Dropbox (DBX 0.68%) went public in 2018 with a lot of hype and fanfare. Its IPO was reportedly 25 times oversubscribed, indicating there was tons of institutional interest in owning shares of the cloud storage platform. However, the three years since its IPO have been less than ideal for Dropbox with shares just slightly above its IPO price of $21. Maybe the expectations were too high for the Silicon Valley unicorn.
With Dropbox underperforming the broad market and significantly trailing its cloud peers (many of which are up triple digits over the past three years), many investors seem to have forgotten the company even exists. However, through the leadership of founder Drew Houston and other executives, the company is actually doing fine and seems to have broken away from its post-IPO woes. Here are four reasons why investors are underappreciating Dropbox.
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A combination of profits and growth
Many cloud, software-as-a-service (SaaS), and tech companies rely on consistent injections of capital to fund their money-losing operations. Dropbox is the opposite. Last quarter, it brought in $487 million in revenue, growing 14% year over year, while also bringing in $30 million in GAAP operating income (up 261%). That bottom-line performance was impressive, but remember that the company is coming off a small base, and profits will likely track closer with or be slightly higher than sales growth over time. Still, investors will appreciate the fact Dropbox can invest in growing its user base while staying profitable at the same time, especially in 2020 with pandemic-related expenses.
Management's long-term target is to hit $1 billion in annual free cash flow by 2024. This would represent a 20% compound annual growth rate over the next four years. Why free cash flow instead of operating profits? With a business like Dropbox that offers subscriptions, it has to recognize its revenue over the life of its contracts even if it brings in most of the cash from customers upfront. This leads to a difference between the revenue it reports and the cash it generates, which is why free cash flow is the better metric for evaluating the cash Dropbox is generating.
Product evolution
Dropbox started as a simple cloud storage tool. This service was quickly commoditized by the likes of Alphabet and Microsoft, which forced the company to pivot to offering what it calls Dropbox Business, a subscription service that offers tools to manage documents, projects, and collaboration in a central hub.
One part of this pivot from storage to workflow was the release of Dropbox Spaces. Spaces helps companies manage projects as employees collaborate from a decentralized work environment, which is huge in a world with more people working from home. Dropbox also acquired Docusign competitor HelloSign and has now integrated the tool for Dropbox subscribers. Having a digital signature service is not revolutionary, but it helps keep users within the Dropbox ecosystem and ever so slightly increases the value of being a subscriber.
Leadership
Founder Drew Houston still serves as the CEO. He owns over 20% of the company, aligning his incentives with shareholders (when he does well, they do well), and he knows the company better than anyone. While Houston was only 24 when he started Dropbox back in 2007, he now has more than a decade of leadership experience under his belt (and almost three years as a public company CEO). This experience will only grow as he leads the company forward.
Valuation
Dropbox currently trades at a market cap just north of $10 billion. The stock sports a trailing price-to-sales ratio (P/S) of 5.5 as of this writing. This is a huge discount relative to its peers with the average systems and management software company currently trading at a multiple of 11.4. Dropbox also has an impressive gross margin of nearly 80%, indicating the company will have high profit and cash flow margins as it matures. Simply put, if management is right and Dropbox can reach $1 billion in annual free cash flow in a few years, a market cap of $10 billion seems very reasonable.
While Dropbox is not a perfect company and has many competitors with large balance sheets, it is focused, founder-led, has great unit economics, and trades at an attractive valuation. Investors should take a hard look at Dropbox at these prices.
