Investors of private and public markets alike were scanning Dropbox’s S-1 filing at the beginning of this year for any signal of the start to a healthy and buoyant season of IPOs for sizeable, private companies. It has kicked off a burgeoning 2018 of listings alongside fellow unicorns such as Spotify and Zscaler, but at the time of filing Dropbox had its own important message to communicate: we’re an Atlassian, not a Box, and value us accordingly. It was with good reason. Dropbox last raised equity capital in the private markets over four years ago in January 2014, taking in $350m at a post-money valuation of $10.5bn in a Series C round of financing. A successful IPO would hinge largely on if it could achieve that same valuation or higher in public markets, but after declaring an impressive $1.1bn in revenue for 2017 the multiple required to do so would have to be 10x or better.
Box, which IPO’d in January 2015 at a market capitalisation of $1.7bn, was trading between 5x and 7x LTM revenue in the months prior to Dropbox’s listing in March. If Dropbox was priced as a comparable, it would be a material down round on its private valuation, and a headache for Series C investors, in at $28.65 a share. By contrast, Sydney-founded Atlassian, a supplier of project management and collaboration software to enterprises, was trading between 15x and 20x its annual revenue, thanks to consistent customer base growth and demonstration of retention. If Dropbox was valued in public markets on a similar basis, it could significantly improve on its last private valuation.
In its S-1 document, descriptions of the company’s competitive landscape included details of shared products with the tech industry’s largest players, followed by a crossover in offerings with collaboration platforms such as Atlassian, before reluctantly admitting competition with Box but only in isolated customer channels. Even the business itself was emphasised as a content collaboration platform, steering clear of Box’s image as a pure play cloud storage provider.
“Certain features of our platform compete in the cloud storage market with products offered by Amazon, Apple, Google, and Microsoft, and in the content collaboration market with products offered by Atlassian, Google, and Microsoft. We compete with Box on a more limited basis in the cloud storage market for deployments by large enterprises.” – Dropbox’s S-1 Filing
Unfortunately for investors, initial pricing expectations in March of $16 to $18 per share suggested Dropbox would begin trading on a multiple comparable to Box and face a down round in public markets. Factoring in restricted stock units, it would be a $7bn valuation handle which, despite making it the largest tech IPO since Snap, would fall well short of the $10.5bn benchmark. Strong demand from institutional investors in the lead up to its debut resulted in a revised pricing range of $18 to $20 per share and pushed Dropbox’s listing price to $21, representing a market capitalisation of $8.3bn. A material uplift was realised in its first day of trading on the Nasdaq, soaring to a closing price of $28.48, up some 35%. The company’s share price has largely tracked sideways since then, currently trading at a total market capitalisation of $11.5bn. It’s not quite an Atlassian multiple, but they have certainly avoided the Box comparable.
Closing at $28.92 on 20 April 2018, Series C investors will be looking at an unimpressive return on their four-year investment. Even in achieving a multiple of greater than 10x its current revenue, Dropbox’s valuation is barely surpassing its last private valuation benchmark. That’s largely because it had the ground to make up in the first place; Dropbox is the only unicorn so far in 2018 to price its IPO at a down round to its prior valuation and stands in stark contrast to some of its newly public peers. Those include DocuSign’s addition of a little over $1.2bn to its valuation before trading, and Carbon Black’s more than doubling of its private valuation to claim unicorn status in emphatic style. Despite the positive sentiment surrounding Dropbox’s debut, the lacklustre returns for this group of investors will serve as a warning to private market counterparts; an overvalued final round, such as its 2015 raise at an EV/Revenue multiple of more than 19x, can erode any opportunity for material value accretion regardless of the future liquidity event’s perceived success.
Series C investors are in the minority however; Dropbox’s successful market debut has left scores of winners in its wake. Few have gained more than founder and CEO Drew Houston, who at the time of IPO held 24% of outstanding Dropbox shares at an approximate value of $2bn. A fair reward perhaps for stewarding the company for 11 years since its inception, in an era when founders are increasingly replaced by ‘professional’ CEOs. Sequoia Capital is the second largest shareholder with 22% of the company and generated a staggering money multiple of 872x on their second investment tranche in Dropbox’s A-1 raise almost a decade ago. For Y Combinator, it’s even more than money, as Dropbox becomes the first graduate of the storied Silicon Valley incubator to go public.
Despite these successes, some of the best risk-adjusted returns were earned, as we are seeing in increasing frequency for large-cap, private technology companies, by investors transacting in secondary markets in the latter stages of Dropbox’s life as a private company. In the months leading up to its IPO, liquidity in the company was available in secondary markets at a price of $15.50 per share to investors with the right access. That turned out to be at a discount of 26% to Dropbox’s IPO price, and 46% below its first-day closing price. Access at materially high discounts in such popular private stock isn’t easily sourced or accessed however; the most attractive prices come from individual, off-platform relationships and often carry with them structuring complexities synonymous with non-exchange traded private market transactions. If the IPO market continues in its current form, profitable opportunities like Dropbox, Spotify and Zscaler will become more frequent, but the ability to access these companies early, in private markets and at a discount will be paramount.
Alexander Assim undertook this research as his role as an Investment Analyst with AlicornCo
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