Dropbox’s invested capital turns, a measure of balance sheet efficiency, ranks third out of the six companies listed in Figure 5. So users of those apps always hav… He is author of the Chapter “Modern Tools for Valuation” in The Valuation Handbook (Wiley Finance 2010). Over half of Americans online have never used cloud storage service Dropbox market share in the Datanyze Universe. David is a distinguished investment strategist and corporate finance expert. As featured in the HBS & MIT Sloan paper, Core Earnings: New Data and Evidence, our superior data drives uniquely comprehensive and independent debt and equity investment ratings, valuation models and research tools. THE CLOUD STORAGE WARS: APPLE LEADS WITH 27% MARKET SHARE. Inferior Offering at Higher Cost Limits Growth. Dropbox is popular with businesses of all sizes because it is one of the best tools for transferring large files. Figure 13: Implied Acquisition Prices to Create Value. For example, Google’s G Suite (which includes Google Drive) has 2 billion active users and Apple has 1.5 billion active devices (which include iCloud). This scenario represents the minimum level of performance required not to destroy value. You can see all the adjustments made to Dropbox’s balance sheet here. Combining human expertise with NLP/ML/AI technologies (feat. Elite money managers, advisors and institutions have relied on us to lower risk and improve performance since 2004. Figure 3 shows some of Dropbox’s direct competitors and their number of users, who have access to a free version of what Dropbox offers. Acquisitions completed at these prices would be accretive to Salesforce’s shareholders. 20% of iCloud customers were paying users in 2018, the last time Apple shared that stat. Dropbox hits 17% of market share with no associated content ecosystem. Figure 13 shows the implied values for DBX assuming Salesforce wants to achieve an ROIC on the acquisition that equals 8% and is greater than its WACC. The cost of cloud storage depends on the amount of space you actually need. This assumption is highly unlikely but allows us to create best-case scenarios that demonstrate how high expectations embedded in the current valuation are. With COVID-19-induced disruptions forcing most businesses to adapt their operations to be more remote friendly, Dropbox was in prime position to gain market share. However, upon closer look, Dropbox’s free cash flow fails to reflect the true economics of the business. Entrenched competition is well-positioned to take more market share, but the stock is priced for just the opposite. Dropbox lets anyone upload and transfer files to the cloud, and share them with anyone. Often the largest risk to any bear thesis is what I call “stupid money risk”, which means an acquirer comes in and buys Dropbox at the current, or higher, share price despite the stock being overvalued. Most of Dropbox’s competition is more profitable too. Dropbox ties its long-term performance awards directly to the performance of the firm’s stock by issuing time-based restricted stock units that vest over multi-year periods. The leading region in the Cloud Storage Industry was North America with a 42% cloud storage market share in 2017, followed by Europe with 28% cloud storage market share, Asia-Pacific with 25%, and the rest of the world with 5%. Box ranks fifth with a 5% share. Fiduciaries should avoid this week’s Danger Zone pick: Dropbox Inc. (DBX). Dropbox stated in its 2Q20 earnings call that it is on a trajectory to achieve its long-term free cash flow target of $1 billion by 2024. Below are specifics on the adjustments I make based on Robo-Analyst findings in Dropbox’s 10-Qs and 10-K: Income Statement: I made $67 million of adjustments, with a net effect of removing $9 million in non-operating expenses (1% of revenue). Sharing. For instance, the firm adds back stock-based compensation, a non-cash, but very real expense that dilutes shareholder value, to its calculation of FCF. Dropbox controls 21% of the cloud storage market, according to Datanyze, putting it in second place behind Google Drive (34%) and ahead of OneDrive (12%). Google Drive is the next in line with 27.27% market share. David is CEO of New Constructs (www.newconstructs.com). Back up and sync docs, photos, videos, and other files to cloud storage and access them from any device, no matter where you are. The report also revealed that cloud storage is overwhelmingly dominated by music, with about 90 percent of Apple, Amazon and Google cloud users storing music in the cloud. There are limits on how much Salesforce should pay for Dropbox to earn a proper return, given the NOPAT or free cash flows being acquired. I think it is difficult to make a straight-faced argument that Dropbox can maintain that level of market share with a more expensive and less integrated product. © 2020 Forbes Media LLC. Dropbox saw only a 16% YoY revenue increase in 2Q20 and a 17% YoY increase in 1H20. Dropbox’s paying users, the primary source of revenue, are growing much more slowly too. Figure 12 shows the implied values for DBX assuming Salesforce wants to achieve an ROIC on the acquisition that equals its WACC of 6%. See what HBS & MIT Sloan professors say in the paper: “…the NC dataset provides a novel opportunity to study the properties of non-operating items disclosed in 10-Ks, and to examine the extent to which the market impounds their implications.” – page 19, “Trading strategies that exploit cross-sectional differences in firms’ transitory earnings produce abnormal returns of 7-to-10% per year.” – page 1. 1.2 Market Analysis by Personal Cloud Storage, Public Cloud Storage, Private Cloud Storage, Hybrid Cloud Storage 1.3 Market Analysis by Enterprise, Government, Personal 1.4 Market Analysis by North America, Europe, China, Japan, Rest of the World 1.5 Market Dynamics 1.5.1 Market Opportunities 1.5.2 Market Risk 1.5.3 Market Driving Force. By dividing the implied revenue in 2027 of $5.6 billion by the firm’s 2Q20 ARPU of $126, I arrive at ~44 million implied paying users in 2027. Dropbox lets anyone upload and transfer files to the cloud, and share them with anyone. Over the past three months, insiders have purchased 4 thousand shares and sold 99 thousand shares for a net effect of 95 thousands shares sold. At the end of January, the consensus estimate for Dropbox’s 2020 earnings was $0.57/share. Dropbox’s net operating profit after-tax (NOPAT) margin of 2% is well below the market-cap-weighted peer group average margin of 21%. I think potential acquirers would be better off leaving cloud storage to the firms that can offer cloud storage as a free add-on to their deeply integrated services, but stranger things have happened than firms being acquired at unnecessarily high premiums to their intrinsic value. Figures 12 and 13 show what I think Salesforce should pay for Dropbox to ensure it does not destroy shareholder value. Should the firm have its first earnings miss, investors could get spooked and send shares lower. Figure 7: Dropbox’s Reported FCF vs. San Francisco, CA 94158, Cloud: Photo & Video Backup! I also optimistically assume Dropbox achieves a 4% NOPAT margin, which is above Dropbox’s TTM margin of 2% and Salesforce’s TTM margin of 1%. Access and share your photos, docs, and more from anywhere for free. In this scenario, Dropbox grows NOPAT from -$43 million in 2019 to $163 million in 2027, and the stock is worth just $7/share – a 63% downside. Cloud Storage Market Share by Region, 2017. Dropbox is at a disadvantage when it comes to competing for its competitors’ users. And with advanced sharing features, it’s easy to share docs and send files—large or small—to family, friends, and co-workers. Dropbox has over 600 million registered users, but as of 2Q20, just 15 million (or 3% of registered users) were paying users. You can see all the adjustments made to Dropbox’s income statement here. [1] My firm’s core earnings are a superior measure of profits, as demonstrated in Core Earnings: New Data & Evidence a paper by professors at Harvard Business School (HBS) & MIT Sloan. However, the cost per user, or average operating expense per paying user (AOEPU) has risen even faster from $85 in 2016 to $99, or 5.2% compounded annually in 2019. WebDrive has a share of 13.13% in the market. See the math behind this reverse DCF scenario. Having to charge users for services they can get free from competitors with whom they’ve already integrated puts Dropbox in a very poor competitive position. Dropbox’s share of the global cloud storage market has fallen from 4.4% in 2017 to 3.6% in 2019 as more competitors enter the space and existing competition ramped up storage options. Back UP your Photos & Videos Automatically!♻️. Dropbox has a share of 34.44% in the online file hosting industry. The number of shares sold short has increased by 4% since last month. Figure 11 compares the firm’s implied future NOPAT in this scenario to its historical NOPAT. Store, sync, and autofill passwords and logins with secure password protection. See our client testimonials. Figure 7 shows that while the firm’s reported FCF is trending up, Dropbox’s true FCF is moving in the opposite direction. Figure 8: Dropbox’s Revenue and Core Earnings Since 2016, Dropbox Is Priced to Reach 44 Million Paying Users or 30% of Amazon Prime Members. This adjustment represents 13% of Dropbox’s market cap. All Rights Reserved, This is a BETA experience. Each implied price is based on a ‘goal ROIC’ assuming different levels of revenue growth. Figure 4: Dropbox & Competitors’ Cloud-Based Storage Plans, Most of Dropbox’s Peers Are More Profitable Too. Further, Dropbox’s relative underperformance to its stronger peers during the COVID-19 disruptions could cause investors to wake up to the fact that Dropbox is losing market share and cause them to rotate their money into better investments. Consequently, these firms can offer cloud storage for free and still make plenty of money while Dropbox must make money on cloud storage. Paper is a collaborative workspace that helps teams create and share early ideas. The market also expects Dropbox to lose more market share given that the global cloud storage market is expected to grow much faster (by 22% compounded annually from 2020 to 2025). Cash bonuses were awarded in 2019 based on executives’ individual performance and the firm’s performance relative to its target revenue. The second platform on our list enjoyed popularity among consumers as an easy-to-use file storage suite, although it has shifted towards the enterprise market in recent years. Dropbox’s return on invested capital (ROIC) only tops Box, and at less than 4%, is well below the peer group’s market-cap-weighted average of 48%. Top Leading Companies of Global Private Cloud Storage Market are Amazon Cloud Drive, Ubuntu One, Apple iCloud, Dropbox, Google Drive, Box, Microsoft SkyDrive, MediaFire, SpiderOak, Mega and others. In the second scenario, the estimated revenue growth rate for year one is 14% in years one through five. This peer group includes Apple, Microsoft, Alphabet, Amazon, and Box. This adjustment represented 1% of reported net assets. In other words, DBX’s current valuation implies the company will grow its paying user base to equal 30% of Amazon Prime members and 22% of Microsoft Office 365 subscribers today. The following funds receive an unattractive-or-worse rating and allocate significantly to DBX: Disclosure: David Trainer, Kyle Guske II, and Matt Shuler receive no compensation to write about any specific stock, sector, style, or theme. Dropbox cloud storage offers a range of plans that uniquely meet personal, small and large business plan needs – from 2 TB to unlimited space. Despite years of rapid revenue growth and reaching profitability, the future for this cloud-based storage provider is murky at best. Since I first placed it in the Danger Zone, DBX is down ~8% while the S&P 500 is up 24%. True FCF. You may opt-out by. The future for cloud-based storage provider Dropbox is murky at best, as competition is well-positioned to take more market share. Investors with fiduciary responsibilities should consider the deteriorating fundamentals, weak competitive position, and the unrealistic user growth implied by the current valuation. In this scenario, Dropbox grows revenue by 17% compounded annually for eight years and reaches $5.6 billion in revenue in 2027, or 7.5 times more than the $737 million of revenue Box generated over the TTM. After adjusting for all liabilities, I can model multiple purchase price scenarios. Cloud drive storage to save photos, music, docs, video! In the first scenario, I use 14% revenue growth in year one and 11% in years two through five (vs. consensus estimates of 14% in 2020 and 11% in 2021). From Dropbox’s proxy statement, the compensation committee notes “annual revenue continued to be the best indicator of our successful execution of our annual operating plan.”. New Constructs provides unrivaled insights into the fundamentals and valuation of private & public businesses. With ties to revenue and stock price, it’s not surprising that the firm’s executive compensation plan has not created shareholder value. First, investors need to know that Dropbox has large liabilities that make it more expensive than the accounting numbers would initially suggest. Below, I quantify the high acquisition hopes that are priced into the stock. Because Dropbox started as a small company, freemium provided a way for more people to try the product and thus enabled people to experience the superior services, therefore expanded their market share. More broadly, Axler worries that Dropbox has saturated its cloud-storage market. If Dropbox cannot outgrow the competition in such a favorable environment, will it ever? Growing registered and paying users is a serious uphill battle for Dropbox since most of its potential paying users are already customers of firms that provide the same service as Dropbox along with many other important services. Catalyst – Slowing Revenue Growth With Increased Expectations. Launched on April 24, 2012, Google Drive allows users to store files in the cloud, synchronize files across devices, and share … See all adjustments to Dropbox’s valuation here. In other words, executives are incentivized to focus on revenue, with little to no regard to the profitability of the firm. Figure 12: Implied Acquisition Prices for Value-Neutral Deal. These days, fewer investors pay attention to fundamentals and the red flags buried in financial filings. And with advanced sharing features, it’s easy to share docs and send files—large or small—to family, friends, and co-workers. 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