It’s not necessarily a surprise that Dropbox (NASDAQ:DBX) stock has fallen. Dropbox stock is an obvious candidate to be sold amid a tech selloff And, indeed, DBX stock is about 50% below its June highs and touched a post-IPO low in December.
But like a number of growth stocks that have sold off, DBX stock still doesn’t look cheap. Backing out a little over $1 billion in cash and investments, DBX trades at over five times analysts’ average 2018 revenue estimate and about 40 times next year’s consensus earnings-per-share estimate.
Dropbox stock, however, is one of the more intriguing “buy the dip” candidates in high-growth tech. The company’s cloud exposure makes its outlook compelling. Dropbox’s revenue growth remains strong; its sales should rise about 25% this year, and analysts expect the company’s top line to increase 16% next year. And Dropbox is profitable already and has solid free cash flow.
DBX stock, however, is facing one big risk. And that risk will determine whether Dropbox stock looks cheap or should be cheap.
The Case for Buying Dropbox Stock
The bull case on Dropbox stock is that it’s a classic software-as-a-service (SaaS) growth story, the kind investors loved until just a couple of months ago. The number of users and the revenue per user on the company’s cloud platform are growing. In the third quarter, the platform’s paying users rose 18% year-over-year, and its average revenue per user(ARPU) increased nearly 6%.
Those users are “sticky” (they are unlikely to give up the platform) because of the sensitive and/or personal nature of much of the content that has been uploaded to the Dropbox platform. As a result, the company’s users tend to stay engaged and keep providing it with recurring monthly revenue.
With a base of 500 million registered users, most of whom use the free version of the site, Dropbox has a huge pool of additional, potential, paid users who could enable its growth to continue for years to come.
And the company’s efforts to add new services to the platform provide another catalyst. Dropbox Paper allows users to create collaborative documents. Dropbox Showcase is an improved way to share files and presentations. Both offerings should generate meaningful revenue going forward.
Meanwhile, DBX stock isn’t cheap on an earnings basis. But the SaaS model generates huge margin gains, which means the company’s earnings growth should nicely outpace its top-line increases. As a result, Dropbox stock can quickly grow into its valuation. Indeed, analysts’ average price target, which is above $34, suggests that Dropbox stock can surge about 60%.
The Competitive Risk to Dropbox Stock
But Dropbox stock is facing one clear risk: competition. In many ways, Dropbox pioneered cloud-sharing, but it’s no longer alone in the space. Alphabet (NASDAQ:GOOG,GOOGL) offers Google Drive. Microsoft (NASDAQ:MSFT) has a massive installed base of consumer and commercial Office 365 users to whom it can market its OneDrive. Amazon.com (NASDAQ:AMZN) can leverage Amazon Web Services to try to capture users as well.
Dropbox has carved out an impressive niche. But it will have to fend off the giants of tech to simply keep that niche intact. On this site in May, Will Healy argued that Dropbox looks like America Online (now owned by Verizon Communications (NYSE:VZ)). AOL was first to market, too, but it was quickly displaced by competitors that emerged.
The obvious risk facing DBX is that Google and Microsoft, in particular, can take over Dropbox’s niche. Dropbox is generating over $1 billion in revenue, but that’s a pittance compared to the top lines of its larger rivals. And even if Dropbox can hold its market share, it may have to lower its prices to do so. Price cuts would lower the company’s revenue growth and limit its margin expansion, likely causing its earnings growth to decelerate.
Can DBX Be Acquired?
An investor looking to buy the dip of DBX stock has to have confidence in the company’s competitive position. And if DBX is able to hold its own against that competition, the fact that Dropbox is competing against giants may turn out to be a good thing for DBX stock.
After all, a strong Dropbox would be a logical acquisition target, whether for rivals looking to add to their market share or new entrants to the market. Dropbox stock spiked in June, a move that appeared driven by rumors of its acquisition by Salesforce.com (NYSE:CRM). Apple (NASDAQ:AAPL) has been rumored to be interested in Dropbox as well.
A near-term deal probably is unlikely; even a 50% premium would value DBX at basically the same levels for which it traded as recently as August. But if the company reports strong growth in coming quarters, Dropbox stock could become a takeover target again. Even speculation about a deal could send DBX stock higher.
All told, DBX stock is intriguing, but its performance will be determined by Dropbox’s competitive strength. With no sign of weakness so far, and DBX stock near its lows, betting on that strength looks like a winning proposition.
As of this writing, Vince Martin has no positions in any securities mentioned.