Hedge Funds and other institutional investors have just completed filing their 13Fs with the Securities and Exchange Commission, revealing their equity portfolios as of the end of September. At Insider Monkey, we follow over 700 of the best-performing investors and by analyzing their 13F filings, we can determine the stocks that they are collectively bullish on. One of their picks is Box, Inc. (NYSE:BOX), so let’s take a closer look at the sentiment that surrounds it in the current quarter.
Box, Inc. (NYSE:BOX) has experienced a decrease in enthusiasm from smart money lately. BOX was in 26 hedge funds’ portfolios at the end of September, down by one from the previous quarter. Not only that the company is slowly loosing interest from smart money investors, it has not succeeded to attract many managers that belong to the wealthy elite (to see which stock have captured their attention take a look at the list of 30 stocks billionaires are crazy about: Insider Monkey billionaire stock index). This is just the beginning of our analysis of the stock, we’ll further discuss hedge fund action regarding the stock, and, at the end of the article, we’ll also compare it with other companies of similar market caps.
In the financial world there are a large number of tools investors have at their disposal to grade stocks. A pair of the most under-the-radar tools are hedge fund and insider trading indicators. We have shown that, historically, those who follow the top picks of the best fund managers can outperform the broader indices by a solid amount. Insider Monkey’s flagship best performing hedge funds strategy returned 17.4% year to date and outperformed the market by more than 14 percentage points this year. This strategy also outperformed the market by 3 percentage points in the fourth quarter despite the market volatility (see the details here). That’s why we believe hedge fund sentiment is a useful indicator that investors should pay attention to.
While researching about Box, Inc. (NYSE:BOX) we found out that Greenhaven Road Capital has added it to its portfolio, and here are its thoughts on the company from its recent investor letter:
“Box started 13 years ago out of a USC dorm room as an online file storage company, effectively offering a cloud- based hard drive to store computer files. Today, there are multiple companies that will allow a user to store a virtually unlimited number of files for a nominal amount of money, or even for free. Online file storage is a “bad” business as there is little value add and it is effectively a commodity. The founders of Box realized that commodity storage could be a race to the bottom, so relatively early on, they began to focus on the enterprise customers (larger companies), and particularly companies in regulated industries. For large companies in regulated industries such as health care or defense, storing information is easy: compliance is the tricky part. Large companies need to control who can access files, and with whom the files can be shared both externally and internally. There needs to be a log of all activity surrounding the file. Who opened it, when and where did they log in from, etc.? There are file retention policies to be enforced. While Google Drive may work for a small business, the compliance needs of an enterprise quickly strain the functionality of Google. Do you want your health records stored on a free Dropbox account your doctor got by sharing the email address of 5 friends? If you run a defense contractor with 150,000 employees, do you want them using a hodge-podge of Dropbox, Google Drive, and OneDrive? Large companies need more robust data storage solutions. They need the ability to share content internally and externally but also to have controls and records of how that sharing occurred. They need the ability to lock files. To gain a sense of the robustness of the Box offering, it is worth perusing this feature comparison datasheet (linked here).
Over the last decade, Box has built a customer base of over 87,000 companies with over 10M users that store their data on Box servers, including 69% of the Fortune 500. Box has integrated with 1,400+ applications so far, including Google Suite, DocuSign, and Slack. The products and integrations allow files stored with Box to be “the source of truth,” which means that while other applications can access files stored on Box, all of the changes are made and kept on the Box version where the security and sharing protocols can be applied. These integrations make it less likely a customer will leave Box, and diminish the chances that a direct or adjacent competitor could create a copycat product.
The robustness of Box’s current product suite and the lack of credible alternatives has led to very low churn rates: retention is 95%. Because of the addition of new products and the sales of additional seats, we can expect the core base of customers (before any new customer adds) to spend more this year than they did last year. In fact, Box’s net dollar retention is running at approximately 108%, so even if no new customers were added, and with some attrition, we would still expect revenue to increase at least 8% before factoring in sales to new customers.
Box has a very sticky product, and a large customer base. There is the potential to further monetize the customer base by selling a lot more product and services to the existing base to take advantage of being the holders of critical data. Box is sprinting at this opportunity. The company is spending over $100M a year on R&D. While meeting the compliance use cases of large enterprises is complex, it does not require this level of R&D spending. Box is aggressively building a robust pipeline of new products for release over the next two years, designed to improve how people work with and share information, the security of information, as well as applying automation and machine learning. Here are a couple of links to provide a sense of the future products and how they take advantage of Box’s unique position and how far Box will be from a simple file storage company.
Box recently added a new board member, Kimberly Hammonds, and in the press release she said,
“Box’s leadership and vision for cloud content management puts the company in a unique position to power digital transformation and improve the business of every enterprise across the globe. Content and information are at the heart of how we work, and are only becoming more critical as powerful new technologies like AI, machine learning, and automation open up all new opportunities to innovate. Box is just scratching the surface as a transformative partner for their customers and I’m excited to be a part of this next phase of their business.”
I feel the same way.
I have not seen Box written up in any of the traditional venues like SumZero but it was presented by venture capitalist CEO Chamath Palihapitiya at the Ira Sohn conference. He argues that Box is a way for individuals and companies to benefit from the improvements in AI (Artificial Intelligence). Over time, Box customers (who are generally larger and have more types of data spread across more users than customers of other solutions) inevitably will want to apply artificial intelligence to their data. In fact, they will likely want to apply AI solutions from multiple vendors. Box is application agnostic and will be able to integrate with all of the major AI players including Google, IBM, and Amazon. Thus, by storing files on Box, companies will have both the security they need and also the flexibility to work with multiple vendors to access and mine their files in different ways. Typically when I hear a buzz word like AI, a combination of words like vaporware, hype, and short come to mind. In the case of Box, at this point only the expense of creating this functionality has been realized as these integrations have been built and are being tested but have yet to launch. The ability to apply the best AI offerings to data stored on box represents a free call option that could be another barrier to exit that generates revenue and is buzzworthy enough to generate multiple expansion.
Box is missing one characteristic that I value: high insider ownership. Box was started by four college-aged friends with limited personal resources. Their first round of funding came from Mark Cuban. Eventually, as the company pursued developing for and selling into the enterprise market, they raised hundreds of millions of dollars in several rounds of financing. As a net result, the co-founder CEO owns approximately $70M in stock and the co-founder CFO just north of $20M. So while collectively they hold less than 5% of the company, they do have “skin in the game” and are not simply hired hands.
Box operates in a massive market that they refer to as “Cloud Content Management” and size at $45B per year. I think no matter how we define it, it is likely growing and worth multiples of Box’s current revenue. Last year, Box generated operating cash flow while spending roughly two-thirds of revenue on sales and marketing and product development (54% and 20%, respectively). Over time, a company’s value should approximate the rates of return that they can get when they reinvest capital. As discussed before, with a customer base of 87,000 companies, it is easy to see a very high ROI on new product development. I am typically skeptical of sales and marketing spend as it can be a sugar high to drive short-term growth. However, with customer retention rates running in the above 90% and net dollar retention running well above $100, Box is actually probably not spending enough on sales and marketing. There is a slide on page 88 of their investor day deck (link) that shows revenue growth by cohort. It is beautiful. Several different years of customer cohorts have been compounding revenue growth well in excess of 20% per year. Now, marketing effectiveness may deteriorate over time, but the last two years have seen CAGR’s of 24% and 20%, and there is still a largely untapped international opportunity as the U.S. constitutes 76% of revenue.
All of the above paints the picture of a high-quality business with a bright future. Companies like this are rarely optically cheap. We are currently buying shares at just north of 4X next year’s sales, which one could argue is cheap relative to many SaaS peers, (Dropbox and DocuSign have valuations twice as rich) but certainly is not on an absolute basis. I think one of the greatest risk factors here is multiple compression, particularly if growth slows. However, given the product pipeline and sales pipeline, I don’t think the slowdown is imminent. In the long run, Box has the opportunity to continuously improve their business through a virtuous cycle of retaining customers and improving monetization. Product improvements lead to greater value add, which leads to greater utilization, greater lock in, lower churn, and higher revenue per user. Revenue growth and margin expansion are highly probable, with multiple expansion a possibility. No additional capital is required to grow. There is a long runway for growth, and multiple opportunities for additional products to be sold into a large and attractive customer base. Continued revenue growth of 20%+ for the foreseeable future, coupled with operating leverage and a very valuable customer base, create an interesting set-up.”
On the next page, we’ll continue with our analysis and take a glance at the latest hedge fund action surrounding Box, Inc. (NYSE:BOX).