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Beware of the Dropbox Inc. IPO

Dropbox may be good for a trade, but careful about the long term

By Lawrence Meyers, InvestorPlace Contributor

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Here comes the next big IPO. We will shortly be seeing the debut of Dropbox Inc., using the ticker DBX. It’s always exciting when there is a new IPO, particularly in the tech space, but it’s a good idea for investors to keep their thinking hats on and not get emotional. I think the IPO may offer a good short-term trade to the upside, but it remains to be seen if Dropbox is really going to be a viable long-term investment.

Remember, what is it that makes for successful business? The product solves a problem.

Except there’s a wrinkle to that. The product needs to be proprietary in some way, or it invites competition. In the case of Dropbox, the concept most certainly solves a problem. People all over the world need an off-site location to store and transfer files. There is certainly plenty of demand for this.

The problem comes in the form of competition. As a matter fact, Dropbox will be staring straight into the face of Box Inc. (NASDAQ:BOX). Not only that, let’s remember that Box was really the first innovation in the space, and is now facing competition from all the big tech names.

So I don’t see why Dropbox is any different. The technology is obviously terrific. I use Dropbox myself. The question is how much market share can Dropbox carve out and maintain over the long-term. When you’re up against players like Microsoft Corporation (NASDAQ:MSFT) and Alphabet Inc (NASDAQ:GOOG, NASDAQ:GOOGL), which have tens of billions of dollars on their balance sheet, you’ve got an uphill battle.

Dropbox has a decent business. It generated $1.1 billion in revenue in 2017. That’s almost a 30% increase over 2016, and 2016’s revenue of $845 million was a 40% increase over 2015’s $604 million.

As opposed to many other operations which just seemed to post ongoing losses, Dropbox is seeing smaller and smaller losses from operations. $306 million operating loss in 2015 was cut $294 million in 2016 and down $214 million last year.

More importantly however Dropbox generated $305 million in free cash flow last year. That’s very good news for the company. On the one hand I could argue that only having 11 million paying users out of 500 million registered users around the globe is not a terribly impressive conversion rate. It’s only about 2%. Alternatively, bulls could argue that there is plenty of room to generate a higher conversion rate, and each customer is worth hundred dollars in revenue on an annual basis.

That is certainly true, but let’s remember that with competition comes price wars. It’s a lot easier for Microsoft and Alphabet to grab market share with a less expensive product because they can afford to. Dropbox cannot afford such a luxury.

One might argue that Dropbox is hitting the IPO market at a reasonable valuation, at roughly 7X revenue. Box generally trades between 5X and 6X revenue. Dropbox is of course larger and also has less of its revenue devoted to marketing expense.

I think, given the state of the stock market, Dropbox is going to benefit from sentiment and momentum and that may make it a good short-term trade. Longer-term, I have my doubts.

Lawrence Meyers is the CEO of PDL Capital, a specialty lender focusing on consumer finance and is the Manager of The Liberty Portfolio at www.thelibertyportfolio.com. He does not own any stock mentioned. He has 23 years’ experience in the stock market, and has written more than 2,000 articles on investing. Lawrence Meyers can be reached at [email protected].


Article printed from InvestorPlace Media, https://investorplace.com/2018/03/beware-of-the-dropbox-inc-ipo/.

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