We’re now two months into 2022, and the dramatic fallout in tech stocks still hasn’t found a bottom yet. It seems, however, that the more value-oriented SaaS stocks have been relatively more shielded from the correction, and Dropbox (DBX) is no exception.
The consumer-friendly file storage software provider, a rival to the more enterprise-oriented Box (BOX), has seen its shares drop “only” 8% since the start of the year, versus many SaaS counterparts that have suffered corrections of 30% or more. Dropbox continues to act as a foil to the rest of its sector: whereas most SaaS companies are growing quickly but printing red ink, Dropbox has seen its growth rates mature but is focusing on margins and profitability. The latter seems to be of more importance to investors these days, hence the relative outperformance. Dropbox also released strong Q4 earnings last week that beat Wall Street’s expectations on the top and bottom line, while also showing superb free cash flow growth.
Given the conservative bent that the market continues to take, as well as the fact that Dropbox remains down ~ 30% from October highs near $ 33, I remain quite bullish on Dropbox’s prospects to continue outperforming the markets throughout the rest of the year. I think Dropbox continues to be a shining example of balancing growth and profitability while also trading at a very compelling value. And it’s not like Dropbox’s growth prospects are nil, either – the company has taken steps over the past few years, through both organic development and M&A, to extend its product platform into areas like e-signatures that offer additional incremental growth opportunities.
Here’s a recap of what I think to be the core drivers of the bullish thesis for Dropbox:
- Dropbox isn’t just trading on a pie-in-the-sky future projection, but on real free cash flow today, singling out from other SaaS stocks in this risk-averse environment. Growth and paying premiums for growth stocks is out; value is in. The fact that Dropbox has routinely dangled a target of hitting $ 1 billion in annual FCF by FY24 while continuously raising operating margins quarter after quarter is a big draw for investors. Note that in FY21, Dropbox already hit north of $ 700 million in free cash flow, so I think it’s highly likely that this original $ 1 billion target gets replaced with something more aggressive.
- Consumer upsells. More and more freelancers have emerged from the pandemic, untethering themselves from a corporate lifestyle and building brands and businesses of their own. Tools like Dropbox have become necessary infrastructure, and one with very low barriers to entry and ease of setup. Accordingly, Dropbox has differentiated itself from Box by appealing to these professional solo acts and small businesses, which is reflected by Dropbox’s greater upsells to premium paid plans.
- Enterprise market opportunity. Dropbox’s traditional strength has always been in smaller / consumer users, though it has started ramping up its enterprise efforts lately. There’s still plenty of opportunities for Dropbox to take market share from Box here.
- E-signature opportunity. The addition of an enterprise tool like DocSend will further flex Dropbox’s muscles in the enterprise space, helping it catch up to its rival Box (the latter of which has long touted superior security capabilities). DocSend also makes a welcome addition to Dropbox’s growing portfolio of collaboration tools, alongside HelloSign (a direct competitor to DocuSign (NASDAQ: DOCU)). Like the rest of Dropbox’s product portfolio, DocSend has a range of plans and pricing for users of various budgets and levels of sophistication, giving it immediate cross-sell applicability to all segments of Dropbox’s customer base.
- Buyback boost. On February 11, Dropbox’s board approved another $ 1.2 billion in share buybacks, which I consider appropriate given the company’s modest valuation (which we’ll discuss next). This authorization covers a whopping ~ 13% of Dropbox’s current market cap.
From a valuation perspective – at current share prices near $ 23, Dropbox trades at a market cap of $ 9.04 billion. After we net off the $ 1.72 billion of cash and $ 1.37 billion of debt on Dropbox’s most recent balance sheet, the company’s resulting enterprise value is $ 8.70 billion.
Meanwhile, as seen in the chart above, Dropbox has guided to $ 2.32- $ 2.33 billion of revenue for next year, representing a growth rate of 8% y / y. I think this estimate may prove to be conservative as Dropbox exited Q4 at a 12% y / y growth rate. It also guided to $ 760- $ 790 million in FCF, representing a 33.3% FCF margin at the midpoint and ~ 10% y / y growth versus FY21. Against this outlook, Dropbox trades at:
- 3.7x EV / FY22 revenue
- 11.2x EV / FY22 FCF
In other words, I think there’s still plenty of undervalued, hidden opportunities in Dropbox stock. This year’s outperformance to date is likely to continue playing out; stay long here and ride the upward momentum.
Dropbox posted excellent Q4 results, though the stock has yet to see any positive reaction post-earnings (falling in sympathy with other tech stocks). The Q4 earnings summary is shown below:
Dropbox’s revenue in Q4 grew 12% y / y to $ 565.5 million, beating Wall Street’s expectations of $ 558.4 million (+ 11% y / y). Note that revenue has been on a slow, but steady deceleration curve; with Q4 revenue growth clocking in one point lower than Q3’s 13% y / y growth pace, which in turn had decelerated one point from 14% y / y in Q2. That being said, Dropbox’s growth target of 8% y / y for FY22 is quite a conservative one that should not be difficult to “beat and raise” against.
User metrics continued on an upward path. The count of paid users in Q4 expanded by ~ 300k to 16.79 million, while average revenue per user also increased to $ 134.76, roughly a dollar more per user than in Q3. As previously noted, ARPU expansion has been driven by the fact that Dropbox has been successful in pushing its more premium-priced consumer plans, plus new offerings like e-sign. The company also added roughly ~ $ 43 million of net-new ARR in the quarter to end at $ 2.26 billion. We note that Dropbox’s $ 2.26 billion in ARR at the end of this quarter already covers 97% of the company’s revenue guidance for next year.
Here’s some commentary from Dropbox CEO Drew Houston on the company’s priorities for the upcoming FY22:
I’m excited to build on all the great work from 2021 this year. As I’ve shared before, there’s never been a better time in history to be building software to improve the experience of modern work, and Dropbox is uniquely positioned to support our customers as they transition to new ways of working. To help frame our strategy, I want to reiterate some of the key macro trends we continue to see in this environment. First, over the last year, we’ve continued to see companies accelerate their shift to the cloud as they adapt to more flexible or hybrid working models. We also see the ongoing growth of the creator economy as new tools and platforms offer more seamless ways to create, publish and monetize content. And more broadly, it’s clear to us that the shift from working primarily in physical offices to working primarily in digital screens is a permanent one. We continue to see a huge opportunity to improve that experience and help organize the digital lives of our customers.
So with these themes in mind, this year, we remain focused on three important pieces of our strategy, much of which is consistent with the work we began in 2021. First, we’ll continue to evolve our core FSS business to improve retention and drive monetization. Second, we’re expanding workflows beyond FSS around documents, with HelloSign and DocSend, while also investing in rich media workflows to better serve creators. Finally, we will stay focused on operational excellence as we continue to balance growth and profitability. “
The latter goal on profitability is already something that is in motion at Dropbox. Pro forma gross margins in Q4 hit 80.9%, 90bps higher than 80.1% in the year-ago quarter. The company expects to be able to sustain ~ 81% gross margins in FY22.
Pro forma operating margins, meanwhile, got a boost to 29.7%, which is 440bps better than 25.3% in the year-ago quarter. On top of the one-point improvement in gross margins, Dropbox also managed to decrease sales and marketing spend as a percentage of revenue by two points.
On top of that, Dropbox’s full-year free cash flow soared 44% y / y to $ 707.7 million, representing a hefty 32.8% margin – seven points better than in the year-ago quarter.
It’s important to remember that Dropbox is a member of the “Rule of 40” – with a 30% pro forma operating margin plus 12% revenue growth, the company’s balance of growth and profitability fares much better than most SaaS counterparts. And yet Dropbox still trades at massive discounted multiples of revenue and free cash flow. For that reason, plus the new $ 1.2 billion authorization in buybacks that should provide a reasonable floor for the stock price, I think Dropbox continues to be an attractive low-risk play for 2022.