Dropbox (DBX -3.39%) used to be a Silicon Valley darling. Founded in 2007, the company skyrocketed to a $4 billion valuation in 2011, propelled by torrid user growth. Then, after going public in 2018 at a price of $21 per share and a market cap of more than $8 billion, it failed to live up to investor expectations. The stock is down around 15% from the closing price on its first trading day, trailing the S&P 500 during that time span.

However, while Dropbox has disappointed investors so far, if you look at its financials, the business has actually improved mightily since it first went public. After releasing its first-quarter results, the company is again showing why it's the ultimate tech value stock.

A blue cloud logo sitting on the edge of a laptop.

Image source: Getty Images.

The first-quarter results

In its latest report, Dropbox generated revenue of $511.6 million, up 12% year over year as it works to continue upselling its paid cloud management and file-sharing tools to the hundreds of millions of customers using its free product.

Paying users hit 15.83 million in the quarter, up from 14.59 million in the year-ago period, while average revenue per user (ARPU) increased 5% to $132.55. All of these inputs led to Dropbox growing its most important top-line metric, annual recurring revenue (ARR), 13% to $2.11 billion.

On the bottom line, Dropbox generated $108.8 million in free cash flow during the period, which was more than four times the $25.5 million it generated last year. Free cash flow is a better metric than net income for evaluating Dropbox's profitability due to the fact it has to defer revenue over the life of customer contracts. Right now, it has $641 million in deferred revenue sitting on its balance sheet, which won't get picked up on the income statement, leading GAAP net income to only hit $47.6 million in the quarter.

Investors should expect Dropbox to steadily grow its free cash flow in line with its customer and sales growth as a sign that the company can achieve steady profitability at scale.

Bolt-on acquisitions

One of Dropbox's biggest initiatives outside of improving its workflow management offering is to acquire new products and companies. It acquired Hellosign, a software tool similar to DocuSign, in 2019 for $230 million.

The goal is to integrate Hellosign within Dropbox and upsell the product to the over 15 million paying users of Dropbox, allowing them to easily send digital contracts all through one platform. According to management, signature requests on Hellosign grew 70% from 2019 to 2020, which indicates that so far, Dropbox has been successful in cross-selling the product to existing users.

More recently, Dropbox acquired Docsend on March 22 for $165 million in cash. The software tool helps investment firms, sales and marketing teams, and investor relations teams secure documents after sending them over to a third party. The core Docsend offering gives document senders analytics tools to track who has viewed what documents and at what time.

Time will tell whether Dropbox can integrate Docsend into its platform as well as it has with Hellosign, but on its face, it seems like the product will fit perfectly within the ecosystem. This should make Docsend an easy cross-sell to existing users.

Returning capital and a cheap valuation

Dropbox's underlying financials and pipeline for growth look solid, but investors should also look at its capital return strategy, specifically with share repurchases. Dropbox had an old $600 million buyback program that it exhausted this winter and has now authorized a new $1 billion program in conjunction with a convertible debt offering that raised $1.3 billion in cash in February. Management also upped its 2021 free-cash-flow guidance to $680 million (at the midpoint), which should help the company fund these buybacks as well.

At a market cap of $9.55 billion, $1 billion or more in share buybacks can meaningfully reduce Dropbox's share count, bringing the stock's valuation down with it. At the end of the first quarter, Dropbox's share count was 389.8 million, down 6% from the prior-year period as management aggressively returned capital to shareholders.

Dropbox trades at a forward price-to-free-cash-flow (P/FCF) ratio of 14 based on its updated 2021 guidance. If management continues to reduce the company's share count while also steadily increasing ARR and free cash flow, this valuation could become even more attractive in the coming years. 

Though Dropbox isn't the Silicon Valley darling it once was growing sales 50% or more every year, it still looks like a perfect tech stock for value investors.