The IPO, rumored for more than a year, would value the company at about $15 billion if sales of its class A shares hit the $500 million proposed maximum offering price based on the number of outstanding class A and B shares listed in the filing. That seems a tall order when its primary direct competitor, Box, has a market capitalization of $3.2 billion, but based on the published financial data, Dropbox is significantly larger and closer to profitability.
As expected, the Dropbox S-1 filing includes many interesting, previously unknown items that shed light on the company's financial health, internal operations, and business strategy. Most encouraging, it shows that the company understands that its raison d'etre, cloud-based file sync and share, has become a commodity service and that it must evolve into an all-inclusive business collaboration platform and away from Dropbox's historical focus on consumers.
Vague, idealistic mission statement belies reasonable strategy
Unleashing the world's creative energy by designing a more enlightened way of working
Dropbox's mission statement is one of the most banal, hollow, vapid — choose your adjective — you'll ever see, which is saying something in an industry known for empty, misleading spin. The S-1 includes a letter from its co-founders, Drew Houston and Arash Ferdowsi that provides context and centers on making the pivot from file sharing to workplace collaboration by pairing aggregated content with new search, document creation software (Dropbox Paper) and machine learning-backed algorithms that automatically surface relevant, task-appropriate information. As the founders put it,
Our workplace should feel organized and surface only what's relevant. It should tune out chatter — more communication isn't always better. The experience should be seamless. You shouldn't have to use one app to write a doc and another to talk about it.
And over time, machine intelligence will allow Dropbox to better understand both you and your team. Imagine getting to work in the morning to find your calendar reorganized so you have a three-hour block of time to actually focus. Imagine starting your day and seeing the perfect to-do list — one based on a deep understanding of your priorities and your team's priorities.
Executing on such an expansive, albeit terribly vague, collaborative vision is Dropbox's only hope for long-term success since I've long contended something that Steve Jobs once told Houston, that file sharing is a feature, not a product. Indeed, when Box filed its public offering in 2014 I noted that it's impossible to have a sustainable standalone business built purely on file sharing. To their credit, Aaron Levie and Box's leadership well understood the problem by targeting business users with an aggressive pivot to an application-agnostic platform strategy more than two years ago. Dropbox is following in their footsteps, and while its initial consumer-centric strategy provided the foundation of a much larger user base, it also means Dropbox is significantly behind in cultivating and marketing to enterprise customers.
As I wrote almost two years ago, Box, which was already subject to the harsh scrutiny of the market, adopted a platform and integration strategy aimed at solving persistent enterprise collaboration inefficiencies and frustrations.
Box’s mission is to become the content management substrate that more and more apps depend on. …. Box isn’t the only company to understand the benefits of platform standardization, look where it got Microsoft. Dropbox, AWS, Google and others surely have similar ideas, but Box is furthest along in transforming from file sharing SaaS specialist to app-agnostic content infrastructure.
Over the intervening months, Box has made significant progress in developer outreach and documentation, APIs and a growing portfolio of revenue-generating products with a platform supported by more than 1,000 third-party applications.
Dropbox's vital signs
S-1 filings give outsiders the first glimpse at a company's operational and financial details. Here are the highlights, based on Dropbox's own numbers:
- Dropbox revenue has grown an average of 35% annually since 2015 to $1.1B while its operating loss is down more than 60% to $113.7 million or 10% of sales versus 50% two years ago.
- The company has 500 million registered users, up 25% in the past year, but only 2.2% (11m) of them are paying customers. Granted, that's up from 6.5 million two years ago (30% CAGR), but it's a tiny base. Half of paid customers are from outside the U.S and average annual revenue per paying user (ARPU) is about $112, virtually flat since 2015. The optimistic view is that Dropbox has immense opportunities to grow revenue, but the grim reality is that that the majority of its users are freeloading off of its very costly infrastructure.
- Dropbox estimates that 60% (300 million) of its registered users have one or more characteristics it sees as making them more likely to convert to paying customers. Unfortunately, the list — registering under a business email address, using certain (unspecified) device types to access Dropbox or living in a developed country — is absurdly broad. Just because you live in the U.S. doesn't mean you're inclined to pay for online services, just ask Spotify. A more realistic goal would be the 17% ratio of paying to registered users at Box, which amounts to an impressive upside of 75 million new customers given Dropbox’s user base.
- Despite turning its focus to paying business customers, Dropbox generates 90% of its revenue from self-service upgrades by users, not direct or partner sales channels. As Ben Thompson points out, relying on organic sales is in stark contrast to Box's top-down sales strategy of courting business executives and enterprise-wide deployments. The bottoms-up approach will only go so far in the enterprise and Dropbox will never land the type of major enterprise deals it needs without substantial C-level outreach.
- Revenue retention for Dropbox Business customers is 100% in aggregate, although the company doesn't track retention rates for individual users. The blended retention rate across all paying customers, namely the annualized revenue from the group in January divided by the revenue from the same population in December, is greater than 90%, somewhat lower than Box, but not bad given Dropbox’s limited direct sales efforts.
Storage infrastructure goes in-house
Dropbox says a key factor in reducing its operating expenses was migrating most of its data storage from IaaS (AWS) to custom-built and operated private infrastructure. Like most SaaS startups, Dropbox was built on an AWS foundation, however as its capacity needs grew, the company felt that it could lower costs and improve scale by doing things itself. The filing states that more than 90% of user data is stored on Dropbox's custom-built infrastructure at facilities in California, Texas and Virginia. It uses AWS for the remainder, along with other AWS services apparently to power its applications and internal systems. Another cost reduction strategy started in 2016 when Dropbox began culling inactive non-paying users to free up unused capacity.
The S-1 states that Dropbox expects the expanded use of internal infrastructure will allow it to scale while lowering unit operating costs. Building and running private infrastructure is a risky move and at odds with competitors like Box and iCloud or online services like Netflix that use one or more IaaS vendors despite having similarly massive capacity requirements. While Dropbox has the scale and resources to operate highly efficient facilities, these come with significant capital expenses and opportunity costs. So far, it appears to be paying off, but it will bear watching how the company manages its infrastructure investments over time.
Indeed, the S-1 details the extent of Dropbox's business relationship with HP Enterprise in which it supplies server and storage systems while also purchasing a multi-year subscription to Dropbox services. While bilateral, the agreement is hardly symmetrical since HPE paid $1 million for Dropbox subscriptions in 2016, while Dropbox spent around $80 million in both 2016 and 2017 for leases, products and services.
The S-1 shows that Dropbox correctly sees sustainable business success as dependant upon its ability to attract paying customers and expand their use of its services. This only works if the company cranks up its development engine to create new products that solve ever-present inefficiencies in enterprise collaboration and digitized workflows. Given the Balkanized landscape of enterprise productivity and collaboration software, its strategy requires much more integration with other products and an extensible platform. On this score, Dropbox has done great with consumer applications, where nearly every important mobile content creation app can natively export and share documents to its platform. In contrast, Box, Slack and Atlassian are far ahead in catering to enterprise needs.
When it comes to developing new collaboration tools, Dropbox's record isn’t great, with Paper an incomplete product that's far inferior to comparable software like Google Apps, Office 365 or Salesforce's Quip. If Dropbox intends to displace rather than embrace such third-party software, it has a significant and unenviable task ahead.
While not directly related to its business and finances, Dropbox's S-1 also details its use of an undemocratic, multi-class shareholder structure that's become prevalent in Silicon Valley where the founders and VCs want investor's money, but don't want their meddling. The Class A shares offered in Dropbox's IPO only have one-tenth the voting rights of the Class B shares held by insiders. If that weren't skewed enough, there are currently almost 30-times more Class B shares outstanding, meaning that buyers of Dropbox stock will have virtually no voting rights on issues of corporate governance. Such a structure ensures that there won't be any pesky activist hedge fund managers causing trouble for Dropbox.
Overall, the S-1 shows Dropbox making significant progress to operational break even, but a murky path to long-term relevance and financial sustainability as an enterprise collaboration platform.