3 Reasons Investors Should Avoid Box's IPO

Cloud storage company Box hopes to raise at least $137.5 million through as many as 12.5 million shares during its IPO, which could be priced between $11 to $13 as early as Jan. 22.

The company, which offers online file sharing and personal cloud content management for businesses, was valued at $2.4 billion during its most recent round of private equity funding. However, if Box makes its market debut at $13, it would only have a market cap of around$1.4 billion. By comparison, Box's most well-known rival, DropBox, is valued at $10 billion.

Box initially filed for an IPO last March, but delayed the offering to strengthen its overall numbers. Since then, Box has raised an additional $150 million in funding, total registered users rose from 25 million to 32 million, and its number of paying customers climbed from 34,000 to 44,000.

Cloud storage certainly sounds like a high growth and high margin business, but here are three big reasons investors should avoid buying Box when it goes public.

Box CEO Aaron Levie. Source: Wikimedia Commons, JohnnyMrNinja.

1. A commoditized businessWhen Box was founded ten years ago, the idea of cloud-based storage for regular consumers and small businesses was revolutionary. Today, that market has been commoditized by similar services like Google Drive and Microsoft's OneDrive.

Google and Microsoft can afford to take losses on cloud storage to tether more users to their ecosystems, which makes it tough for smaller players like Box and DropBox to remain competitive:

Source:CNET, Dec. 2014.

Google and Microsoft already give more users free storage, let them upload larger files, and offer lower-cost plans. That leads into Box's second problem ...

2. A lack of profitabilityTo compete against those tech behemoths, Box might have to slash prices in the future. If that risk weren't enough, Box doesn't expect to be profitable for the "foreseeable future" even with current pricing. This is not an enviable position.

Box's revenue rose 70% year-over-year to $57 million last quarter, but its net loss only slightly narrowed from $51.4 million to $45.4 million. This gives Box very little freedom to lower its prices and margins. Over the first nine months of 2014, Box's operating expenses rose 30% to $242 million, with 63% being spent on sales and marketing to attract new customers.

The good news is that Box's new order growth remains healthy. Over the first nine months of 2014, 60% of its new orders came from new enterprise customers (businesses with over 1,000 employees) or the purchase of additional services for existing accounts.

During that period, Box reported a retention rate (renewals and selling new services) of 130%, indicating that its existing customers -- which include General Electric and Procter & Gamble -- won't be switching over to Google or Microsoft's services anytime soon. This is probably due to Box's Salesforce and NetSuite integration, which lets business users synchronize files with other enterprise platforms and easily collaborate on projects.

3. Dual share classesLike Google, Box will issue multiple share classes. Its Class A shares, which will be offered publicly, will only have a tenth of the voting power as a Class B share, which will be held by company insiders. This could make it nearly impossible for even the largest investors to influence Box's business decisions.

That might not matter to an average investor who buys a few hundred shares, but it also means that Box's top executives will get the final say over any business partnerships, acquisitions, or responses to takeover attempts. In other words, investors are basically giving money to Box with no strings attached.

The verdictI'm not saying that Box's IPO is doomed to flop. However, investors should be aware of the dangers that Google, Microsoft, and other larger companies pose, its lack of profitability, and its rising expenses. Box's partnerships with industry giants like GE and its retention rates are impressive, but it could be years before the company achieves profitability. Therefore, I believe that investors should keep an eye on Box's IPO, but there's absolutely no need to rush in.

The article 3 Reasons Investors Should Avoid Box's IPO originally appeared on Fool.com.

Leo Sun has no position in any stocks mentioned. The Motley Fool recommends Google (A shares), Google (C shares), NetSuite, Procter & Gamble, and Salesforce.com. The Motley Fool owns shares of General Electric Company, Google (A shares), Google (C shares), and Microsoft. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.