Confident Dropbox pleases markets, but what about customers?

Dropbox's share price took a new turn today on its rollercoaster ride since last summer, spiking 20% in response to its Q4 earnings report, released after market close last night. The catalyst was a $600 million share buyback plan and a commitment to improve operating margins by up to 3% a year between now and 2024. But while investors were pleased, the implications for customers were less clear.

Dropbox is in a transition at the moment, having launched a new app in the summer which it believes will help grow its sales to the business and enterprise sector. Back then, investor nerves about growth prospects triggered a 32% fall in the stock price, and the vendor's Q2 results failed to impress. But the company came out fighting yesterday, citing new management hires and a plan to reduce spend on R&D and sales and marketing through better efficiency, at the same time as maintaining double-digit revenue growth.

There was meagre evidence however that the new app is gaining ground, with the emphasis on "early traction." CEO Drew Houston said that driving up adoption will be a key goal in 2020:

Our primary focus this year will be on driving adoption of the new Dropbox. Today millions of users are active in our desktop experience, and with rollout to just a portion of our user base we’ve seen early adoption in over 450,000 business teams.

UK marketing agency Exposure was cited as a Q4 win for a "wall-to-wall" roll-out of the new app against competition from Microsoft and Google. Other Q4 wins were unnamed, with healthcare, government, finance and real estate among the sectors cited. Among them, one US-headquartered medical technology company will be rolling out Dropbox to over 10,000 employees under a three-year contract, having experienced organic adoption among sales, operations, marketing and design teams in recent years.

New features to encourage team usage

Dropbox plans to add new features in 2020 to make it easier to roll out team usage, said Houston:

Most Dropbox users in the workplace are still using one of our individual or basic plans. As a result, there remains a large embedded opportunity within our existing user base to drive both conversion and upsell into a business team plan.

Upsell and expansion opportunities will include:

• Making it possible to add new team members by user invitation, rather than needing an admin to add and approve each new user as at present
• New add-on functionality for the enterprise market, such as extended version history and legal hold
• Better in-app promotion of add-on applications including Dropbox-owned HelloSign and close partner BetterCloud

While expanding take-up among business teams will be the main focus, Dropbox will also introduce new products designed to appeal to individual users, Houston added, including offering single sign-on to multiple services:

Our customers deal with fragmentation and distraction in their personal lives too. This year we’ll start to address some of those challenges — like accessing and sharing information such as your tax returns, or digital copies of passports, or managing passwords across services.

These pain points open up opportunities for us to extend the secure and collaborative capabilities of Dropbox to our users' most important workflows at home, while expanding our monetization opportunities and the overall value proposition of our platform.

But Houston admitted that it was still "early days" for measuring Dropbox's success in cross-selling SMB e-signature and workflow services from Hellosign, acquired a year ago. The e-signature market is still largely underpenetrated in the self-serve SMB space where HelloSign has most appeal, he added.

A squeeze on operating expenses to drive up margins

Q4 revenue was $446 million, up 19% year over year, and full year revenue for 2019 came to $1.66 billion, again up 19%. Guidance for full-year growth in 2020 was 14% to 15%, producing around $1.9 billion in revenue. The Q4 revenue figure was above analyst expectations and showed some stabilization after the jitters of previous quarters, although the lower growth rate for 2020 reflects continuing caution.

The impact of decelerating revenue growth is outweighed by Dropbox's plan to put a squeeze on operating expenses over the next few years, driving up margins. Dropbox plans to be profitable on a GAAP basis by the end of this year, to drive operating margin from just over 20% up to near 30% in 2024, and be generating annual free cash flow of over $1 billion by that date.

This will mean reducing the proportion of revenue spent on R&D and sales and marketing by a around a sixth, but it will be achieved by efficiency and productivity gains rather than any reduction in outcomes, says Houston. The overall message is one of delivering shareholder value while continuing to invest in the business, he explains:

We did see an opportunity this year to strengthen the investment thesis we wanted to bring to market and put a couple stakes in the ground in terms of our long-term profitability and cash generation that reflect the inherent efficiency of our business.

And just be really clear, that we want to expand margins as we scale, drive efficiency, drive productivity while still leaving us plenty of room to invest.

An important contributor to this new trajectory are the top-level hires Dropbox has made over recent months. These include Timothy Young, who has joined as SVP and GM of Core Dropbox, and Bharat Medirattam, who joined as CTO and SVP of Platform. One of the most important hires is incoming COO Olivia Nottebohm, who previously helped build and scale the SMB business at Google Cloud. Houston says her role will help free up more of his time to focus on product development. Finally, Tiffen Dano Kwan joined as CMO last month, bringing more than 15 years of experience in SaaS, most recently CMO of SAP Ariba.

My take

I would have liked to have heard more about enterprise adoption and how the new Dropbox app is making strides in the existing customer base. The vendor made a big pivot in the summer with the launch of the new app, and as I said back then, it's a huge job to persuade its user base to switch to this new way of working. I'd like to see more evidence of progress.

Managedment has chosen instead to send a message to investors that it plans to look after their interests with a focus on driving down costs to improve margins. The overnight reaction suggests that this has done the trick. Customers may worry that reduced spend may mean reduced capacity, but it's equally possible to argue that Dropbox is simply demonstrating a new level of maturity in how it organizes its operations.

In summary, it remains too early to judge whether the Dropbox app is getting established. There's more work to be done to persuade customers of its merits. But in the meantime, Dropbox is growing up as a business and that's no bad thing. There's still prograss to be made but the overall picture is one of a business that means to be here for the long term.