In 2020, rising profits drove Dropbox's (DBX 1.34%) stock up more than 20%. Yet on Jan. 13, Dropbox announced that it's laying off 315 employees -- or 11% of its workforce. CEO Drew Houston wrote a letter to all the Dropbox employees citing this as an effort to focus on "strategic priorities." While layoffs are always difficult to endure, they can help businesses focus their resources on key initiatives and be more successful long-term. Here's why I think this is one painful step to a more profitable future for Dropbox.
Narrowing its focus
Around 2017, Dropbox began pivoting from consumer-focused storage to business-focused collaboration. However, Dropbox competes in a hypercompetitive industry with deep-pocketed competitors like Microsoft (MSFT 3.20%) and Google (GOOGL 2.37%) who can afford to undercut Dropbox on price and steal away customers. To combat the competition, Dropbox has narrowed its focus to designing the best products for virtual work while minimizing friction within multiperson teams.
To achieve this goal, Dropbox seems to be slimming down and demonstrating where its priorities lie. Eliminating teams of employees focused on other initiatives not only helps reduce expenses, but also allows Dropbox to focus on its top performers. Netflix (NFLX 0.58%) CEO Reed Hastings famously defines this concept as "increasing talent density." Cutting out employees who aren't contributing substantially to the current goal at hand allows companies to optimize their existing workforce while running a leaner operation. Most people might call this ruthless, but the material benefits are hard to refute.
If we assume the average salary of a Dropbox employee is about $100,000 a year, then by laying off 315 employees, Dropbox is saving more than $30 million in costs annually, excluding the three-month severance it has committed to paying out. In addition to the payroll savings, Dropbox has stated that it's allowing employees to work virtually indefinitely, which should minimize expenses required to maintain its offices. As long as these departures don't compromise the product or customer experience, these savings should result in extra cash on hand -- and Dropbox has made clear how it intends to spend that cash.
In Drew Houston's email to all employees, he stated that one of Dropbox's top priorities for 2021 is investing in new products built for distributed work. Just months before Houston sent the companywide email, Dropbox announced that it was preparing to launch a new feature called Spaces 2.0. Spaces is similar to a shared folder, providing a unified place for multiple teams to collaborate on a single project from start to finish. This new feature will include an app center that should allow teams to easily meet, assign tasks, edit and upload files, sign contracts, and much more, all stemming from the same initial collaboration hub.
Building on success
Dropbox looks to be piggybacking off a very successful year. In the last 12 months, the company added 1.25 million paying users, a 9% increase, while boosting the average revenue per user from $123.15 to $128.03. For the first nine months of its current fiscal year, Dropbox booked a 16% year-over-year jump in revenue and a 21% boost in gross profit.
At the customer level, it's very difficult for an enterprise team to change storage providers or collaboration tools. Not only does it take time to switch all the files from one place to another, but adopting a new system is a laborious process. The time consumed by switching platforms tends to cut into a company's overall production. That hassle means Dropbox's 15.25 million paying users seem unlikely to switch to a rival, especially since Dropbox continues to innovate and bolt on additional layers of functionality. New products like Spaces, or the recent acquisition of e-signature provider Hellosign, might not independently move the needle in terms of new customers, but each additional feature offers yet another reason to stay on the Dropbox platform.
With the addition of new customers and the strength of existing customer spend, Dropbox delivered substantially higher profit margins year over year, On a GAAP net income basis, Dropbox transitioned from unprofitable to profitable over the first nine months of the year. And over the trailing 12 months,Dropbox generated roughly half a billion in free cash flow. Yet despite the impressive year, the company still trades at a market cap of just under $9 billion. At 18 times its trailing-12-month free cash flow, Dropbox looks fairly cheap versus competitors like Microsoft and Google, who both trade well above a free cash flow multiple of 30.
As customers stick around, and Dropbox reduces overall costs, profits should rise -- and shareholders will likely benefit.