Dropbox S-1 Benchmarking: How the First Decacorn SaaS IPO Measures Up

February 24, 2018

2018's tech IPO market is off with a bang. Dropbox, one of a handful of decacorns (private companies valued at $10bn or more), has filed its S-1 with detailed financials, giving a much clearer picture of the company's financial history and outlook. I've gone through Dropbox's S-1 and pulled out the relevant parts: here's how Dropbox measures up to other public SaaS companies and some thoughts on how investors with value it.  




No matter how you cut it, Dropbox will IPO as one of the biggest SaaS companies in the world. Here's how 2017 revenue compares to various other public SaaS companies I follow (in millions of dollars):



Dropbox will be one of the largest public SaaS companies by revenue, behind only Salesforce, Workday and ServiceNow, dwarfing the size of many recent IPOs.


Financial results: 


A few things leapt out at me when I built my financial model.


First, Dropbox didn't add much more revenue in the 2017 ($262m incremental) vs. 2016 ($241m incremental). This has led to slowing, albeit still healthy, growth- the company grew revenue 40% in 2016 and 31% in 2017, entering 2018 growing in the high 20s. 


More striking was the gross margin story- as recently as 2015, Dropbox had insanely low margins and looked much more like a storage company (yuck!) than a SaaS company. On $604m of revenue, DBX generated just $196m of gross profit for a 33% gross margin. I would keep that number private too. =)


Thankfully, margins drastically improved. In late 2016, Dropbox completed a transition to using its own datacenters, enabling it to dramatically reduce storage costs by avoiding unnecessary duplication. Here's how the company describes it:


This improved gross margins such that DBX looks like a SaaS company after all: it ended 2017 with a gross margin of 67%. Not high by SaaS standards, but in the right ballpark and still improving. As a result, since 2015 the company's gross profit has more than tripled, despite revenue less than doubling in that time. Here's the full annual financial summary from my model (quarters hidden):

A few other points:


1) Dropbox spends more on R&D than it does on Sales and Marketing. This is very rare for a SaaS company- the last time I ran the numbers, only Atlassian and Workday looked similar. 


2) At first glance, Dropbox seems to be generating more free cash flow than the true economic reality. That's because some payments on datacenter leases are classified as "cash flows from financing" and so don't impact the traditional free cash flow calculation. I've adjusted for this, and the result is ~10% lower FCF margins. There's nothing fishy going on here, but astute investors will realize that this is a real, ongoing cash expense and factor it in when valuing the company. 




I benchmark the financial health of SaaS companies using a growth vs. profitability scatterplot. The chart below plots 2017 revenue growth (y-axis) against 2017 free cash flow margin (x-axis). I'm a stickler on stock based compensation and treat it as a cash expense here. 



It is better to be above the trend line, because that means a company is generating higher revenue growth for a given level of cash burn/generation. Dropbox sits right on the line, at about breakeven adjusted free cash flow with just over 30% annual revenue growth. This is very different look from recent SaaS IPOs that tend to be at the top left of the chart: Okta, Mulesoft and MongoDB. All in, Dropbox is a pretty run-of-the-mill SaaS company from a metrics perspective- it is growing about as fast as I'd expect for its rate of cash generation. 




I value SaaS companies by comparing their EV/Gross Profit multiples to the sum of the two variables in chart above: free cash flow margin and growth rate. Traditionally I use gross profit growth, as I don't like the swings in services intensity that often impact relative growth rates (SaaS companies often go through waves of re-investing in and/or pulling back from providing professional services).


In Dropbox's case, this is a generous way to account for growth given the company's rapidly expanding gross margins- but it is unclear how sustainable the rate of improvement is and so it is worth being cautious. I've still plotted the company using gross profit growth rate, but I think of the company's position on the x-axis as "soft" with risk skewed to the leftside. The positioning on the y-axis assumes a $10bn enterprise value, equal to the valuation from the last round, as a placeholder since we don't have an initial price range for the IPO yet.  


This framework, adjusted for "softness," suggests that DBX looks inexpensive at $10bn of enterprise value and should earn a multiple somewhere between Workday and Salesforce.com (CRM), or 11-13x 2018 gross profit. I model just over $1bn of gross profit in 2018, so my updated prognosis is that Dropbox will end up settling at somewhere between $11bn-$13bn of enterprise value at the end of day one. Given normal IPO dynamics, this means the initial range will likely value the company at less than $10bn, with it only achieving my estimate after the first day pop.


Takeaways and congratulations:


1) While I like to be dispassionate when evaluating the financials of a company, let's be clear that this is a resounding success. Drew et al have built one of the biggest modern software companies, and there's a ton to be proud of here.


2) Kudos to Sequoia for one of the great software investments of all time- turning $7m of initial capital into close to $3bn is a remarkable feat, powered in part by how long Dropbox stayed private and continued growing.


3) More than anything, Dropbox's success is a testament to playing into long term trends early. In this case, it looks like high storage costs led to low gross margins for much of the early history of the business. Thankfully, storage costs continued their secular decline, allowing the company to improve margins in time for what will be a successful IPO. 


4) Whither late stage crossover investing: while Dropbox will likely be priced above $10bn, the massive late-stage round that valued the company there in 2014 was almost certainly a bad investment. Most public SaaS companies have doubled in value or more since 2014. Expect this trend to continue, as unicorns wait patiently until they'll be able to just exceed their last round valuation at IPO while later stage investors eat massive underperformance relative to comparable public companies. 


One last note: I have a simple financial model built for Dropbox with first take projections for the next five years- if you'd like a copy just shoot me an email, I'm happy to share it. 




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