Jim Cramer was very bullish on the initial public offering for Box (NYSE:BOX), suggesting that investors pay up to $18 for shares of the online storage company. Apparently he wasn't the only one, as shares soared as high as $24.73 on Friday -- a 77% gain relative to their $14 offering price.
Count me out. A quick look at the offering prospectus was enough to convince me that the offering price looked rich to begin with. Post-opening "pop," I wouldn't go anywhere near the stock.
Here are three reasons investors ought to be skeptical regarding this IPO.
Little to no competitive advantage
A lack of competitive advantage is not the rule with companies in this sector. When corporate software vendors can get their hooks into companies' IT infrastructure, they can be hard to dislodge. However, take the time to read the "Risk factors" section of the offering document, as you should with any company you're thinking investing in. It isn't just boilerplate copy, and you'll be rewarded with some critical information. Here's what Box has to say (my emphasis is in bold):
The market for cloud-based Enterprise Content Collaboration Services is highly fragmented, rapidly evolving, and highly competitive, with relatively low barriers to entry for certain applications and services. ... Our competitors include Citrix, Dropbox, EMC, Google and Microsoft. ... Some of our principal competitors offer their products and services at a lower price, which has resulted in pricing pressures on our business. With the introduction of new technologies, we expect competition to continue to intensify in the future.
A market that's highly competitive won't allow ordinary participants the opportunity to earn an economic return, which is what fuels market-beating stock returns. Box states openly that it's vulnerable to pricing pressure in response to the actions of larger, better-financed competitors. Furthermore, not only is the market highly competitive today, but there is also no expectation that this situation will change in the future. In fact, the company expects competition to intensify. For any long-term, business-oriented investor, this point alone rules Box out as a serious candidate for investment.
Classified as an "emerging growth company" under the JOBS Act of 2012, a classification the company could keep for up to five years post-IPO, Box is exempt from a number of reporting requirements. That in itself wouldn't bother me if I hadn't found a glaring example of opaque reporting with regard to a crucial metric: retention.
For a business of this type, getting a sense for retention is essential for gauging how "sticky" Box's services are and, thus, whether it has any hope of developing a defensible franchise. But instead of estimating retention on the basis of customer numbers, Box tracks the ratio of aggregate "annual contract value" of one period relative to the year-ago period. This is indeed a good "indicator for the growth of our business," but it isn't a great measure of retention, as the metric consistently exceeds 100%.
The stock isn't cheap
At the $14 offering price, the shares are valued at 8.5 times revenues for the 12-month period ended Sept. 30. At $24, that multiple leaps to 14.5. There is no problem, in principle, with paying a sky-high price-to-sales multiple for a high-growth company if you reasonably expect it to earn an economic profit. Doing the same for an unprofitable business that faces intense, growing competition requires you make a coherent argument that the company will be able to turn things to its advantage in that environment. Remember, growth in itself is not enough to justify paying up for a stock. Unprofitable growth destroys value at an increasing rate.
At its current price, Box looks like a very long-odds bet -- rather than clamoring to own shares, it ought to be easy to walk away from this offering.