate on it directly. Now, with edit permissions recipients can easily collaborate with folders in the same way as a single piece of content. We also drove meaningful improvement in loading performance with previews, which is one of our most traffic surfaces. After a number of technical improvements, users are seeing these pages load 30% faster compared to the beginning of the year."

Profitability is another key focus for Dropbox, which should align well to investors' risk-off attitude this year. Pro forma operating margins in Q1 rose 120bps to 30.3%, as shown in the chart below:

Dropbox margins

Dropbox margins (Dropbox Q1 earnings deck)

The boost in margins was driven largely by Dropbox's continued focus in hiring talent outside of its high-cost headquarters location in San Francisco. Note as well that success on this front encouraged Dropbox to slightly take up its operating margin guidance on the year to 29.0-29.5% (versus its prior outlook of 29.0%).

Free cash flow also grew nicely in the quarter, up 20% y/y to $130.7 million and representing a 23.2% FCF margin, two points higher than in the year-ago Q1.

Dropbox FCF

Dropbox FCF (Dropbox Q1 earnings deck)

Key takeaways

Stick to Dropbox - it has a number of great qualities for a sideways market, including an appealing valuation, strong profitability that technically makes Dropbox a member of the "Rule of 40" club, and rich free cash flows. Take any dips as buying opportunities.

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This article was written by

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With combined experience of covering technology companies on Wall Street and working in Silicon Valley, and serving as an outside adviser to several seed-round startups, Gary Alexander has exposure to many of the themes shaping the industry today. He has been a regular contributor on Seeking Alpha since 2017. He has been quoted in many web publications and his articles are syndicated to company pages in popular trading apps like Robinhood.
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Disclosure: I/we have a beneficial long position in the shares of DBX either through stock ownership, options, or other derivatives. 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.

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