Editor’s Note: This article was corrected on May 6, 2019.
When file storage platform Dropbox (NASDAQ:DBX) announces its first-quarter results this coming Thursday, current and would-be owners of Dropbox stock will (rightfully) be focused on one key metric… its margins. A disappointing margin outlook up-ended DBX stock three months ago, but hope for improved margins ultimately kept that weakness in check.
The market is optimistic about DBX’s results, as shown by the recent rebound of Dropbox stock. DBX stock is up 15% from last month’s low, and it’s putting pressure on a key technical resistance level. And, perhaps investors are correct to be optimistic about the company’s upcoming results.
Make no mistake though. Dropbox stock is still just a story stock, and the story will take a turn for the worst once investors realize the barrier to entry into the file storage business is quite low.
In fact, several huge tech names like Microsoft (NASDAQ:MSFT) and Alphabet (NASDAQ:GOOGL, NASDAQ:GOOG) already offer document-sharing solutions to the same business customers whom Dropbox is addressing. The gorillas just have not turned up the heat on those features. When and if they do (more “when” than “if'”), things could get real ugly real fast for the up-and-coming company and for Dropbox stock.
Margins Pressured
In Q4, DBX’s revenue and operating profits were solid enough. Dropbox did $375.9 million worth of business versus analysts’ average estimate of $370 million, and turned it into an operating profit of 10 cents per share, topping the consensus outlook of 8 cents per share.
The top and bottom lines were also well up from their prior-year comparisons. Sales were up 23% year-over-year, and Dropbox only earned 3 cents per share in Q4 of 2017.
DBX’s margin guidance left something to be desired, however.
Dropbox told investors that its Q1 operating margins would likely be between 7% and 8%, compared to analysts’ consensus estimate of 12.1%. For all of 2019, operating margins were projected by the company to come in between 10.5% and 11.5%, versus the consensus outlook of 13.4%.
The pressure on margins mostly stems from the purchase of HelloSign, which generated $20 million worth of revenue in 2018. Due to accounting rules, Dropbox will write down a “significant portion of HelloSign’s deferred revenue,” preventing the addition of that business to the company’s 2019 top line.
Analysts, for the most part, weren’t fazed. B of A analyst Justin Post upgraded Dropbox stock in the midst of the sharp selloff following the news, suggesting the file-storage company’s concerns were more short-term in nature than even Dropbox had realized. Its margins could, and likely would, rebound, Post stated.
JMP Securities analyst Pat Walravens agreed with Post’s thesis, saying “So look, the long-term fundamental drivers seem to be very much intact. Those are: Having your users and average revenue per user go up. As long as those two things are happening, the company is going to do great. [The drop of Dropbox stock] is really about the margin guidance, which was disappointing. It’s just below what people were expecting.”
Walravens believes the write-down of HelloSign’s deferred revenue in 2019 will ultimately reduce DBX’s margins by about a percentage point, but he, too, expects the company’s margins to eventually rise.
No Moat
The margin headwinds may well only be short-term in nature. But investors should also recognize that the nature of Dropbox’s business doesn’t allow it to build any sort of meaningful moat around itself.
Dropbox is, in the simplest terms, a cloud-based disk drive that can be accessed by different users using different devices. The company adds a myriad of bells and whistles to its interface, but at its core its product is a relatively simplistic and easy-to-replicate solution.
Others have already replicated it, in fact. Google Docs documents can be shared with, and even edited by, multiple people. Ditto for Microsoft Office documents managed via the cloud-based version of its Office productivity suite. Salesforce.com (NYSE:CRM) ofers the same features.
Those three platforms have an edge on Dropbox, collectively and individually. That is, they already do business with many companies. It’s highly likely, in fact, that most major enterprises are already customers of one if not two of those platforms. It will be easier for these companies to add a new feature from a vendor whose products they already use than to start doing business with DBX from scratch.
Dropbox doesn’t add enough value to draw a large number of customers away from the service providers they’re already familiar with.
Dropbox’s most effective solution is competing on price, which crimps its margins.
Once Google, Microsoft, and Salesforce decide to truly tout their respective document-sharing features, Dropbox will be forced into becoming even more price competitive.
The Bottom Line on Dropbox Stock
While the upcoming quarterly report will shed some more light on this pivotal matter, the story won’t end on Thursday. Dropbox remains a work in progress. It could take several quarters to truly get a feel for whether or not the company’s margin headwinds are going to be short-lived or the new normal.
More than that, the bigger and better Dropbox gets, the more compelled its rivals will become to fully enter the file-sharing sliver of the market. It could take years for the matter to be truly settled.
But at least the current and prospective owners of Dropbox stock know what’s going to push the stock’s buttons in the future.
As of this writing, James Brumley did not hold a position in any of the aforementioned securities. You can learn more about James at his site, jamesbrumley.com, or follow him on Twitter, at @jbrumley.
