Dropbox's Mixed Q4 Results: Growth Concerns Amid Earnings Beat

Dropbox: Top Line Trends Are Worsening Further (NASDAQ:DBX)

Though cheap at ~8x FCF, Dropbox's lack of clear growth drivers makes it a value trap that's best to avoid. The markets are expecting a tough macro climate across all industries heading into the second half of this year, but when investing in tech stocks, one rule remains paramount: don't trust a company that isn't able to grow. For Dropbox (NASDAQ:DBX), this unfortunately appears to be the case, as the file storage company continues to post lackluster growth rates and customer additions. Year to date, shares have lost more than 20% of their value. It rebounded ever so slightly after posting Q2 results, but that's largely a function of muted expectations. Despite a cheap valuation, Dropbox remains a snare as a value trap. I last wrote a bearish note on Dropbox in June, when the stock was trading at similar $22 levels. Since then, growth has continued to decelerate further, and the company hasn't been able to turn performance around and lift its guidance. Furthermore, it's becoming more evident with each passing quarter that Dropbox is losing market share to its rival Box, which has more insulation against the current macro due to its greater concentration to enterprise clientele (which tend to have lower churn rates). As such, I'm renewing my sell call on Dropbox. To me, continued deterioration in Dropbox's fundamentals serves to highlight all the red flags underpinning the bear case for this stock, which include: Growth rates are tepid and customer acquisition counts are faltering. In its most recent quarter, Dropbox added only 63k new users (a small fraction of a total ~18 million user base). Revenue growth has slid to the low single digits, and constant-currency growth is even lower than what the company is reporting. AI isn't a major tailwind for Dropbox, especially with its customer base tending toward simpler, smaller users. Though the company has released a smart-organization tool called Dropbox Dash, AI features haven't lifted the company's top-line growth rates, nor is AI spend likely to be a major tailwind for Dropbox going forward - especially as the majority of Dropbox's base tends to be consumers or smaller businesses that don't need complex AI tools. Dropbox is proving to be less sticky than originally thought. As churn rates have increased over the past year, many investors are re-evaluating the stickiness and value of Dropbox's subscription revenue base. Net debt. Despite its large free cash flows, Dropbox is still maintaining a net debt position, which is atypical of an enterprise software company of its scale. Deep competition. Dropbox has always been in a tug-of-war with competitors Google Drive (which has an advantage in pricing and integration with consumer email accounts) and Box, Inc. (BOX), which is better known for its enterprise-grade features and security. Steer clear here and invest elsewhere. Q2 download Let's now go through Dropbox's latest quarterly results in greater detail. The Q2 earnings summary is shown below: The core highlight here is revenue, which grew only 1.9% y/y to $634.5 million in the quarter; though this came in marginally ahead of Street expectations of $630.5 million, or 1.3% growth. Not only is this the lowest quarter for growth in Dropbox's history, the already-slow growth rate got sliced further in half from Q1 (dropping 140bps relative to 3.3% growth in Q1). A word here on Box's results -- Box has a January year-end (versus a regular December fiscal year for Dropbox), and so Box hasn't yet reported its Q2 (May results). But in Q1, Dropbox grew 3% to Box's 5%. And even if Box decelerates this quarter, it likely won't be as low as Dropbox's 2% (especially when Box has been successful at attaching its Box Skills AI solutions and selling multi-product packages to its enterprise clientele). In other words, Dropbox's competitive luster against Box continues to falter. And though we can't see results broken out for Google Drive, Drive continues to be a compelling option for freemium users, with up to 15GB free storage on any Google account that seamlessly integrates with email and other Google services. Dropbox, which isn't natively integrated with anything, offers only 2GB of free storage with its free basic plan. So on the enterprise side, Dropbox is getting squeezed by Box, and on the consumer/SMB side, it has to contend with Google Drive. To top it off, in the SMB (small business) space where Dropbox may have a shot, macro headwinds are darkening and threatening elevated churn. One bright spot of good news that we'll acknowledge: the company did add 63k net-new paid users in Q2, which was higher than 35k in net adds in Q1. Still, it's likely that the bulk of these adds are on the consumer side, as it's not moving the needle on revenue growth (though these users have the potential to expand their usage and upgrade their plans over time). The company noted that it continues to face macro headwinds and a more elastic reaction to recent price increases, but to its credit, it is optimizing certain sales motions to improve results. Per CEO Drew Houston's remarks on the Q2 earnings call: However, we continue to face headwinds from factors, including the challenging macro environment for SMBs, price sensitivity following our recent Teams price increase, and changes we made to the storage limits for our advanced Teams plan. These headwinds have thus far largely offset the progress we've made across our top of funnel initiatives. To combat these headwinds and to ensure a tight alignment of our product development and go-to-market efforts, we recently concluded an in-depth refinement of our customer segmentation model. The segmentation work informs our product roadmaps and guides both our self-serve motion and outbound sales teams as we build integrated sales campaigns targeted at key user profiles across our priority industries and geos. Specifically as well, the company notes that a lot of its new user sign-ups come from when an existing Dropbox user shares a file, so it has improved the sharing experience to make for more seamless lead additions here. Optically, it does look like Dropbox increased its profitability this quarter - but there are some one-time drivers underneath that are partially responsible. Pro forma gross margins increased 180bps y/y to 84.5% this quarter, but note that this was primarily due to the company extending the accounting on the useful life of its server hardware, reducing the depreciation cost captured in cost of sales. Pro forma operating margins, meanwhile, rose 160bps y/y to 35.9%, as some of the optical gross margin benefit was offset by higher sales and marketing, as well as general and administrative spending. We note operating margins are sequentially lower than 36.5% in Q1, where the company had improved eight points on a year/year basis: which is a disappointing result when growth rates tumbled so sharply since Q1. Valuation and key takeaways At current share prices near $22, Dropbox trades at a market cap of $7.30 billion. After we net off the $1.18 billion of cash and $1.38 billion of debt on the company's latest balance sheet, its resulting enterprise value is $7.50 billion. Again, we'll emphasize that Dropbox is one of very few enterprise software companies sitting on a net debt position instead of having ample net cash. Against the $930 million midpoint of Dropbox's $910-$950 million FCF target for this year, the stock trades at 8.1x EV/FY24 FCF, which is the only main appeal to this stock. Still, I'd caution that with a slowdown in margin expansion, as well as near-zero revenue growth that makes future margin or FCF growth very difficult, Dropbox has all the signals of a value trap. Steer clear here and continue to invest elsewhere. With combined experience of covering technology companies on Wall Street and working in Silicon Valley, and serving as an outside adviser to several seed-round startups, Gary Alexander has exposure to many of the themes shaping the industry today. He has been a regular contributor on Seeking Alpha since 2017. He has been quoted in many web publications and his articles are syndicated to company pages in popular trading apps like Robinhood. Analyst's Disclosure: I/we have no stock, option or similar derivative position in any of the companies mentioned, and no plans to initiate any such positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article. Seeking Alpha's Disclosure: Past performance is no guarantee of future results. No recommendation or advice is being given as to whether any investment is suitable for a particular investor. Any views or opinions expressed above may not reflect those of Seeking Alpha as a whole. Seeking Alpha is not a licensed securities dealer, broker or US investment adviser or investment bank. Our analysts are third party authors that include both professional investors and individual investors who may not be licensed or certified by any institute or regulatory body.

After Earnings Beat, Dropbox Growth Is Worth Keeping An Eye On (NASDAQ:DBX)

Dropbox's balance sheet shows negative shareholder equity, but manageable debt with potential for growth if user conversion to paid services continues. Growth stocks are great, until the growth slows down. Then you have a relatively stagnant company trading at bad premiums to its underlying value. Today, we'll be looking at one of those growth stocks that has seen some slowing of its growth in recent quarters, Dropbox (NASDAQ:DBX). The software company has some interesting multiples which may make it worth our attention. We will be looking at Dropbox not just for its lack of shareholder equity, but also from a potential value and growth perspective, particularly after they came in with earnings last week which beat estimates. Understanding Dropbox Dropbox has a service which allows the storing and sharing of digital data among various users. The company has substantial market penetration already, and reports that it is storing multiple exabytes of data. The company offers products related to the Dropbox service like Dropbox Passwords, Dropbox Sign, DocSend, Dropbox Capture and FormSwift. The various services are premiums which are offered through subscription fees. As of the end of 2023, Dropbox reported in its annual reports that they have 18.12 million paying users for their services. Dropbox also reported that they are investing in artificial intelligence technology, with an eye toward incorporating it into their services. They are a fairly substantially sized service, so it makes sense that they want to retain a comparative advantage that could be offered by AI. The Earnings After close on Thursday, Dropbox reported their earnings. The company came in at $634.5 million and 60¢ earnings per share, both of them beating estimates. The company also reported that they now have 18.22 million paying users for subscriptions. With admissions by the company that their growth has been slowing recently, coming in ahead of the estimates is a very good thing. Beating the earnings could, if it continues on a regular basis, show that Dropbox still has room for substantial growth. Consolidated Balance Sheet Cash and Equivalents $515 million Total Current Assets $1.23 billion Total Assets $2.72 billion Total Current Liabilities $1.18 billion Senior Notes $1.38 billion Total Liabilities $3.09 billion Shareholder Equity ($371 million) Click to enlarge (source: most recent 10-Q from SEC) Like a lot of growth companies, Dropbox has more liabilities than assets, and therefore a negative shareholder equity. That's not good if the growth doesn't start to pick up again. If the company is growing consistently going forward, the senior notes, which are paying in 2026 and 2028, respectively, will be readily manageable. Even as it stands, the debt isn't too scary. The Risks As mentioned above, the rate of growth of Dropbox has been declining recently. That's a potential issue, especially because data storage and sharing is such a competitive market, and customers have a lot of alternatives if Dropbox no longer seems like the en vogue thing to use. To maintain the view as a growth company, what they really need to do is continue to convert their new users of free services into paying users. The company makes a very nice gross margin, as we'll see later, but there's only that sort of margin for end users who are actually paying for some subscription service. Important in maintaining the company as it currently stands, Dropbox needs to find ways to retain existing users and ideally to convince them to upgrade into higher premium services than what they already have. Statement of Operations 2021 2022 2023 2024 (1H) Revenue $2.1 billion $2.3 billion $2.5 billion $1.3 billion Gross Profit $1.7 billion $1.9 billion $2.0 billion $1.1 billion Operating Income $274 million $181 million $539 million $270 million Net Income $336 million $553 million $454 million $243 million Diluted EPS 85¢ $1.52 $1.31 73¢ Click to enlarge (source: most recent 10-K and 10-Q from SEC) Dropbox has been growing, but as mentioned, it is growing slower than it had been previously. The thing I really like about the company is how high its gross margins are, which gives them a lot of room to offer discounts to try to grow their paid user base. As reported in 2023, the company would have a P/E ratio of 17.17. That's not a terrible premium for a company that is growing like Dropbox has the potential to, but if the growth continues to slow, it's a bit rich from my perspective. Still, estimates are that the company will be growing in the years to come. In 2024, the company is expected to come in at $2.55 billion with an earnings per share of $2.24. That gives us a forward P/E of a very reasonable 10. In 2025, the estimates predict things to continue about at the same pace, with revenue of $2.60 billion and earnings of $2.38. Conclusion Dropbox is trading at a fairly modest multiple to earnings, if the growth continues at an appealing enough rate. That's a big if, unfortunately, and to me, that's the difference between this being a buy at current levels, and what I view it, which is a hold. I believe the company does have a possibility of being at a justifiable price at these levels, and after last week's earnings beat I think it is important to keep a close eye on it, as it is possible that the company will keep up its growing that we've come to expect. If the stock does test its 52-week lows again, I would definitely be interested in the possibility of revising the stock to a buy. Dropbox is a solid company that would make a nice fit in a lot of portfolios, and at prices around or below $20 per share, I'd be very interested in adding some. I'm Jason Ditz and I have 20 years of experience in foreign policy research. My work has appeared in Forbes, Toronto Star, Minneapolis Star-Tribune, Providence Journal, Washington Times and the Detroit Free Press, as well as American Conservative Magazine and the Quincy Institute for Responsible Statecraft. I have been writing investment analysis, with a focus on deep-discount value plays, for over 25 years. I I got my start analyzing securities for a stock-picking contest on the now defunct StockJungle in college. After winning one of the top prizes for quarterly performance, I was hired to write a monthly article about micro-cap stocks, again with a value perspective. After StockJungle went belly-up, with its focus on momentum investing, I started to take a close interest in the contrarian investment philosophy of David Dreman. I began writing for Motley Fool and ultimately Seeking Alpha. My goal is to find underappreciated companies with a focus on returning value to investors. Analyst's Disclosure: I/we have no stock, option or similar derivative position in any of the companies mentioned, and no plans to initiate any such positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article. Seeking Alpha's Disclosure: Past performance is no guarantee of future results. No recommendation or advice is being given as to whether any investment is suitable for a particular investor. Any views or opinions expressed above may not reflect those of Seeking Alpha as a whole. Seeking Alpha is not a licensed securities dealer, broker or US investment adviser or investment bank. Our analysts are third party authors that include both professional investors and individual investors who may not be licensed or certified by any institute or regulatory body.