Chit Chat Stocks - Box (BOX) | Fundamental Analysis

Episode Date: January 31, 2021

Box is a cloud-based content management company. The company has surely developed since its founding in 2005. The company now operates as cloud storage and collaboration tool for individuals and enterprise companies. As always, enjoy the show. Subscribe to 7 Investing with the code "CCM": https://7investing.com/subscribe/ Subscribe to us on YouTube: https://www.youtube.com/c/ChitChatMoney Follow Chit Chat Money on Twitter: https://twitter.com/chitchatmoney Learn more about your ad choices. Visit megaphone.fm/adchoices Learn more about your ad choices. Visit megaphone.fm/adchoices

Welcome to Chit Chat Money. On this show, host Ryan Henderson and Brett Schaefer interview industry experts and riff on the world of investment. As a quick reminder, Chit Chat Money is a CCM Media Group podcast. Ryan and Brett are not financial advisors. Anything discussed on Chit Chat Money by Ryan or Brett or any other podcast guest is not formal advice or a recommendation. Now, please enjoy this episode. Welcome in. This is the Fundamental Analysis Show on Chit Chat Money. And today we're going to be talking box. I know everyone is probably still, I mean, minds are elsewhere in the investing world.

There's a war going on on Twitter. And honestly, we're having a hard time focusing. We're recording it at the end of the week. But we're going to try to get you back to some fundamental analysis, learning about companies and investing for the long term like we do. And if you want to, I mean, this is a great segue. If you want to actually learn how to truly invest in companies for the long term, you can try out 7investing with our code CCM at checkout for $10 off. So it's only $7 for your first month to try it.

Great service. And, yeah, one thing we just actually talked with Simon and some of their team, and they do, like, advisor calls, kind of like a Zoom meeting type deal or more kind of a conference call type deal where people can ask questions. They really try to learn with each other. It's like a real community. Yeah, yeah. So yeah, they make it try to be very community-based. You can read their recs and then if you like one of them in the call, you could ask a question and actually discuss it and it's not just you on one side and them on the other side. You're actually collaborating.

Yeah. But yeah, contrary to popular belief, there are other stocks out there than GameStop and AMC right now. Yes, and if you want to actually invest for the long term, you can try 7investing. But the show today is going to be about Box. They're very similar to Dropbox or Google Drive, but Ryan's going to get into them and what they do as a business. Yes, they describe themselves as a cloud content management platform. Basically, they are very similar to Dropbox. So it is your hard drive in the cloud and cloud storage as a whole is pretty commoditized now.

Like, I mean, it's been commoditized almost for a decade. So each provider is trying to basically build on the additional functionality so that hopefully the teams that are on it stay and it becomes instead of just a place to store files, a collaboration place where you can access, assign stuff, share folders, just basically become the central destination of a worker's day. So that's sort of the, I'm trying to describe the zero, zero of your workday. If you're looking at your workday as a coordinate plane, it's your zero, zero. That's kind of where you start. But the only slight difference here is that Box started with an enterprise focus. Well, technically they did not. Technically they started with an individual focus in its very early years, but they switched to enterprise before Dropbox did.

Dropbox didn't really, they were pretty much consumer focused until like 2015. And the way they typically attract customers, Box, is either through, they have a direct sales team and sales and marketing. I think they spent, I think it's like 30% of revenue. I forgot. But they have the sales staff and they can go after like CTOs, CEOs, head execs and try to build the, make an entire team become a Box customer. But really what typically happens is you bring on a team, like if you're at the firm level, if you're an enterprise, let's say Microsoft. They bring in a team from a consulting company or something, and they are used to using Box. They will use Microsoft's money to pay for their Box subscription within that small team within a company, and then they'll expand out that way.

So they will bring in other people from the company, like this big company. And so it kind of has intercompany network effects, if that makes sense. And then they can also have external teams work on it as well. And so that's sort of the bottoms-up approach that they have as far as sales go. And then they tend to sign up with multi-year contracts, and the revenue is recognized over the life of that contract. So the number you really want to pay attention to is revenue plus remaining performance obligations, which is defined as deferred revenue plus backlog. So that's really how much they'll be bringing in in total, except they'll add new customers in that time. That's how much they're extrapolating out.

So when you look at losses, they're looking at really – like you see the top line and then you look at operating profits as a percentage of revenue. They're looking at it as a percentage of bookings because they know how much is coming in. Yeah, and the operating – or sorry, the revenue is very stable. It's highly recurring. Like it's all recurring basically. So they can have a period say, okay, they know over the next two years they have this much guaranteed to come in and they have this product pipeline or contract pipeline in the works. If they invest now, lose a bit of money on a gap basis, you know, they kind of know it's similar to Netflix in that way or someone like that where they know that the revenue is going to be there or hopefully, you know, theoretically it's going to be there because their churn is pretty low. And then they can invest heavily, you know, with confidence.

Yeah, it is extremely predictable top line. But it feels like a very typical, like very prototypical Silicon Valley story. So Box was developed originally as a college product by Aaron Levy, who I believe is a Twitter FinTwit presence. Feel free to check him out. He's a minor FinTwit presence, yeah. But when he was a student at USC, he developed Box, and that was in 2004. In 2005, he left USC to work on Box full-time, and that is University of Southern California, not University of South Carolina. I know there's that East Coast discrepancy.

So here on the West Coast, USC is California, as it should be across the country. but interesting note Levy and all his co-founders were friends from childhood and they actually grew up on Mercer Island close to our offices where we're talking right now

literally like two, three minutes away from us right now so super close so they all grew up in high school there and here's a quote on sort of how

the four friends molded into a team of their executives early on it says Levy and his three co-founders had a great idea what they didn't have

however was any real business experience or even a firm grasp of a basic business basic business concepts regardless the four friends were undeterred as the idea guy and most knowledgeable of the four levy was the clear choice for ceo dylan smith's sense for figures made him the obvious pick for cfo although his technical chops were lacking goads or maybe it's gods had the most programming

experience making him boxes cto and finally quasars or quasars i might be saying that wrong practical experience of installing cable modems secured his position as boxes head of it they're just giving each other there's four guys and giving each other executive spots kind of funny but originally the entire business was basically they would rent out server space for a dollar a month was pretty much how much cost a dollar per user a month they would sell people one gigabyte of storage uh for two dollars 99 cents a month and then they could just everybody could access their files from anywhere uh and they got a bunch of people to sign up and it so it was working they had like a thousand people signed up i think but it was a pretty

unsustainable business model because obviously as you scale you start to have more costs and so they went looking for funding but apparently all the founders were like 19 and 20 so no one would give them money makes sense uh it seems hard to give people money when they're 19 yeah but uh mark cuban had no problem doing it and he originally they sent a letter to try to get publicity i think mark cuban was running some blog at the time and this is right off the back of his sale uh well however much he sold it for billions um and so he gave him 350 000 uh for 30 percent shout out to mark cuban i guess uh he took the leap of faith uh and that just helped kickstart him but yeah that's basically it for the history kind of unique and i think aaron levy

and uh the cfo i'm yes dylan smith i think they're both still on i don't know about the others yeah all right i'll get to the valuation enterprise value right now is about three billion ticker, BOX, so very standard ticker there. Last 12-month EV to sales of 4.1, which always makes me happy if something's under 10, if it's a software business in this market environment. And the shares are down like 5% today too. Oh, hey, there we go. Unprofitable right now too, so there's no earnings ratio, but they are cash flow positive. EV to operating cash flow of about 19.5 over the last 12 months. And if the stock's down 5%, that's going to be even lower. Minimal cap X. So EBITDA free cash flow is similar, but that EBITDA free cash flow

will be slightly higher. No dividend, as you're probably expecting. And share count is going up a bit. Looks like they take a big hit on valuation from the share dilution. I don't know the exact percentage number, but it wasn't immaterial. So something to watch out for, for sure. They just raised, for example, a $315 million convertible note with 0% interest due in 2026. And if you don't know what a convertible note is you're thinking what zero percent interest all the way out then that doesn't make any sense but the reason companies do that and i think it has a strike price of around 30 a share if box throughout any of this time period up till like 2024 it might be after 2024 whatever the rules are they're pretty simple um if their share price is up above

like 30 a share the bondholders are able to convert this 315 million dollars to equity so that'll further dilute the company, but it's an easy way to raise money without having to pay interest payments. And if it converts to equity, they won't have to pay back the debt. So it's kind of a give and take, but that's how it works. Last things on the balance sheet, working capital is a deficit, but that's mainly due to $300 million in deferred revenue on the liability side. So nothing too concerning there. And it's probably good that, you know, they run a pretty working capital like business because, I mean, with that recurring revenue, there's no need to just pile a bunch of cash on the balance sheet, especially if they're trying to invest through

the income statement, as people say. And then, yeah, they don't really have much long-term debt about, I mean, technically that convertible note is debt, but they have about $200 million in operating leases. So that's not too bad as well. Yeah. It's, the leases matter and that's a big component of their cost structure is because They have all these servers that they're renting out from these basically big data centers. And so they have to pay maintenance and depreciation costs and all that.

But I'll get into the earnings. Revenue for the first nine months this year was $572 million, up 11.5% year over year. They had $34.3 million in operating losses during the quarter versus $111 million in operating losses from the year before. So they are getting there in terms of GAAP profitability. Their remaining performance obligation was $756 million, up 19% year-over-year. Good sign there. And then gross margins were 71% versus about 68% from a year ago. Net losses followed operating losses.

They've both diminished. They're getting towards break-even profitability in terms of a gap basis. They had $139 million in operating cash flow for the first nine months and $79 million in free cash flow for the first nine months. So that's a free cash flow margin of 14%. percent last year was about negative one percent so they are showing that uh at scale they really can be a cash flow machine um and i i think they obviously have room to grow into that as well but they spend about 20 of revenue on stock-based compensation um and then like you said if you

take out deferred revenue from their current liabilities they have plenty of working capital i would take it out because it's very unlikely that that's not going to get filled yeah but the thing is like you can't technically just take it out yeah uh because there is the assets that match it up with the cash uh but it kind of shows like all right you got a lot it looks like they have a lot of current liabilities and technically deferred revenue hasn't been realized yet but the likelihood that it's going to be realized with a company like box seems very very high um it hits you get it like aggressive on the balance sheet but i mean it doesn't seem too bad like at first glance if you just saw the working capital number you'd be like oh that's tough because they're gonna have

to keep continually invest but it really doesn't look like they're in trouble yeah i agree yeah okay that's it then for the first half we're gonna take a break and then do some more analysis on the back end cox panoramic wi-fi includes advanced security to help protect all your connected devices you'll get real-time alerts oh like this one so you don't have to worry about malware or when your kid downloads a song from a shady link and now all your computer can play is red color red color where are you all blocked thanks to advanced security included with cox panoramic wi-fi advanced security must be enabled in the panoramic wi-fi app restrictions apply okay welcome back in first question is digging trenches so what are we thinking here zero one

two or three on the moat rating competitive advantage what do you think yeah churn i believe was about five percent this quarter um do they explicitly say that i think they said that in the conference call the net retention rate is was 103 percent um which isn't great and it's been declining so it gives me pause but churn's been declining as well it went from like six percent to five percent yeah i um i don't know it's obviously competitive like uh cloud storage and people are like dropbox versus box what are you going to go with well i'm not sure uh it's it's definitely not a winner-take-all scenario if you can charge higher prices if you can make your platform sticky enough that teams are going to stay on it um you can continue to raise prices

incrementally over time and then cut operating expenses uh and just generate more and more cash And as a shareholder, that's what you want to see. And Dropbox and Box can do that simultaneously. And then Google Drive is obviously a little more customer-focused and OneDrive for Microsoft. But those are also integrated into the platform. So it's not necessarily – I would say this is more an aggregator of all those different functions like OneDrive products and Google or G Suite products instead of like a competitor to them. yeah and you when you say one drive you probably mean more office 365 yeah yeah okay so i guess two two and a half yeah because dropbox and box yeah they compete yeah microsoft and google and

others have competing products but box goes after the big enterprises to do like complex things highly secure that's kind of their marketing pitch is like we're super secure uh which you know dropbox has that reputation of not being secure but dropbox goes for like small businesses and individuals but box is really going for those like million dollar contracts or even 10 million dollar contracts so yeah i'd probably agree with you too um we don't know the tech as well as someone like you know tim byers or hyper growth um muji muji hyper growth that's his pseudonym but we both had those guys on talking about companies like this and i know tim byers did talk about how he does like box so that's kind of what we got interested in it but

But it's hard to give a rating of a three when we don't understand how the business works from a fundamental level. But next up is for the reading, which is something we want to learn more about. What do you got? Well, just so they depreciate the useful life of their data center leases on a straight line basis. And so basically you're seeing this large differential between cash flow and gap earnings. And some of that is coming from the depreciation of these basically data centers and the servers in them. And so according to Dropbox's 10K, they do it over three to five years, which we were talking about. It seems kind of aggressive.

I'm curious how much they're actually incurring on depreciation and what they expect the useful life really is. Because you can estimate, I mean, I guess you just take the cash flow number, but if there's less depreciation than what GAAP requires them to estimate, there's a little more operating leverage in the business than we might think. Yeah, and that does make a tax advantage too. The one thing to check on that is over time what the CapEx is versus the depreciation expense because if they're spending equal amounts on CapEx and depreciation, that does make it line up. it's not apples to apples but it's kind of a good indicator but it would make it similar if you're trying to think as a comparison to the cable business where they do have to depreciate stuff and the useful life is estimated it's probably not three to five years it could be over a different time period but in reality a lot of the times those things are you know they have a longer

useful life so box could be in a similar situation that could make them tax advantage that could make them cash flow advantage versus their gap earnings um but yeah it's kind of it's hard to know right yeah it's maybe it's not some we'll ever figure out i guess you really just look at capex over time but i don't i mean maybe it's just a reason not to pay as much attention to gap earnings as it is cash flow yeah definitely or cash flow minus stock based compensation that's uh so we're like All right, my further reading is why is this different than Dropbox? That's kind of a question I'm trying to ask, and we've kind of answered that where it's more secure

and it's more customizable for enterprises. So they're going after, I think they have a customer in like Morgan Stanley, which probably wouldn't use Dropbox, but they definitely would use Box. Yeah, I think they have a lot of government contracts too. Yeah. So, yeah, I think they also get the reputation of more secure. Um, I've, I've read some like tech blogs and they're like, it doesn't really make a difference anymore because Dropbox hasn't really had an issue in like five years or whatever.

Um, and there, apparently there was some reason behind that, but they have like the reputation of higher security. Yeah. And I can stick for a long time. Um, I don't know. Sometimes when I get a company like this, though, it feels to me like similar to when I was researching MongoDB. That's a company I used to own in my personal portfolio.

I researched it, thought I understood it. And then I realized when looking at other companies and competitors I didn't even know existed, all right, maybe I don't understand this industry as much. It seems a little simpler than the database software or whatever cloud-based database solutions that MongoDB plays in. But I would be concerned. Before I want to invest, it's something I'd try to understand at least from an outsider's perspective. Yeah, I'd agree with that. It seems maybe simpler than it actually is. What do you have for future growth opportunities?

is okay they have a product called box shield um and we're both just going to talk about products that they have because in reality like they have one product and that's box but there's a lot of add-ons that you know enterprises can customize with uh it takes a while for me to understand these a lot of times they get explained and on their website you kind of look at the info pages right and you're like all right i guess that sentence makes sense but why would anyone need this so this one though just back to box shield they focus on security and shield is one of those features you kind of add it on as a subscription and you can auto classify like security memos so it hopefully will use some sort of machine learning where they see some certain code it

kind of classifies it for say your government or a financial institution anything that needs certain security measures you put them in each classification so that doesn't get mixed up and you know if it saves efficiently and then it can also detect things if you know malicious stuff is happening uh malware whatever if that's going on it hopefully can detect that so that's kind of like the that's why they call it box shield because it shields your uh great name yeah whatever that is um but i think that's a good thing that can make their products again more differentiated than someone like you know google drive or dropbox where it is actually worth it for these big enterprises to choose them and that could give them, you know, that competitive

advantage. Yeah. Mine's similar to yours. It's called Box Relay. So they added this in February of 2020 and they've added some new capabilities in the recent quarter. And so this basically just allows teams to create specialized workflows instead of a one size fits all approach. So, you know, if you're assigning different tasks, you can do it in a specialized way. is that am i describing that in a way that makes sense yeah i think i think so so it's more like yeah if you have a team you can instead of just having everyone go in you can create a specialized like this assignment's here to this person this assignment's here then you guys collaborate on this that kind of thing okay so it's like customizable monday.com if you've ever heard

of that or asana or whatever okay yeah and just if you're actually curious on these specific functionalities just go look up a youtube demo honestly because that's usually the most helpful plus good uh dramatic background music every time yeah but there's no there's no one uh add-on or integration that they're going to put on there that's going to move the needle for them in terms of clients in my opinion uh just their their only job is to keep up and keep integrating with the functions that the teams need if you can keep doing that you're going to keep giving them more reason to stay on the platform and that's the name of the game for them and hopefully raise that retention rate or keep it above 100 for a sustainable period um but yeah future growth

opportunities for companies like that are kind of bland it's yeah it's hard as there's no reason to expect them to come out with a new product anytime soon uh it's all going to be add-ons yeah similar to dropbox okay highlights and lowlights what do you have uh i like to the rpo bill growth, 19%. So again, that's remaining performance obligations. That's another way to talk about their backlog of kind of contracted things. So for example, if someone signed a three-year deal, they don't realize all that revenue and they don't bill everything through that deal right away. So that's kind of stuff, you know, similar to, I don't know, a lot of companies do that. But again, 19% growth is solid. CEO and CFO have been talking a lot on the

conference calls and stuff like that about efficient growth. We're seeing that in the numbers here although you know if you back out stock-based compensation the numbers aren't looking as great uh and i do like the long-term nature of the business it's like something that feels like the lifetime value of a customer is very high it could be worth 10 20 million dollars um if it's a big enterprise but then lowlights though found it they're found in 2004 and they're still not profitable they use a ton of stock-based compensation as a mature company and we talk about stock-based compensation it's not necessarily a bad thing and it makes sense when you're a startup stuff like that you know you're kind of short on cash it's a good way to get everyone

involved everyone get ownership but as a mature company it seems like a lot of the smart businesses transition to paying you know just employees and stuff and better salaries competitive salaries and you have a few stock options out but 20 of revenue maybe that's a one-time thing but it feels like a lot um and then lastly i'm not sure they have any competitive advantages outside of switching costs um maybe a little bit but that does concern me a bit too okay my highlights are uh well it just feels like the market's discounting this because people think of cloud storage as commoditized which is fine but if you have like a five and a half percent free cash flow yield and you have sticky customers and you can reduce operating expenses it doesn't really matter uh if your

competitors are also good like you can still be a good investment so if but they got to make sure if they didn't dilute shares and i hit harpy on this and i started reducing share count that could be very nice but yeah maybe i'm just a little too optimistic there so yeah i would say that is a low light as well there's also this this might sound stupid but we talked about reputational risk as a low light for Dropbox. I think we did. Because if you're a firm and you have to take certain financial documents,

some clients might not want you to use Dropbox as storage because there's the security problems that they've had in the past. And so that just kind of sticks with them as a reputation. I think they should have used a different name than Box. Because the unacquainted might just think Box is like slang for Dropbox. Well, yeah, they were founded before Dropbox, but they could have changed their name.

I'd say Dropbox has more notoriety. Yeah, among consumers. I would say, yeah, the stock-based compensation is a concern, and then the net retention rate continues to fall. It was two years ago, it was 106%. Last quarter, it was 103%. And churn was actually higher than I would have thought. 5% seems really high for enterprise customers. maybe they have certain contracts where it's like projects uh so like timely projects where

they have like one year contracts uh and they're not planning to uh like renew them i'm not really sure but i might have to look into that as well yeah that all makes sense uh all right last question before we wrap up are we more or less interested i'll let you go first i'll go with more interested it feels like them and dropbox can both be winners uh and it feels like the market's giving it a bit of a heavy discount just because cloud storage is commoditized i'm putting that in air quotes um you know like i said before they can continue to generate higher cash flows as they reduce operating expenses as a percentage of revenue uh they can incrementally improve prices and then they're continuing to bring on more users as well so i don't i don't know i like

the business feels like a stable one and something i could easily sleep at night yeah yeah i'm more interested i mean it's not some phenomenal business where but the thing is it's trading at a reasonable price so the main reason i'm interested is because it is trading at you know whatever four times sales and they can likely get to 25 free cash flow margins at scale which seems very reasonable um or maybe even higher with that gross margin structure but yeah i mean stock-based compensation is a concern i'm not sure i mean would it be best for this the founding ceo and cfo to leave i mean they've been there a long time and i mean they haven't done much in the public markets like yeah i guess the business is still doing okay uh but it feels like right for

activism uh seems like someone could definitely come in potentially something like that but i mean the business does seem solid i agree with all your points i want to be surprised if they went the way of dropbox because dropbox just recently fired like 11 of the workforce um i mean they're still hiring people but if they're trying to cut or like cut out bloat where they can i want to be surprised if box has to do that as well yeah yeah true i they are hired yeah they are saying they're trying to become more efficient um and we'll just have to hold it to that if you are going to be an investor in this company or thinking about being an investor you probably want to look over the next three years okay are margins getting better are they spending a little

bit less you know is the leverage actually going to be there you got to hold them to their word of what they're going to say also a highlight uh the person that i know the the one person that i know who knows the most about software said this was his recommendation a while back on our show so yeah he said that's like a company he's looking at yeah not not right yeah not a recommendation it's one he looks at a lot yeah so i don't know i mean confirmation bias there you go yeah always looking for that uh but that's gonna do it for this episode um thank you guys for listening use our promo code ccm at checkout to get ten dollars off your first month at seven investing remember we are not financial advisors anything we say on this show is not formal advice

or recommendation. Thank you for listening. We'll see you on our next episode.