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Morningstar | Better than Expected User Growth Headlines Dropbox’s 1Q; Raising FVE to $13. See Updated Analyst Note from 09 May 2019

Dropbox exceeded its revenue guidance in first-quarter results and raised the outlook for the remainder of 2019. While the company reported progress on several new initiatives including a partnership with Google for G-Suite and integration with leading workflow automation tools vendors, we believe these types of offerings are not differentiated. Rather, we remain focused on Dropbox’s inability to drive paid user conversion on its base of 500 million users. However, due to better than expected user metrics and time value of money, we are raising our fair value estimate to $13 per share from $12. With shares trading near $24 after hours, we believe that Dropbox shares are overvalued.Dropbox reported revenue of $386 million, up 22% year over year and 2.6% sequentially beating revenue guidance midpoint of $380.5 million. Dropbox benefited from the February closing of the HelloSign deal which added 100,000 paid users. In total, Dropbox added 500,000 paid users, bringing the total to 13.2 million. Paid users are up 14.8% year over year and 3.9% sequentially. ARPU came in at $121.04, up 5.9% year over year and 1.2% over last quarter. ARPU continues to rise as new users choose higher tier plans. Non-GAAP operating margins came in at 10.1%, down from 11% posted in the first quarter and full year of 2018. The margin contraction is due to duplicate facilities as Dropbox prepares to move into new headquarters and the duplicate costs will disappear in the back half of 2019.

Turning to the outlook next quarter, Dropbox is expected revenue to be $399-$401 million with non-GAAP operating margins of 9%-10%. We are forecasting that Dropbox will add another roughly 380,000 paid users with another 1% increase in ACV for revenue of $405 million, a 5% sequential growth. For the full year, management raised revenue guidance to $1.634-$1.646 billion, up from $1.627-$1.642 billion. We are expecting Dropbox will add 1.1 million more paid users in 2019 with $1.64 billion for the year.

At 13.2 million paid users, Dropbox remains near a 2.6% paid user conversion rate. While management insists it is structuring its business for consistent growth by converting the highest value users, we remain concerned that there are not enough high value users to support long term growth for Dropbox. Deferred revenue was only up 14% year over year on revenue growth of 22%, due to a higher percentage of customers adopting monthly plans. While this will benefit the top line in the short term and management indicated that user metrics are positive so far, these are the customers we believe historically have higher churn and lower lifetime customer value.