What’s in the Box? Nothing good, apparently

It’s pretty interesting to follow the first earnings release/conference call for a newly-listed public company: oftentimes you see the first published numbers for a new listing well and truly ‘scrubbed up’ so as to paint the best picture possible to the analyst community. Frankly, Wall Street is as much about marketing and telling a story as any other industry so it’s hard to blame executives for trying to start out on the right foot.

Which is why it’s fairly meaningful when high-flying IPOs really bomb their first earnings report – as Box (NYSE: BOX) did today. The cloud storage/SaaS name IPO’ed to much fanfare in January, selling ~12.5mm shares @ $14 each; the stock promptly roofed it to $24, and before the recent earnings report was selling at $20.5 – a cool 10x sales (forget earnings, operating margins are negative 63%).

But this report really jumped off the page – for all the wrong reasons. Thing is, it’s not as if the bar was particularly high: for 4Q, analysts were expecting net losses of ~$2.25 a share (GAAP) – yes, that’s right, losing $2.25 per share on a $20 stock, in one quarter – but Box managed to lose $2.64 a share. More worrying was the decline in billings (a non-GAAP measure that is a forward looking indicator for out-year sales) growth rate, from 46% in the first 9months of FY14 to just 33% in 4Q (and well below sales growth rate of 61% in the quarter).

This is important because when you are losing money at the prodigious pace Box is managing, you really need to see accelerating revenue and billings growth to justify the increased opex spend. In fact one of my main gripes with Box- and indeed, many other JOBS Act IPOs – is that they haven’t really proven themselves as viable businesses and so have no reason to go public.

Thinking about it more broadly – how do you ‘know’ if you have a viable business or not? Well clearly, viable businesses generate profits and cash flow. But if you can’t make money today, as long as you can see a feasible path to profitability, you may still have something to work towards. What you really want to see is economies of scale and operating leverage: the more of X you sell, the cheaper it costs to produce X, and hence margins expand (often starting negative, then going very positive over time as fixed costs don’t grow with revenues). This is how you justify negative operating margins when a business is small, hoping to grow the business to a point where you can enjoy the benefits of operating leverage.

Now let’s go back to Box. I am not an expert on cloud storage, nor the ‘software-as-a-service’ industry. What I can say, though, is that Box’s business, even as it has grown, is not demonstrating the kind of scalability you need to think it could be sustainably profitable. Revenue in the most recent year was $216mm – this is no longer ‘de minimis’ – and grew 75%, but opex grew 30% too. Operating margins at -77% in FY14 may look like a massive improvement from -128% in FY13, but really this business is not scaling anywhere near fast enough given the valuation. Consider that even if Box grows revenues at ~40% next year and costs grow just 10% – beyond unrealistic – the company will still be running ~-25% operating margins.

Actually analysts are more bearish than this, and project even -20% negative operating margins out to FY18, but you get the point: it is still very unclear if Box has a viable business at all. Any business that is so hyper-competitive that you have to spend 96% of your revenues on sales and marketing (as Box did in FY14), can’t really be called a ‘business‘; ‘money pit’, ‘forest fire’, or ‘black hole’ may be more apt descriptions.

And we are not talking about small dollar amounts, either. Box – post IPO – has ~$306mm in cash as of Jan’15; according to analysts they will lose ~$148mm in EBIT next year (of which some is stock comp so lets say ~$120mm cash burn). The company has shown themselves to be acquisitive too, and assuming that continues, Box has maybe ~1.5-2yrs worth of cash (again if we take the street’s pretty rosy consensus estimates at face value). As such, current shareholders are likely to get diluted – probably more than once – in the next couple of years.

In the meantime, Box shareholders also need to contend with the ugly reality that just 12.5mm (9%) out of ~144mm shares outstanding are currently in the float, and that a ton of locked up stock, most of it with strike prices $0-$6, will hit the market in the next 6months. Most insiders were happy to sell down at $14, with the business looking better 3 months ago…methinks they’ll pull the parachute hard anywhere north of $10 now. The stock is trading at $17 in the after-market – still a crazy ~9x sales – but likely not for long…

Disclosure: no position in BOX

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