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Morningstar | Dropbox Shares Could Sync as Cloud Storage Becomes Further Commoditized; Lower FVE to $12. See Updated Analyst Note from 21 Feb 2019

Dropbox reported decent fourth-quarter results but provided investors with a relatively tepid first-quarter forecast as the firm completed its first full year as a public company. We continue to be concerned about Dropbox's competitive position in what we believe will be a commoditized cloud storage industry. Furthermore, we believe that Dropbox’s collaboration offerings lack meaningful differentiation from the solutions provided by rivals Microsoft and Google. As a result, we maintain our no-moat and negative moat trend ratings for Dropbox and we are lowering our fair value estimate to $12 from $14. Even with shares down about 10% after hours, we still view Dropbox as materially overvalued.

Dropbox continued its steady growth in average revenue per user, or ARPU, and paid user adoption. ARPU increased to $119.61, a 5.5% increase year over year. Despite the success in 2018, we are skeptical how much further ARPU can expand in the coming years. In particular, we find it likely that Google or Microsoft will undertake a marketing campaign that will limit Dropbox’s pricing power.

In the fourth quarter, Dropbox added another 400,000 paying customers, bringing 2018 net new paid users to 1.7 million and total paying users to 12.7 million. While Dropbox indicated that its mix shift continues to shift toward business users and a focus on converting higher value customers, we remain unconvinced that users are finding the collaboration tools compelling enough to upgrade from a free account. We believe that Dropbox’s low conversion rate continues to imply that roughly 97% of users view Dropbox as a commodity cloud storage provider.

Turning to revenue, fourth-quarter revenue came in at $375.9 million, ahead of the midpoint of the firm's prior guidance of $368.5 million. The fourth quarter marked the third consecutive quarter (in as many attempts) that Dropbox had exceeded their quarterly revenue guidance by over 2%.

Full-year 2018 revenue of $1.392 billion also exceeded the guidance midpoint of $1.385 billion. Management released revenue guidance for 2019 of $1.627 billion-$1.642 billion, slightly below our forecast of $1.67 billion. We forecast that Dropbox will be a 4% increase in ARPU in 2019 while adding an additional 1.4 million paying users.

Other highlights from the call included new video commenting capabilities and new infrastructure cost-saving initiatives.

Other highlights during the quarter included Dropbox's comments around new video commenting capabilities and new infrastructure cost saving initiatives. Dropbox continues to find ways to keep improve integration and collaboration features to ensure users can complete their required tasks without leaving the platform. In the case of user comments on videos, the company observed that comments had become a very manual task, requiring users to timestamp their comments while switching back and worth between the video and their notes. Dropbox has a solution for this now, allowing users to provide time-coded feedback to a team member without having to leave the Dropbox platform.

Dropbox continues to find ways to reduce infrastructure costs, announcing that they had introduced a new storage tier which allows less frequently accessed files to be stored at lower costs. Though this initiative could reduce infrastructure costs by 10%-15%, we don’t expect any associated margin expansion from it in the near term as the company plans to reinvest those savings into international expansion.