Dropbox & Box vs Apple, Amazon, Microsoft, and Google

Buy the rumor, sell the news

I was asked on Quora why Dropbox’s stock is trading at a relatively low price (around $30 as of this writing), in spite of it having decent earnings.

The answer I gave is a pretty straightforward, albeit concise, one:

Dropbox offers a commodity—cloud based storage—and it competes with Amazon, Microsoft, and Apple, to say nothing of the similarly named Box, in providing that service. AMZN, MSFT, AAPL have much larger balance sheets over which to amortize the cost of providing such a service. Thus, investors don’t like Dropbox’s (or Box’s) chances.

I thought I’d flesh this out a bit more.

Dropbox and Box provide cloud-based storage services to individuals, enterprises, governments, etc. The problem with this business model is that the service has become commoditized. Dropbox and Box compete with four much larger competitors, who provide more or less the same service: Apple, Amazon, Microsoft, and Google.

Each of those four companies have large balance sheets over which to amortize the cost of providing cloud storage services. In other words, neither Apple nor Amazon nor Microsoft nor Google needs to run their cloud storage business profitably. They can finance its operation with revenues from other lines of business.

The history of Silicon Valley is one of plucky underdogs laying waste to established companies. While that tale is frequently relevant, it is not here: Dropbox and Box are both large, publicly traded companies. And they’re competing against companies with much more cash, which cash comes from a diverse array of revenue streams.

Therefore, the market looks at Dropbox and Box, and has determined that, in spite of recent good performance in both companies, the future prospects of both companies is not great. And the market has priced their stocks accordingly.

Here’s a chart of Dropbox’s stock performance since its IPO:

And here’s Box’s stock performance since its IPO:

The standard way to value a company’s stock is via discounted cash flow analysis. This valuation methodology purports to value a company’s estimated future cash flows, apply an appropriate discount rate, and calculate a fair present value for the stock. In other words, the price that a stock trades at is a bet (in part) on the company’s future prospects.

If stock market participants think that a company’s future cash flows will grow over time, they will bid up the price of the company’s shares because growing future cash flows means that the present value of the stock becomes more valuable. In other words, a stock chart that is up-and-to-the-right indicates that investors expect the company to be more valuable in the future than it is in the present. Investors are betting on a brighter future.

On the other hand, when a company’s stock chart is down-and-to-the-right (as with both Dropbox and Box), investors are betting that the company’s future cash flows won’t grow in value. And the company’s stock is priced accordingly.

Given that Dropbox and Box are competing against four of the most well-capitalized companies in history, investors have determined that their futures are not great.