Dropbox: In Value Territory (NASDAQ:DBX)

Relooking Dropbox

In 2021, I had written two deep dive articles on why I consider that Dropbox (NASDAQ:DBX) is a boring however steady and essentially robust firm. Over the previous 1.5 years, Dropbox’s worth has remained comparatively flat and skilled a 11% drop final Friday following its 4Q22 outcomes.

However, I consider that Dropbox has been executing nicely and in keeping with my unique thesis two years in the past. While macro headwinds have brought on Dropbox to underperform inner expectations and far of the expansion got here inorganically in 4Q22, I consider that Dropbox stays essentially sound & the present worth means Dropbox is now in worth territory. Additionally, given Dropbox’s SaaS nature and $2.5b ARR, this additionally supplies draw back safety since a 3rd of its market cap is recurring in nature.

Therefore on this article, I will probably be highlighting some key positives and negatives of 4Q22 outcomes, sharing my opinions on why Dropbox has been executing nicely and at last offering easy and fast valuations to offer a gauge of how a lot worth you may be getting from shopping for Dropbox as we speak! Should you want to learn my deep dives on Dropbox, you possibly can view them right here:

• Dropbox: A ‘Boring’ But Solid Cloud Company (Jul 2021)
• Dropbox: You’ll Be Boxing Yourself If You Don’t Buy The Drop (Nov 2021)

The Negatives

While Dropbox posted earnings beat, I consider that almost all traders and analysts might have been spooked by among the feedback through the earnings name. There have been two notable negatives which may fear traders:

• Dropbox underperformed their addition to paying customers expectations, attributed to 2 causes. (1) High churn from training (2) Softness in groups and plus plans as a result of macro headwinds
• ARPU fell to $134.53, vs $134.78 for a similar interval final 12 months
• ARR progress for 4Q slowed to +$83m, the place $50m was from

In common, this implies that the financial system is not doing too nicely and we must always anticipate additional softness within the upcoming 12 months. Investors appeared to be spooked by this, however I personally consider that it’s an overreaction.

It ought to have already got been evident that we live in a interval of big macroeconomic uncertainty now, and lots of tech and non-tech firms have already began to point out weaknesses of their financials. Be it promoting {dollars} or commerce quantity, progress is stagnating and even declining therefore it will inadvertently have an effect on subscription {dollars}. This was additionally evident in slowing natural ARR progress and falling ARPU. However, I might be aware that FX headwinds had a $4.2 influence on ARPU therefore there was a 3% progress on a continuing foreign money foundation.

The Positives

Despite the worrying macro-economic situations, I really extracted extra optimistic sentiments from the current earnings and name:

• No of paying customers underperformed in 4Q however nonetheless elevated 5.8% the complete 12 months to 17.77 million vs 16.79 million for a similar interval final 12 months
• Management diligently adopted up on their buyback plan, lowering share rely by virtually 10% the previous 1.5 years. There continues to be >$700m left of their authorised buyback plan, which means there may be nonetheless room for an additional 10% discount
• Revenue & FCF continues to be anticipated to develop in 2024 at 6% and eight% respectively on their decrease estimates vary
• GAAP gross margins grew to 80.7%, up from 79.5% the 12 months prior
• Management remained optimistic on the 2024 $1 billion FCF purpose

Hence on a internet foundation, I felt that Dropbox total outcomes was optimistic to me as a shareholder. Fundamentals continued to enhance with rising income, margins (regardless of inflation) and paying customers whereas administration has executed nicely on their buyback program. If share costs proceed to remain low, it will permit much more shares to be purchased again within the coming 12 months, and shareholders will immediately profit from this.

SMB Threat

Another facet that traders might be anxious about is that Dropbox’s goal market is principally SMBs, who normally fare worse off in a recession. However, due the character of Dropbox’s enterprise — Cloud SaaS, which means that Dropbox is a necessity to operations and firms must proceed paying their subscription to make use of it. For companies of SaaS nature, customers additionally are inclined to delay upgrades reasonably than cancel their plans altogether.

Companies who find yourself churning are normally those who go underneath. To put issues into perspective, there was a peak enterprise chapter price of 60,000/12 months through the 2009 GFC whereas Dropbox has over 600,000 enterprise groups and 17.7m distinctive customers. Even if we assume the majority of income comes from enterprise groups, and all enterprise bankruptcies are Dropbox’s prospects, this solely will increase churn by an absolute 10%. A ten% churn nonetheless supplies an ARR of $2.25 billion. Even if this repeats for a second straight 12 months, ARR nonetheless stays at $2 billion with no additions. At an $8 billion market cap, this represents a P/ARR of 4 on the excessive worse case. This a number of (trade common) was final seen in… you guessed it, 2009!

Hence, it’s evident that Dropbox is already priced for the acute worse. I do not prefer to trouble predictions on the long run SaaS multiples however from a worth perspective, it’s clear that the upside is far better than the draw back!

Where Is The Value At?

The worth of Dropbox is evident, and I wish to present extra figures. Using a $22 worth, Dropbox has TTM multiples of:

• P/S: 3.4
• P/E: 14.5
• P/FCF: 10.5
• P/FCF (ex SBC): 18.5

This is reasonable, it doesn’t matter what comparisons you wish to use. In the long term, I consider Dropbox can develop FCF simply by 10-15%. A easy & conservative breakdown is as follows:

• Increase in paying customers +5 to 7% (Constant 2.5% freemium conversion, already on the low finish of HBR’s 2-5% estimate)
• Growing ARPU +2-3% (Inflation pegged, excluding cross and upselling to be conservative)
• Other progress can come from cross/up-selling and margin growth, all of which Dropbox are already doing, however will miss now to be conservative.

Hence, we are able to see that Dropbox has very engaging financials and we’re paying a P/FCF of 10.5 for a ten% minimal progress.

Good Capital Management

With robust FCF, we additionally want to make sure that it’s accretive to shareholders, and that is one other facet that I like Dropbox for. With free money circulate, we are able to see that administration has been participating in lively buybacks to complement shareholders, along with prudent investments to reinforce the Dropbox ecosystem. In a interval the place many SaaS firms have began shifting to bigger and pricier acquisitions for progress, Dropbox has caught to their technique of small, focused acquisitions to develop their ecosystem.

Their success has been mirrored within the firm’s excessive and rising ROIC. Just have a look at their ROIC in comparison with rivals!

A Final Angle

Finally, I have a look at Dropbox utilizing administration’s $1b FCF goal. Following my due diligence, I’m comparatively assured in Dropbox executing and hitting their goal. For this valuation, I’ll use Dropbox’s FCF ex. SBC to be conservative.

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For P/FCF I’ve used three believable situations. First, P/FCF of 15 represents the low vary of blue-chip SaaS – Oracle (ORCL) and SAP SE (SAP). P/FCF of 20-25 represents the common of blue-chip SaaS earlier than the pandemic increase. Dropbox’s P/FCF has additionally largely trended inside that vary, therefore it’s cheap to anticipate a restoration given robust fundamentals.

Therefore, even at worse, I’ll nonetheless be seeing 3.1% progress in Dropbox’s intrinsic worth over the subsequent two years, and the upside is extraordinarily massive, even when utilizing believable, sensible FCF and multiples.

Conclusion

In all, I’ve illustrated that Dropbox is a top quality and worth funding as we speak. You would possibly discover, I’ve not executed any advanced fashions or projections normally proven in different articles. However, it is because the worth in Dropbox is obvious to me. Sometimes, investing may be easy. Dropbox is an easy enterprise. Not a market chief, not quick rising, however this permits the corporate to thrive underneath the radar – offering a distinct segment providing to SMBs and offering robust accretive FCF to traders.

I’ll be aware some dangers earlier than ending. Admittedly Dropbox is unloved by the market and would require robust catalysts to be revalued at a premium. I do not see many robust catalysts past future earnings beat for now. If macro-environment deteriorates worse than anticipated, earnings targets would even be revised downwards. However, I primarily used TTM multiples so even when Dropbox information 0% progress in FY23, the valuation right here will stay the identical. In all, I consider the risk-reward profile of Dropbox may be very engaging and extra so given the unsure funding local weather as we speak.