Why Is Seth Klarman Buying Dropbox?

Described by many as the next Warren Buffett, Seth Klarman is at the head of a new generation of prominent investors following a value investing strategy. Although this strategy has underperformed the market in recent years, Klarman and others like him strongly believe that value investing is still the best strategy for realizing long-term growth in the stock market.

Now, Seth Klarman appears to have set his sights on cloud storage giant Dropbox (DBX). True to Klarman’s value strategy, Dropbox appears to be more of a long-term position than a company poised to deliver rapid growth. Here’s what you need to know about why Seth Klarman is bullish on Dropbox and why the stock could be a win for value investors.

How Much Dropbox Has Klarman Bought? 

Baupost Group, the hedge fund led by Klarman, currently holds the second-largest institutional position in Dropbox stock. Its holdings are valued at $271.4 million, only slightly behind Renaissance Technologies’ $280.3 million stake.

In terms of total allocation, however, Klarman’s bullish bet on Dropbox is far heavier. Only 0.4 percent of Renaissance Technologies’ portfolio is invested in Dropbox shares. By comparison, Baupost’s position represents 2.5 percent of its portfolio.

Why Dropbox Is a Top Buy for Klarman 

Looking at Dropbox, there are several factors that could excite investors like Klarman. The company’s basic business model of offering users a certain amount of storage space on a free basis and then upcharging for more space and functionality has proven extremely effective.

As of 2017, 90 percent of the company’s revenue came from paid customer conversions through self-serve channels. As a result, Dropbox has been able to build a large base of paid customers at a relatively low cost.

Dropbox’s focus on cloud storage gives it some competitive advantage, but its moat isn’t absolute. Google and Microsoft are both strong competitors, especially when it comes to workplace collaboration. For non-business use, Amazon Drive also competes with Dropbox.

However, Dropbox is quite competitive in its industry and seems to have a decent lock on its part of the cloud storage arena. With a 21 percent share of the cloud storage market, it is unlikely that Dropbox would fall from its position as a major player in that space any time in the near future.

Dropbox also appears to be quite strong from a fundamental perspective. In its final quarter of its last fiscal year, the company outperformed its revenue guidance, generating $550 million in overall revenue. The year-on-year revenue growth for the quarter was a respectable 12.9 percent.

Earnings per share reached $0.37, beating out a consensus estimate of $0.35. Revenue per customer also rose, demonstrating Dropbox’s ability to capitalize on its existing client base. The per-customer revenue in Q3 reached $133.79, up from $128.03 the year before. 

Dropbox is also appealing for its commitment to reaching long-term financial objectives. By 2024, the company plans to increase its free cash flow to $1 billion. The same timeline applies to its goal of reaching operating margins of 28-30 percent. Achieving these goals would position Dropbox as a standout value stock in the often volatile tech sector.

Overall, Dropbox appears to be a solid stock from a value perspective. While the company is growing at a slower rate than several of its immediate competitors, it appears to have good fundamentals and stable prospects for long-term growth. For a value investor like Klarman, this type of stock is often more appealing than trendy, high-growth tech stocks.

What Are the Downsides of Dropbox?

Dropbox isn’t without its drawbacks. As noted above, other stocks in the tech sector and even in the cloud storage space offer higher growth rates than Dropbox. While this isn’t necessarily a negative to a long-time value investor like Seth Klarman, it could make the stock less appealing for investors pursuing a growth strategy.

It’s also worth noting that Dropbox has gone through a rocky period in terms of share price. Shares sold off over the past few months, bringing the stock price below its 2018 IPO level. For Dropbox bulls, this selloff represents a buying opportunity. However, it’s difficult to ignore the role of negative investor sentiment in share prices at the moment.

Analyst price targets for Dropbox also don’t show strong 12-month growth compared to where the company has traded recently. The average 12-month target for Dropbox currently stands at $31.67. While this does represent a substantial jump from the current price, shares were trading at $30 as recently as early November 2021. Short-term gains, therefore, will largely be a function of price recovery instead of new growth.

At the end of the day, given Seth Klarman’s success as a value investor, though, it’s hard to ignore the company’s future prospects. Buying Dropbox while the price is still low following the recent selloff could present value investors with a solid window of opportunity to maximize long-term gains.