Dropbox (NASDAQ:DBX) has lived up to its name, or at least the drop part. The stock started trading around $30 a share in 2018 following its initial public offering. Since then, shares have generally trended lower and are now down 40% since their debut. With earnings coming up Thursday, should traders give Dropbox stock one more chance, or is it time to throw in the towel?
Earlier this month, well-known short selling firm Spruce Point Capital took aim at Dropbox. Spruce Point concedes that the average investor views Dropbox as a “quintessential Silicon Valley software unicorn: a fast-growing, highly cash-generative SaaS company with a sticky customer base.”
However, Spruce Point claims that the truth is much darker. Instead Spruce Point writes that Dropbox is in a declining industry, is missing a major chunk of its addressable market, among other concerns.
Spruce Point’s Claims
Spruce Point makes a whole bunch of assertions. To summarize, though, they suggest that Dropbox is a company that has lost its direction. Look at Dropbox’s CEO Drew Houston recently joining Facebook’s (NASDAQ:FB) Board of Directors. It shows an executive that has free time while his primary company is struggling to turn things around.
Or look at Dropbox taking on a ton of new office space just a couple of years ago while its core business was losing momentum. Spruce Point calls the HQ a “poorly-timed and expensive vanity project,” particularly at a point where Dropbox is struggling to retain key employees. To that end, look at the departures of not one but two Chief Technology Officers along with the Chief Customer Officer.
More broadly, Spruce Point says Dropbox’s business just isn’t that good. The core storage operation is becoming a low-margin product with competition from all sides.
Dropbox has, they claim, missed chances to find higher-profitability niches within the space. To that end, Spruce Point slams the recent HelloSign acquisition as an “expensive” deal that still leaves Dropbox “not competitive in enterprise.”.
What to Watch with Earnings
This will be the first Dropbox quarterly report since Spruce Point’s negative research point. As such, it will be particularly interesting to follow some of Spruce Point’s most biting critiques.
For example, Spruce Point claims that the company’s total addressable market is almost saturated and that problems with its relationship with Samsung will limit app sign-ups. Thus, the total registered user number will be key. Spruce Point also expects the conversion rate of registered to paid users to come in below expectations.
More broadly, Spruce Point says brokers are too optimistic, with the average analyst maintaining a $27 price target. That gives them a ton of room to downgrade the stock if earnings miss on Thursday.
Spruce Point predicts that: “Brokers will slash price targets once 15% sales growth and 160 basis point margin expansion becomes [clearly unachievable] in 2020”.
Reinvention Efforts Are Struggling
Backing away from Spruce Point’s thesis specifically, let’s look at Dropbox’s position in the tech stock universe. In a way, you could argue that Dropbox was one of the original software-as-a-service companies. It was selling a cloud subscription service long before it became the hot Wall Street model.
A decade ago, Apple’s (NASDAQ:AAPL) Steve Jobs offered to acquire Dropbox. It turned him down. By 2014, Dropbox had 300 million users and a $10 billion valuation in the private market. Dropbox had all the momentum and credibility that cloud and SaaS companies are striving to obtain nowadays. The company seemed like a slam dunk winner at that point.
And yet, it all went wrong from 2014 onward. Integrated cloud storage alternatives from Apple and Google (NASDAQ:GOOGL) consumed much of Dropbox’s market. Meanwhile, workplace productivity applications like Slack (NYSE:WORK) stole Dropbox’s thunder within workplace applications.
Regardless of what you think of Spruce Point’s claims, Dropbox is clearly at a fork in the road. If they can’t evolve their business model quickly, they’ll see their moat erode painfully over time.
Dropbox Stock Verdict
Steve Jobs famously criticized Dropbox for being a “feature” rather than a “product.” File storage is important to have, to be sure, but does it really need to exist on its own? In the years since Jobs’ comment, file storage has become increasingly built into other products. iOS just made another big leap toward friction-less file sharing in recent months, for example.
Dropbox has long tried to build a workplace productivity suite around its core feature. However, these efforts haven’t succeeded to date, and the company is starting to run out of time.
There’s little indication that Dropbox will be able to pivot to a successful broader workplace productivity platform. And the company’s overhead and costs are simply too high for the current size of the business, particularly considering the commodization of their core product.
The stock could theoretically work. It looks like a value in an otherwise overheated market for cloud and SaaS stocks. Maybe Microsoft (NASDAQ:MSFT) or another of its rumored suitors comes in with a bid.
If things keep going down their current trajectory, however, Dropbox stock is unlikely to deliver favorable results to its shareholders. Dropbox has a lot to do this Thursday with its earnings report to prove the skeptics wrong. Otherwise, the stock is likely to plunge to new lows.
Ian Bezek has written more than 1,000 articles for InvestorPlace.com and Seeking Alpha. He also worked as a Junior Analyst for Kerrisdale Capital, a $300 million New York City-based hedge fund. You can reach him on Twitter at @irbezek. At the time of this writing, he owned FB stock.