Deep dive into Dropbox ($DBX)
The outsider with a sticky product
1.0 Introduction
Back in 2017, two MIT students (Drew Houston and Arash Ferdowsi) secured funding from seed accelerator Y Combinator, for what would become Dropbox, one of the first companies to offer cloud storage and file syncing.
It had a first-mover advantage, that combined with a simple user-friendly interface, and a freemium model, allowed the company to grow from 1 million registered users back in April 2009, to over 700 million in 2021. Although this sounds impressive, I’ll argue this is a pointless metric, but I’ll get back to that.
The freemium model attracted many users to test out their product and access a limited amount of storage for free. If they need more storage, then they can opt for various paid plans (Dropbox Plus, Dropbox Business).
2.0 An incredibly sticky product
A crucial property to take into account is the stickiness of the product.
The perceived risk and effort involved in transferring large volumes of data often outweigh the potential savings of switching services.
Cloud storage platforms hold critical, often irreplaceable, data that users depend on for continuity and productivity. The migration process can seem risky—not just for the potential of data loss or corruption, but also for the disruption it could cause to established workflows and collaborative setups.
Moreover, the time cost of planning, executing, and verifying a migration is significant for larger organizations.
Even if a competitor offers a cheaper option, the combined weight of time, complexity, and the fear of potential issues can make the cost savings feel secondary.
For many users, the existing service might offer just enough value or reliability to make the switch feel unnecessary, reinforcing Dropbox's and similar platforms' stickiness.
3.0 The pointless metric & what actually matters.
It is not unusual for companies to have some sort of storytelling element in their disclosures, press releases, or earnings reports. The purpose of these elements is nothing else but to create excitement, even if it is pointless.
You’ll notice, Dropbox chose registered, instead of active. Given that their base model is free, once someone becomes a user, that person remains a user forever! So the number of registered users will always go up.
However, if we take a look at the paid subscribers, historically, that is ~2.5% of the registered users. So, 97.5% of all registered users are freeloaders (including myself) and add no value to the company.
Don’t get me wrong, having over 18 million paid subscribers is impressive. It is important to focus on this number and acknowledge that the growth days are behind.
The competition is fierce, ranging from Google and Amazon to Microsoft and Apple.
What surprised me was that during the pandemic, there was no growth acceleration.
4.0 The past acquisitions
The company has engaged in numerous acquisitions:
July 2012, TapEngage - a startup that enables advertisers and publishers to collaborate on tablet-optimized advertising.
December 2012, Audiogalaxy - a startup allowing users to store their music files and playlists in the cloud and then stream them to any device.
December 2012, Snapjoy - a company allowing users to "aggregate, archive and view all of their digital photos from their cameras, phones and popular apps.
July 2013, Endorse - a mobile coupon startup.
April 2014, Loom - a photo-sharing company which would be shut down and integrated with the then-recently announced Carouse
April 2014, Hackpad - a document-sharing startup
May 2014, Bubbli - a startup that has built some innovative ways of incorporating 3D technology into 2D views, and packaging it in a mobile app.
January 2015, CloudOn - a company that provided mobile applications for document editing and creation.
January 2019, HelloSign - e-signature company (largest acquisition $230m).
March 2021, DocSend - secure document sharing and analytics product.
October 2021, Command E - universal search company
November 2022, Boxcryptor - end-to-end zero-knowledge encryption for cloud storage services
December 2022, FormSwift - form management platform
There have been many studies that acquisitions (on average) tend to destroy shareholders’ value. If you agree with that, then Dropbox should be avoided like the plague given their past activity.
5.0 The financials
If you look at the financials, this is impressive, especially given the fact that they’re competing with Google, Amazon, Microsoft, and Apple.
A lot of focus (especially from the management) goes to FCF and there’s a reason for that. Every company that has high stock-based compensation would like to focus on the free cash flow, as SBC is a non-cash expense.
From 2018 (when the company became public) until H1-2024, the company generated $3.9 billion in free cash flow. This might sound impressive, given its market cap is $8.5 billion, however, it incurred $2.3 billion in stock-based compensation.
So, where did the $3.9 billion go to? Share buybacks.
The number of shares outstanding is down ~20% since becoming a public company.
Based on their capital allocation over the last 5 years, it seems as if their capital allocation strategy has changed from acquiring more companies to returning capital to the shareholders via buybacks.
6.0 The valuation
How does one value a company of this kind?
It has a sticky product that generates relatively stable cash flow that is returned to the shareholders via buybacks. I’ll argue that it has a lot of similarities with a bond and a dividend discount model is an appropriate model to value a company of this kind.
Except, instead of using the dividend, I’ll use free cash flow - SBC.
Based on the assumptions shared above, the fair value of Dropbox is close to $8.8 billion ($27/share), which isn’t that far off from today’s share price of $26.
7.0 My thoughts
A company with a sticky product that has stable financial performance is expected to be less volatile than the average company out there. This is indeed the case, and the stock price beta is 0.6. Beta is a measure of risk that compares the volatility of the share price vs. an index (in this case, the S&P500). However, low risk goes hand in hand with low return. Therefore, expecting ~8% long-term yield seems fair.
I don’t find this an attractive opportunity, at this price point. However, if the share price decreases to $20, then the answer would be different.
The only scenario where I see a significant upside is if Dropbox is being acquired by a giant, such as CRM 0.00%↑ Salesforce.
I hope you enjoyed this post, feel free to share your thoughts.
Thanks.