Dropbox’s Wall Street Challenge

Dropbox boasts a valuation in the $10 billion range. Last February the company hired a new CFO, which for many startups is a signal that their IPO moment is coming sooner rather than later. Nobody knows for sure of course, and Dropbox isn’t talking, but if the company does decide to move forward with a flotation, it could face several challenges in spite of its strong market presence.

For starters, last week, tech stocks got dragged to the woodshed by Wall Street in a market that has turned ever more skeptical about growth over profits. Against this backdrop, any tech company thinking about an IPO, may want to hunker down until the bankers are in a better mood.

Should that happen, Dropbox could still have trouble persuading a doubtful Wall Street money machine, which has shown little love for cloud companies, that it can overcome several hurdles:

  • For starters, it will need to convince them that the subscription business model with a different reporting methodology is viable.
  • It must defend its hybrid consumer/enterprise approach — and perhaps face questions where it will concentrate its resources moving forward.
  • Finally, the company with its core business in storage and file syncing has to find a way to overcome the commoditization of these services and the race to the bottom with some of the biggest names in the business.

Those issues aside, Dropbox has a lot going for it. It didn’t secure a $10 billion valuation for nothing. It’s a hot cloud company that has raised over a billion dollars. It claims over 400 million registered users with 8 million companies using the service. It put file sync and share on the map and has changed the way we exchange files.

That kind of traction should mean the company is capable of overcoming anything we outline here, but it may have some educating to do on Wall Street whenever it decides to move forward with an IPO.

The Subscription Business Hurdle

Dropbox sells its consumer and business products on a recurring basis. As you have heard myriad times by now, companies that sell digital services using a subscription model — SaaS shops, in other words — collect revenue over time, and record costs up front.

That means that as you grow as a SaaS company, you are building a predictable revenue stream over time, in the face of often stiff losses as growth ROI has yet to catch up. It’s a fine model, provided that a startup doesn’t overpay for new accounts, and that those accounts eventually generate a multiple of their initial cost to acquire. (Or, if you prefer the boring version, it’s a fine model if your gross margins are in the eighty percent range, and your LTV to CAC ratio is greater than three.)

Dropbox’s consumer business evolved last year, when the company lowered the price it charges for storage; in the face of crashing storage costs, other providers of cloud storage offered dramatically lower prices. Dropbox put off lowering its own prices, but eventually had little choice but acquiesce. We’ll touch on the price question in a moment, but keep in mind that Dropbox’s consumer mind and market share are important tools to get Dropbox into corporations that may become enterprise customers.

So, Dropbox couldn’t afford, somewhat ironically, to abandon competing for consumer share as that could have added friction to its enterprise sales process.

That brings us to Box. Given that the Dropbox ‘For Business product competes with other EFSS players that sell into the enterprise, we can use market analogs to grok how public investors are valuing SaaS firms at current tip. So, Box. And things don’t look great: As of Friday, Box is trading just above (barely) its $14 per share IPO price.

So, despite Box posting better-than-expected financial performance in its most recent quarter, and boosting its full-year guidance, shares in the popular firm are trading at all-time lows.

Venture capitalists love the predictability of SaaS revenue growth. But when public investors are spooked, positive cash flow can be even more attractive.

The implication is that investors are less bullish on SaaS losses in the short-term. That could be predicated on merely shifting sentiment towards companies with cheaper revenue growth, or it could simple be that investors are shifting cash to firms that have a faster ramp to profitability.

I’ve heard every story and then some about Dropbox’s financial performance. From that, we can say nothing. However, we can understand that if Dropbox shares the various weaknesses that Box once had, and has hauled ass to rein in, it could have a hard time explaining to investors why it is worth so much more than its competitor.

Venture capitalists love the predictability of SaaS revenue growth. But when public investors are spooked, positive cash flow can be even more attractive.

The Business Definition Hurdle

Before Dropbox came along, we kluged a number of work-arounds to move our files across devices such as emailing them to ourselves or using thumb drives to move them from device to device “sneaker-net” style.

With a tool like Dropbox, your files sit in one place and you access them from anywhere on virtually any device. It became so easy to move files that before you knew it, we were moving our files to and from work via Dropbox. In fact, this practice became so widespread that by around the 2012 timeframe, it became known as the “Dropbox problem” in IT, emblematic of new class of software that enabled employees to provision their own tools in the cloud, and move company content  — usually without official permission.

Given that kind of heady freedom, and simply wanting to get their work done, people flocked to tools like Dropbox — and its user numbers soared.

As this was happening, Dropbox recognized that these millions of users represented a business opportunity, but only if it could turn some of those users, many of whom were using the free version, into paying customers.

The problem is that consumers are conditioned not to pay on the internet. The surest way to get paying customers was to create a business version with some protections and administrative controls built in. In April of last year, it released Dropbox for business and has been refining it ever since.

On one hand, this hybrid approach is a great business model. You have the hundreds of millions of consumers using the tool and it makes perfect sense that a business would want to tap into that popularity and give their employees what they want. The downside to this approach is that Wall Street may wonder where the company’s true focus lies. If it leans too heavily on consumers, it could run smack dab into the next hurdle  — convincing Wall Street it isn’t in a commoditized business racing to the bottom with technology industry giants.

The Storage Race To The Bottom Hurdle

Returning to our prior notes on pricing, there is a question of value. Dropbox cannot compete in selling storage; it can’t have a lower cost profile than larger cloud players who can invest at scale to lower marginal storage costs. This is one advantage of being a monied incumbent.

Without that option, Dropbox can compete on productivity apps, platform quality, security, its developer network, integration with OEM handset shops, and first-party apps. But so can its competition.

Without that option, Dropbox can compete on productivity apps, platform quality, security, its developer network, integration with OEM handset shops, and first-party apps. But so can its competition.

Having seen a former revenue lever — storage capacity — removed from its revenue growth toolbox, at least in part, shifts the onus of top line to other income sources. For a very rough analogy, newspapers had a hell of a time transitioning from classified ad income. That’s business.

All of this doesn’t mean the situation is hopeless. We know the markets are going to do what they do and Dropbox will very likely wait for a more opportune moment. CEO Drew Houston has been answering these types of questions since he launched the company in 2007. As Wall Street stiffens against tech in general and cloud in particular, the company is going to have its work cut out for it. Whenever that magic IPO moment happens, it’s just going to have to deal with it.