SOPA Images/LightRocket via Getty Images
SOPA Images/LightRocket via Getty Images
Shares of Dropbox (NASDAQ:DBX) have lived up to their name, as shares dropped in a huge way following its fourth quarter earnings report. Moreover, it was the outlook for 2024 which essentially calls for stagnation in terms of sales, and certainly earnings. Given these developments, I am very cautious here as I see Dropbox facing continued fiercer competition.
This comes despite an increase in the product offerings, with more entrenched and larger players better positioned to provide such services as well, making me very cautious here, even after a setback seen in the share price already.
Dropbox describes its business as a leader in sync and share, offering a smart workspace for digital content collaboration, fostering individual and team workflows. The company stores over a trillion pieces of content, having more than 700 million registered users, which, of course, is something different from active users, but certainly something different from paying users. In fact, just 18.1 million users pay for these services, about one in forty users.
This compares to a user base of about 500 million at the item of the offering, with some 10 million users willing to spend for the services.
While the service has organically turned from a content backup and sync provider to a wider range of solutions, fostering and allowing teams to work in sync, with more services being added with the passage of time. By adding services and seducing more users towards paid versions, Dropbox aims to grow the business, but it faces stiff competition from multiple and much larger players. Teams and OneDrive from Microsoft (MSFT) come to mind, among others.
This news about stiff competition is nothing new; in fact, shares have been performing sluggishly and range-bound since the company went public in spring of 2018. The stock went public at $21, but immediately traded in the $30s, to subsequently trade in a $15-$30 range in the years which followed, despite a generally good environment for technology names.
By mid-February, investors in Dropbox had seen another disappointment, causing shares to fall from $33 to $25 overnight. The company reported a 7.6% increase in full-year sales to $2.50 billion. Dropbox posted adjusted earnings of $685 million, equal to $1.98 per share, yet this excludes a heavy pre-tax $338 million stock-based compensation charge. If I subtract these expenses, earnings are seen closer to $1.20 per share.
For the fourth quarter, growth slowed down with sales up 6.2% to $635 million, yet this growth and full year sales growth stood in sharp contrast to annual recurring revenues being reported essentially flat at $2.52 billion.
Despite a huge user base, the number of paid users rose by just 350,000 to 18.12 million over the past year, and in fact was down 50,000 since the third quarter. This is of course a red flag, with average revenues per user coming in around $139.
With 344 million shares now down to $25 per share, the company commands an $8.6 billion equity valuation. This includes about $1.35 billion in cash and equivalents, offset by a similar amount in convertible loans outstanding. This valuation has come down over time, as the company has bought back a chunk of its shares since the public offering, while it has seen solid sales growth, but moreover has seen operating leverage, having become profitable in the meantime.
Right here, valuations have fallen to about 3-4 times sales and around 20 times realistic earnings, as the market recognizes that the business has become much more mature, as lack of growth is what is driving fear among investors.
While a 20 times (realistic) earnings multiple for a technology name looks fair, the issue is that momentum is clearly slowing, as seen in flattish ARR trends and more recently some paid subscriber losses as well.
This is acknowledged on the conference call as well, as the company is not just seeing increased churn, it sees down-selling practices as well, with customers being more cautious on spending. Some of the churn was induced by the company itself, closing some loopholes by eliminating unlimited storage and family plans, among others.
These efforts weigh on the anticipated performance of the business into 2024 as well, with sales expected to come in between $2.535 billion and $2.550 billion, suggesting just about 1-2% sales growth. This comes amidst the efforts made by the business to tackle misusage in recent times, yet the company has hopes for improved commercial traction with new products features like Dash, its search capabilities. If all goes to plan, it might be (partially) monetized later this year.
That is badly needed as stagnation casts real doubts with investors, as the company sees adjusted margins between 32.0% and 32.5% of sales in 2024, comparing to margins of 32.8% reported in 2023. Rationalization efforts should in theory drive margin growth but comes amidst greater investments made into new product line-ups, as well as more limited pricing power.
Amidst all this, I understand why investors are fearful. While Dropbox has not posted impressive growth rates in recent years, the complete stagnation in ARR and paid user base raises concerns of migration to other, cheaper, or even free software options, or more embedded pieces of software likes Teams or OneDrive. This certainly casts a shadow on the competitive positioning of the firm.
Given this, I am not yet willing to see great appeal, even as valuations look reasonable for a technology player, as the lack of growth is quite telling.