Dropbox, Inc.

    • Dropboxs (“DBX” or “the Company”) was once seen – and is still seen by most investors – as the quintessential Silicon Valley software unicorn: a fast-growing, highly cash-generative SaaS company with a sticky customer base and a long runway for upsells. Spruce Point finds overwhelming evidence that the story has changed: Dropbox is a decelerating business in an increasingly low value-added space, with little network effects or barriers to entry. Meanwhile, management’s recent attempt to reaccelerate growth appears to be falling flat. We have collected unique data showing that its late FY19 decision to raise prices after creating a more “business-friendly” platform – dubbed the “New Dropbox” – has enraged some of its core individual/SMB user base, and has given customers new reason to consider switching. Some investors take solace in Dropbox’s seemingly healthy cash flow, but Spruce Point believes that its FCF margin is misunderstood by the Street by as much as 2x. Dropbox is a melting ice cube, and management’s last-ditch turnaround attempt is poised to disappoint lofty analyst expectations. Spruce Point believes that its new normal of accelerated churn, increased capex, and rising customer acquisition costs will come to bear on results as soon as the next few quarters.
    • Increasingly Low Value-Added Industry: In the decade since Dropbox was one of the first to market with retail cloud storage in the late 2000s, industry behemoths like Google, Microsoft, and Apple have begun to offer cheap or free storage plans as part of broader cloud software solutions, causing Dropbox’s paid user growth to begin to approach single-digit levels. Margin expansion – as high as 1,500 bps per year as recently as FY17 – has also skidded to a virtual halt. Dropbox is effectively a “pure play” company in an industry which is becoming increasingly commoditized to the point of near-zero returns at the extreme.
    • Missing The Boat On The Remaining TAM: File storage and sync competitors such as Box, as well as other new entrants, are focusing their efforts on the enterprise vertical, where companies are increasingly looking to outsource file storage onto the cloud in a secure manner. Dropbox initially carved out its niche among retail and SMB users, and has failed to make similar inroads among large corporates. Industry experts tell us that Dropbox is virtually “nowhere to be seen” on the marketing trail in the enterprise vertical, as it does not meet many of the stringent compliance and cybersecurity needs of large businesses in heavily-regulated industries. The initial response to Dropbox’s new feature rollout appears to be “too little, too late” among these potential customers.
    • Not-So-Sticky Customer Base Given A New Reason To Switch: In an attempt to appeal to the enterprise market – and to raise prices on existing customers – Dropbox rolled out an entirely new platform (“Dropbox Spaces”) in Sept 2019. The customer response appears to be extremely negative, with users speaking out across forums to voice their displeasure with the price hike. Spruce Point’s proprietary customer survey reveals that half of Dropbox users – individual and business alike – do not believe that the new features justify the price hike, and that two thirds do not believe that it would be difficult to shift to a different cloud storage provider. Our survey results also indicate that the changes to Dropbox’s platform and pricing structure will result in accelerated churn in the near term, about which management is rarely transparent in its own right. Not surprisingly, key Dropbox executives are departing just as these changes take effect.
    • Cash Flow Potential Misunderstood By A Significant Margin: We find that Dropbox, like most aggressive tech companies with poor business models which we’ve evaluated, tries to spin a rosy “Non-GAAP” measure of Free Cash Flow, suggesting 30% FCF margins. However, Dropbox depends heavily on capital lease spending – effectively deferred capex – that is growing faster than the market believes, yet which its proprietary FCF metric ignores. This capex, along with rising customer acquisition costs and heavy share repurchases to offset stock compensation programs, will cause Dropbox’s cash flow to fall significantly below expectations.
    • Spruce Point Sees 25%-60% Downside Given Near-Term Headwinds And Cash Flow Adjustments: Analysts have largely maintained their lofty pre-IPO price targets on DBX, seeing 50%+ upside despite tangible evidence that the growth story is faltering. Bulls may think that its 3.8x NTM sales multiple is starting to “look cheap,” but this view ignores the declining quality of DBX revenue, tied to a fickle customer demonstrating rising churn, and to a service with a declining value proposition. We see a major reset coming as management’s levers to increase ARPU disappear, its TAM taps out, and more human capital departs in search of the next hot Silicon Valley growth story. As revenue challenges mount, we believe investors will focus more on the economics of Dropbox’s cash flow. While it currently trades at 105x our projected 2020 FCF, we believe that maturing “SaaS” plays with higher margins trade at 25x-50x, implying material downside risk.