Enterprise cloud provider Box (NYSE:BOX) was on the move on Wednesday. The BOX stock price rose nearly 9% as speculation increased that Box could be a takeover target.
The rumors do make some sense. Box is often compared to fellow cloud play Dropbox (NASDAQ:DBX). But despite the similar names and business models, the two companies serve two very different markets. Dropbox focuses more on consumers and SMBs (small and medium-sized businesses), while Box serves larger enterprises (among its customers are Procter & Gamble (NYSE:PG) and General Electric (NYSE:GE).)
That enterprise focus creates a number of logical suitors for Box. Alphabet (NASDAQ:GOOG,GOOGL) has been floated as a potential buyer. Microsoft (NASDAQ:MSFT) might make some sense. Even private equity funds might be interested, according to at least one analyst.
As a result, M&A chatter has surrounded the company since its 2015 IPO (and even before), with the BOX stock price spiking this summer on takeout rumors as well. But that chatter alone hasn’t been enough to keep BOX stock afloat. The stock still trades below its first-day close of $23, and touched a nearly-two-year low last month.
The problem with BOX stock is the flip side of the M&A argument: competition is intense. The same giants who could buy Box out may also choose to simply undercut the company on pricing in order to take its market share. And with profitability still narrow in a nervous market, that risk is enough for investors to stay away from BOX, despite the rumors.
The BOX Stock Price Jumps
The case for BOX stock admittedly goes beyond just M&A. Box is growing nicely. Revenue is guided to increase 20% in fiscal 2019 (ending January), after 25%+ growth last year. That guidance was raised in the third-quarter report, though the BOX stock price fell on the news anyway.
BOX is unprofitable — but earnings are around the corner. The company is guiding for its first quarterly profit in fiscal Q4. Spending has been high in the past, and operating leverage minimal, but that’s starting to change, just as management predicted a few years ago. Adjusted operating margins rose over 8 basis points in Q3, and should improve further going forward as add-on products help revenue growth and margins.
That growth should continue for years. Existing customers will stay “sticky”; Box’s revenue retention rate remains over 100%. (That’s a notably better figure than Dropbox, whose consumer customers tend to come and go.) New customers are being on-boarded, with the total base clearing 90,000 in Q3. And as more and more enterprise activity moves toward the cloud, Box should benefit.
It’s a strong growth case — and there’s the takeover angle as well. Box would fit in nicely with Microsoft’s cloud strategy. The enterprise customer base would be of great interest to Google. Other enterprise software players like Salesforce.com (NYSE:CRM) could be kick the tires. In a takeout scenario, profit margins are less important. And at roughly 4x FY19 revenue, BOX could merit a premium in a sale.
The Risks to BOX
The most obvious risk to BOX stock is on the competitive front. The same giants that make sense as buyers also are existing competitors. Google offers Business Solutions for Enterprise. Microsoft obviously has decades-long relationships of some type with nearly every major company on the planet. Back in April, Will Healy highlighted the competitive problem here — and little has changed since.
And the problem, if BOX doesn’t sell itself, is that the financials aren’t strong enough yet. It’s true the company is moving toward profitability, but Q4 adjusted earnings are expected to be only 2-3 cents. Consensus for full-year fiscal 2020 earnings per share is just 2 cents.
Even those figures exclude a substantial amount of stock-based compensation which has been 20% of revenue so far this year. This simply is a business that is a long way from true, consistent profitability.
That means investors have to show quite a bit of patience — while hoping the company can fight off competition. That seems a tough combination and one likely to result in another pullback at some point. With investors already nervous at the moment, BOX stock hardly seems the choice for a flight to safety.
A long position at this point has to be, in large part, a bet on a sale. But, even with the speculation, a takeout isn’t guaranteed. If a giant decides to rescue Box, the BOX stock price could soar. If not, upside could be tough to find. It seems like, even in this market, there are more compelling long cases out there.
As of this writing, Vince Martin has no positions in any securities mentioned.