Is Dropbox a Buy?

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Cloud storage provider Dropbox (NASDAQ: DBX) was the second-biggest tech IPO of 2018, raising $756 million in March, and it was initially one of the more successful ones, as its shares nearly doubled in value.

As the year wore on, however, the stock steadily declined, and Dropbox closed out 2018 up just 3% from its offer price -- but down 53% from its highs. With over 500 million registered users and more than 12 million paying ones, Dropbox is still formidable -- let's look at if it's a buy at this price point, or if investors would be better off storing this one away for some other time.

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An uphill battle

Part of the concern surrounding Dropbox is that it competes against some of the biggest names in the industry, including Amazon.com, Apple, Google, and Microsoft, all of which provide free cloud storage solutions. The challenge for Dropbox is to scale its business while converting its free riders into paying customers, which analysts actually believe it can do over time.

Analysts at JPMorgan Chase forecast Dropbox may be able to make good on its goal to convert as many as 300 million users to the paying side, though the cloud storage site admits it has fewer than its published number of users because some may have more than one account. That suggests there may be a little more optimism than is warranted, though the more users Dropbox converts, the lower its user costs will be.

Dropbox also needs to make further inroads into the enterprise market if it wants to achieve profitability, but with Alphabet and Microsoft already offering enterprise-level collaboration tools, it's not an easy transition. Furthermore, Box (NYSE: BOX) is also competing in the space, and though it has only 63.5 million registered users, it has also converted nearly one-fifth of them into paying customers.

While Dropbox does have enterprise-level partners like Hewlett-Packard Enterprise and Adobe, there may be more opportunity targeting small- and medium-sized businesses, which is arguably a market closer in nature to Dropbox's consumer-oriented roots and one which it is more familiar with.

Doing what it does best

Despite the competitive hurdles Dropbox faces and the challenge of broadening its customer perspective, the company looks to be executing on its promise. Third-quarter revenue rose 26% to $360 million as the number of paying customers increased by 18% year over year to 12.3 million. And revenue per user rose to $118.60 from $112.05 a year ago, an important advance.

Margins also improved year over year as gross margin expanded by 690 basis points and GAAP operating and net losses shrunk. Adjusted operating margin widened to 12.8% and adjusted net income nearly doubled to $45 million. So even though Dropbox's current user-conversion ratio is pretty low, it's increasing its profitability despite having to drag the free riders along.

Right now, Box generates orders of magnitude more revenue per customer than does Dropbox, but Dropbox is generating more total revenue than its rival and growing at a faster pace. The end user is mostly different for each -- Dropbox with a consumer focus and Box more geared towards enterprise businesses -- but that may narrow as time passes and each company seeks to diversify its user base.

It could be time to pick up Dropbox

Dropbox has a solid business that's steadily moving in the right direction. It does have some competitive threats from larger players as it attempts to expand its horizons to fuel further growth and profitability, but its gains will come at the expense of its bigger peers.

With the one-year anniversary of its IPO on the horizon, Dropbox trades at essentially the same price as it was offered to the public markets, making this look like a good level at which to pick up this cloud storage dynamo.

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John Mackey, CEO of Whole Foods Market, an Amazon subsidiary, is a member of The Motley Fool's board of directors. Suzanne Frey, an executive at Alphabet, is a member of The Motley Fool's board of directors. Teresa Kersten, an employee of LinkedIn, a Microsoft subsidiary, is a member of The Motley Fool's board of directors. Rich Duprey has no position in any of the stocks mentioned. The Motley Fool owns shares of and recommends Adobe Systems, Alphabet (A shares), Alphabet (C shares), Amazon, and Apple. The Motley Fool owns shares of Box and Microsoft and has the following options: long January 2020 $150 calls on Apple and short January 2020 $155 calls on Apple. The Motley Fool has a disclosure policy.