With trailing twelve month sales of $1.9 billion, a market cap of $8.4 billion, $1.2 billion in cash, and zero bank debt, Dropbox (NASDAQ: DBX) is a leading provider of cloud-based file synchronization, backup, and content management software. Founded in 2007, the inspiration for the company came from CEO Drew Houston, who, as an M.I.T. student, began to conceive of an easier way to backup and share files.
Originally conceived as a way to conduct cloud-based file sync and backup—essentially replacing the need for a flash drive—Dropbox has evolved into a cloud-based content management software company, with subscription and monthly use plans for consumers, and businesses, which range in size from freelancers to the Fortune 100.
Since its inception Dropbox has deployed a bottoms-up freemium sales model, in which users typically sign up for a free service plan, and migrate over time to a paid plan, through either an annual subscription—greater than 50 percent of the time—or a monthly plan. Dropbox’s content management software plans range from free to more than $240 per year, depending on the level of functionality and customer support selected. The company’s unique freemium model has enabled it to reach and serve over 600 million registered users in 180 countries, who manage over 550 billion pieces of content.
At the end of Q3 2020, the company had 15.3 million paid users generating average revenue of nearly $128 per year, as compared to last year, when it had 14 million paid users, who generated an average $123. Roughly 12 million, or 80 percent of the company’s 15 million paid users use Dropbox for work purposes.
Dropbox does not break out revenue by vertical industry, however some of the more popular ones include technology, media and advertising, as well as construction. Other popular verticals include colleges and universities, manufacturing firms, consumer and retail, and financial services. As a content management tool, Dropbox is used by virtually all functional groups, including sales, marketing, product, design, engineering, finance, legal, and human resources.
Paying users as a percentage of the registered total is just three percent as of the most recent quarter. Dropbox believes that as many as 350 million, or roughly 60 percent of its non-paying, registered installed base of 585 million are high value targets, meaning that they exhibit many of the same characteristics as its installed base. By virtue of their existing registration, the company has created a large funnel from which to draw future paid subscribers. It can also reach and sign up prospective users at a fraction of the cost of many enterprise software companies that rely primarily on a direct sales force.
Over the last several years, Dropbox has expanded from a focus on consumers to small, mid-sized, and large businesses and non-profits, including colleges and universities. The company’s software is well-suited to workgroups of all sizes, which must collaborate across multiple functional areas and geographies. The company has been assisted by the growing trend to remote work, as stay-at-home orders mandated by governments, corporations, and non-profits, in the U.S. and abroad, in the wake of COVID-19, has increased the pace with which knowledge workers must collaborate regardless of their physical location.
Dropbox, whose revenues have grown from $1.1 billion in 2017, the year before it came public, to roughly $1.9 billion this year, has grown organically, with the assistance of only a few tuck-in acquisitions along the way. As Dropbox shifts its emphasis from consumer file sync and share to content management for businesses of all sizes, many greenfield opportunities lie ahead.
IAC/Interactive (NYSE: IAC), the large internet and media conglomerate with a market cap of $21 billion, annual sales of roughly $4.8 billion, $3.4 billion in cash, and $3.1 billion in total debt, announced its intention on Friday, December 20th to acquire Care.com for $15 per share in an all cash deal. The valuation is, according to IAC, a 34 percent premium to Care.com’s closing share price on October 25, 2019, the last trading day before a press account indicated that a deal might be in the offing.
With a history of acquiring somewhat distressed internet companies with solid brands and customer sets, IAC’s acquisition of Care.com is consistent with several of its previous purchases, including Ask Jeeves, and Angie’s List, which following its merger with HomeAdvsior is now called ANGI Home Services (NASDAQ: ANGI). Our understanding is that IAC will roll Care.com (previously) into the IAC/Interactive umbrella. As part of the deal, IAC has already assigned a new CEO to run Care.com. It would not be unreasonable to assume that pending changes to its management and operational structure, that IAC would either establish a tracking stock, or spin-off Care.com in the future, perhaps under a new name, or with additional businesses currently owned by IAC, or ones yet to be acquired.
Undeniably, it has been a challenging year for Care.com. Back in March of 2019, The Wall Street Journal published a damaging expose which criticized Care.com’s screening processes, and found hundreds of instances in which daycare centers listed on its website were not properly vetted. The WSJ expose prompted Care.com to immediately remove flawed agency listings as well as unveil new security and background checks to be paid by the company.
The June resignation of the company’s CFO, who remained in a transition role through August 31, the early August announcement that founder, Chairwoman, and CEO, Sheila Marcelo would transition to a new role as executive chairwoman, along with a reduction in revenue and earnings guidance, all contributed to a 70 percent contraction in its share price. In our opinion, the damage inflicted on Care.com’s brand is by no means permanent, though the cost to ensure consumer satisfaction with the level of background checking on caregivers remains in flux. An additional question mark has been the cost of assigning Care.com employees to fulfill caregiving roles for the corporations and universities utilizing its last minute backup care services.
Getting Care.com’s board to agree on a take-over bid may have been easier than hiring a brand new executive management team, which would have much work to do behind the scenes to re-establish a profitable, predictable growth trajectory. A new team would also be required to make decisions publicly, rather than behind the aegis of a large conglomerate, such as IAC/Interactive. We have no reason not to believe that all reasonable strategic buyers were consulted during the company’s sale process, so it is unlikely—though not impossible—that another suitor would enter the fray to make a higher bid Care.com.
As the internet has transformed commerce, social, and work life over the last 10 years, consumers have become increasingly willing to entrust personal safety to operators of websites that provide matching services. Dating over the internet, once taboo for fear of linking up with a sociopath, has given way to comfort with finding in some cases, partners for life. Finding and accepting transportation over the internet comes along with the risk of placing one’s personal safety in the hands of a driver whose qualifications and personal habits are something of a mystery.
On Friday, March 8th, the day after Care.com released Q4 results, The Wall Street Journal published a highly critical article about Care.com’s screening practices for caregivers in its online edition, entitled, “Care.com Puts Onus on Families to Check Caregivers’ Backgrounds—With Sometimes Tragic Outcomes; The largest online marketplace for such services says its members are responsible for ensuring background checks are performed.” The article was also published on the first page of the Journal’s week-end print edition. Without reviewing here the entire contents of the article, the most salient points were that the Journal had found hundreds of instances in which daycare centers were listed on Care.com’s website as state-licensed, but were not. In at least one instance children died while under the care of a non-licensed facility.
The article was also critical of Care.com’s screening procedures. Care.com’s preliminary screening checks multijurisdictional databases, as well as the National Sex Offender public website, as part of a manual process, which can take up to 48 hours, and which rejects an estimated 10 percent of those seeking a listing within 24 hours. Existing and prospective customers can also purchase additional packages that range in price from $59 to $300 to conduct a more detailed level of screening.
The article, while specific to Care.com, raises the question of responsibility and liability for companies operating in the gig economy. Like LinkedIn, Indeed, and other jobsites, Care.com does not conduct employment level background checks. Uber, for example, like Care.com, conducts a background check on its service providers, ie. drivers. This includes a Motor Vehicle Record review, as well as a criminal background check. Background checks for Uber drivers, according to the Uber website, are conducted by Checkr, a third party background check provider that is accredited by the National Association of Professional Background screeners.
On March 11th, Care.com filed an 8-K with the SEC in which it noted that it would no longer allow caregivers that are new to the platform to engage with the platform until the preliminary screen has been completed. The company also disclosed that it was exploring solutions to help verify the identity of both caregivers and care seekers on its platform. Care.com will also be looking at potential changes regarding notification of members on its websites when, for example, a caregiver is no longer allowed to provide services on the platform. Care.com also eliminated all listings of daycare centers that were not updated and reviewed by the daycare center itself. Finally, Care.com announced a new board level committee that will oversee the company’s safety and cybersecurity programs.
To be sure, the concept of guarding personal safety over the internet continues to evolve. It is likely that industry best practices will emerge over time. However, there is still likely to be an element of trust every time someone steps into an Uber or Lyft-driven vehicle, accepts an invitation for lunch through an online dating site, hires a person based in part on job experience posted on a website, or employs a care-giver in their home.
As of this writing in late December, Twitter (NYSE: TWTR) continues to struggle, relative to its internet advertising peers Facebook (NASDAQ: FB) and Google (NASDAQ: GOOGL). Despite a flurry of activity in the fall, during which the company was rumored to be on the auction block, the stock has floated back down to earth, and then some, as investors consider several ongoing challenges faced by the company. Among these are persistent management turnover, a struggle to rekindle user growth, and what we perceive to be mediocre earnings quality.
Management Turnover Continues
In the first 18 months following its IPO in November of 2013, Twitter was plagued by rampant management turnover, including a 60-day interval, during which three of the top five executives listed in its S-1 filing resigned or were reassigned to new posts in the company. Jack Dorsey, Twitter’s Chairman and co-founder, became CEO in October of 2015, and, until recently, management turnover had stabilized.
On November 7th Twitter COO Adam Bain informed the company of his decision to resign, after a six year stint, which featured a role as head of advertising sales. Two days later, Twitter announced that it had appointed CFO Anthony Noto as COO. Noto will continue in a dual role as COO and CFO until a new CFO is hired. The COO position is crucial, as Twitter’s CEO Jack Dorsey continues to split his time between Twitter and Square, another company that he co-founded. Noto, who had been in charge of live content, in addition to his CFO responsibilities, is now in charge of global advertising sales, data, MoPub, as well as global partnerships and business development.
Then on December 20th, Twitter’s chief technology officer, Adam Messinger, resigned. On the same day, Twitter’s VP of product, Josh McFarland let it be known that he was leaving the company to join a venture capital firm.
Working to Rekindle User Growth
Twitter reported its lowest-ever rate of year over year revenue growth in Q3 2016, as advertising sales rose just six percent over the prior year. This was the seventh consecutive quarter that sales growth declined. Monthly active users (MAUs) grew by just three percent in the last quarter. In addition, the company has, for several years, declined to report the number of daily active users, which are suspected to be considerably lower than its 317 million MAUs.
Twitter is working behind the scenes to induce users to utilize the service more frequently. Efforts underway include the addition of new content, such as Thursday Night Football, as well as the application of machine learning and artificial intelligence to improve the user experience, particularly in the area of notifications, and home timeline, where the majority of user time is spent. The company is focusing in particular on improving the relevance of user notifications, and emphasizing topics and interests, rather than following people per se, as methods to improve user engagement.
Earnings Quality Remains Poor
Like most VC-backed West Coast technology companies, Twitter utilizes a healthy dose of stock-based compensation, which reduces the near term cost of compensating employees, but passes the longer term cost along to shareholders, who are left to absorb the increased issuance of stock in the form of reduced earnings per share, once the options grants are exercised. In the third quarter of 2016, stock-based compensation accounted for 32 percent of gross operating expenses. SBC is particularly noteworthy within research and development, where it accounted for 49 percent of gross research and development expenses in the third quarter.
Another area of concern regarding Twitter’s EBITDA presentation is how it accounts for research and development costs. Twitter continues to capitalize, rather than expense, a considerable portion of its research and development costs. While this is a perfectly legal practice, we believe R&D costs should be expensed in the period in which they are incurred, rather than capitalized as assets that can be amortized later through COGS, at which point the non-cash amortized expense is viewed by many to be inconsequential.
Twitter continues to languish relative to its internet advertising peers. Our sense is that the company still has obstacles to overcome, as its management ranks continue to shift, user growth remains tepid, and the company’s earnings quality remains low.
With projected calendar 2015 sales of $410 million and a market cap of roughly $3.3 billion, Veeva Systems is a leading provider of cloud software for salesforce automation, content management, and sales contact data to the global life sciences industry. Based on an exclusive software license from salesforce.com (NYSE: CRM), Veeva’s CRM software is now utilized by 17 of the top 20 largest pharmaceutical and biotech companies, including eight of the top 10. Within the top 20, only three have thus far not made the switch to Veeva: Switzerland-based Roche Holding, France-based Sanofi, and France-based Novo Nordisk, which ranks in the top 15.
Veeva has identified an annual market spend of over $5 billion in software for CRM, content management, and sales data, and so it has much running room ahead. Veeva has already captured an estimated 50 percent of the CRM market for pharma and biotech, and could very well capture as much as 60 percent of the market over the next several years, as the company continues to roll out new seats to existing customers, and sell additional CRM add-on modules.
Since Veeva is cloud-based, and features a multi-tenant architecture, the company can update the software of its entire customer base at the same time, reducing the time, aggravation, and cost associated with maintaining and updating several versions of the same software program. Veeva’s cloud-based product set stands in contrast to two of its largest competitors, Oracle (NASDAQ: ORCL), and IMS Health Holdings (NYSE: IMS), which support and maintain several software packages simultaneously, many of which have been developed for older client server computer systems, and are not hosted in the cloud. Support for these older software products detracts from keeping their cloud products up to date, which will likely lead to further market share erosion.
Veeva’s newer products for content management and sales data, respectively, accounted for less than 10 percent of sales a year ago, but now account for about 20 percent of product sales. These products carry slightly higher gross margins than the company’s CRM products, and more than double its addressable market. Veeva has additional room to sell Veeva CRM, Veeva Vault, and Veeva Network to existing and new customers, as well as to sell the new products to other segments in the life sciences market, such as medical devices, laboratory instruments, and CROs—segments with which the company conducts limited business currently.
Veeva benefits from an experienced management team, led by Peter Gassner, a former SVP of Technology at saleforce.com, and at Peoplesoft (later acquired by Oracle), where he was Chief Architect and General Manager for PeopleTools, and at IBM Silicon Valley Lab, where he participated in database research and development. Matt Wallach, co-founder and President, was formally GM of the Pharmaceuticals and Biotechnology division of Siebel Systems (later acquired by Oracle). CFO Tim Cabral has held financial management positions at Peoplesoft and other technology companies. Detailed knowledge of the specific needs of the pharma and biotech segments, gives Veeva a leg up over its competitors, many of whom have only general knowledge of the life sciences sector.
Veeva has a strong balance sheet, which features $438 million in cash and no debt, and continues to generate very solid cash flow, all the while growing the business, while running at a 30 percent operating margin in the most recent quarter.
With projected 2014 revenues of $574 million and a market cap. of roughly $1.8 billion, WebMD is a leading provider of ad-driven health-related content. Online ad sales, principally to drug companies, account for 80 percent of sales. WebMD also provides private content portals to 100 companies, which account for the remaining 20 percent of sales. These portals provide information, advice, education, and services that enable employees and health plan members to evaluate healthcare benefits, treatment, and insurance options.
With the assistance of new management in the last couple of years, WebMD rekindled growth in its online business in part by reducing ad pricing and offering more flexible business terms, including ad campaigns of shorter duration, as well as targeting healthy lifestyle consumer advertisers and health insurance sponsors. As a result, WebMD’s online ad business rebounded by 11 percent in 2013, following a precipitous 18 percent decline in 2012.
In the last couple of quarters, however, online ad spending growth has begun to decline, due in part to tougher comparisons against last year’s performance, a greater emphasis on mobile advertising, for which advertisers spend less than on full-fledged PCs and tablets, which offer larger screen sizes, and the ability to gain more metrics on user behavior. Although not a single company accounted for more than 10 percent of ad sales in either 2012 or in 2013, WebMD depends on a concentrated customer base of drug companies, and an unspecified contribution from non-pharma brands in its online ad business. Recent and proposed consolidation in the global pharmaceutical business is likely to increase the company’s customer concentration.
WebMD’s private portal business, in which it provides healthcare related information to employers, employees, and health care services providers, contributed 18 percent of sales in WebMD’s Q3, and grew by 21 percent over the prior year, almost entirely due to the Blue Cross Blue Shield Association Federal Employee Program that the company launched at the beginning of 2014. The five million member program is WebMD’s largest-ever contract in this category, although the margin impact is less clear. We note that WebMD does not disclose the gross or operating margins for the private portal business, making it difficult to assess the financial impact of the transaction. Elsewhere within the business trends are not positive. WebMD had 100 private portal customers as of the end of the end of the third quarter of 2014, down from 113 in the prior year.
Key swing factors for the next 12 months include whether WebMD can (1) maintain and/or grow its share in online ad spending by the drug companies; (2) attract more consumer brands and health plan sponsors to advertise on its websites; (3) achieve margin expansion beyond current levels, while investing in new platforms and programs.
With annual sales of $233 million and over 2.6 million active customers, Pompano Beach-based PetMed Express (NASDAQ: PETS) is the largest pet pharmacy in America, and a leading online provider of medication, nutrients, and health-related supplies to pet owners and their dogs and cats. Leveraging the trends toward online commerce, an aging pet population, and the impending shift from topical medication to prescription pills, PetMed focuses on the health management needs of its customers’ pets. About 45 percent of sales comes from prescription medication, 45 percent from health-related products, and 10 percent from pet lifestyle products.
Health-related trends in the pet population mirror trends affecting their owners. These include rising levels of life expectancy, yet greater presence of disease and chronic conditions such as obesity, thyroid, and arthritis. Like their human companions, pets are benefiting from greater awareness of the impact of a nutritional diet.
A key factor impeding PetMed Express’ sales growth over the last couple of years has been the emergence of numerous brick and mortar and online retailers that have expanded their efforts in the pet health category, seizing upon an obvious area of consumer interest. PetMeds’ strengths include the ability to fulfill 80 percent of prescription orders through an online customer care group, at prices that range from 10 to 50 percent below veterinarians’ prescription medication prices. PetMeds boasts an 80 percent one-day turnaround time on orders, and an 80 percent reorder rate among customers. PetMeds’ highly efficient operations yield over $1 million in revenue per employee, which enables it to achieve a 12 percent operating margin, 20 percent higher than PetSmart, its closest publicly-traded peer, despite a dramatically lower sales volume. That said, competition ranks as the number one impediment to PetMeds’ near-term growth.
An experienced management team has been focused on identifying areas of profitable growth for the company, including a greater emphasis on higher margin prescription drugs. Newly introduced creative advertising may help to generate sales to new customers, an area which has been growing at a slower rate in the last year. While the company develops a profitable growth strategy, investors can draw upon a dividend, which has increased steadily over the last several years. Its current yield is 4.4 percent.
PetMeds’ core competencies in online distribution, customer service, efficient inventory management, and advertising, combined with a 2.6 million pet owner active customer base, and solid balance sheet make it an under-valued asset, one which we believe will grow in value over time.