IPO of last resort: Box has no choice but to go public, despite its ugly numbers

By Michael Carney , written on January 9, 2015

From The News Desk

Why is Box, a cloud storage company in an increasingly commoditized category that continues to bleed cash, planning its IPO? The short answer is that it has no other choice.

As we reported late in July, after a less than enthusiastic Wall Street response to its early 2014 IPO attempt, Box was forced into raising a rather penal late stage funding round from traditional public market investors, TPG and Coatue. The round included onerous terms that Box would need to go public within one year or pay a $0.75 per share penalty (totaling $5.625 million over the 7.5 million shares it sold in the round) for each quarter such an IPO is delayed.

Moreover, Box is burning through cash and will need to raise more in short order to keep the lights on. The company had just $79.2 million in cash on hand as of April 30, approximately two months before closing the TPG and Coatue round. The company’s latest filing reveals that it burned a total of $120.8 million over the nine months ending October 31, 2014, and ended that period with just $165 million in cash and cash equivalents. That may seem like plenty, but at the rate Box is burning cash, that’s barely a year’s worth of reserves.

Put simply, not only will Box pay a penalty for not going public by July, but given the terms it had to accept to raise privately last summer – and considering that it continues to lose massive amounts of money and gives no expectation of that changing in the foreseeable future – an IPO is really it’s only option to keep the lights on, and not a great one at that.

So go public, Box will.

But pulling the trigger on an IPO is only the beginning of Box’s problems. Also contained within the terms of the July round were provisions that state Box must go public at a value of no less than $20 per share (approximately $2.4 billion total valuation) or TPG and Coatue would be entitled to purchase additional shares at a 10 percent discount to that IPO price.

Box’s updated S-1 filing today states that the company plans to price its IPO in the range of $11 to $13 per share, resulting in a valuation of just $1.55 billion. While it’s common for early pricing ranges such as this to change as an IPO approaches, it’s hard to imagine Box generating enough shareholder demand for that change to be positive. So TPG and Coatue will be free to buy shares at well below other IPO investors if thing continue on the current path. Whether they'll want to is another matter. And, even assuming that Box exits at the highest end of that range, its IPO would represent a massive down-round from the TPG and Coatue round and would end up below even its December 2013 venture round which carried a $2 billion valuation.

Box notes in its filing that it had an independent valuation completed in December 2014 which considered a hybrid scenario weighting a 90 percent likelihood of an IPO and a 10 percent likelihood of a non-IPO. The result of this analysis assigned the company an estimated valuation of $14.05 per share. The fact that the company is now offering a discount to even this value in its proposed IPO terms suggest that its underwriters have found underwhelming interest in its shares.

As we’ve stated in the past, Box is really between a rock and a hard place. Aaron Levie and his team have built a large scale, high growth business – revenues grew 80 percent to $153.8 million in the nine months ended October 31. But cost of that revenue shows no sign of shrinking with scale. Box’s net loss of $121.5 million over the nine months in question is down only slightly from the $125.2 million loss figure from the same period a year earlier. Effectively, every dollar of revenue the company generates costs it $1.79 in expenses – not a recipe for a sustainable business.

Making matters worse, Wall Street has done an about face in the last 12 months, particularly in the enterprise SaaS sector, in which companies with high burn rates are being punished severely. Box's window to enter Wall Street during a more forgiving enterprise IPO climate appears to have long since passed.

The challenge for Levie is that Box is a business built on a massive sales operation. The $152 million it spent on sales and marketing in the nine months ending October 31, represented nearly 63 percent of its $242 million in total operating expenses. But, as the company has demonstrated, such spending is necessary to drive the current growth rate – which totaled 80 percent year-over-year, during the nine months in question. Without this growth rate, Box would hold even less appeal to Wall Street.

The other reality confronting Box is that its consumer counterpart, Dropbox, will eventually need to go public itself. And while Dropbox’s number are far from perfect, according to most industry estimates, they’re thought to be far more attractive than Box’s. Put another way, the only thing worse than being a cloud storage company with ugly financials, is being the second cloud storage company to test the IPO market with the uglier of the two sets of financials. Box absolutely has to go out before Dropbox.

Given the above, the first question investors will have to ask themselves when evaluating Box’s offering is can the company eventually reach a point where it can reduce sales and marketing expenses while still maintaining an acceptable growth rate. In other words, is this a near-term land-grab campaign which will pay long-term dividends once a reasonable portion of the market is won? Judging by the data, that will be a hard conclusion at which to arrive.

Looking beyond Box’s financials, the other question sure to be weighing on investors’ minds will be, is cloud storage a sustainable business to be in, or will it be commoditized? Web giants like Google, Microsoft, and Amazon have already shown an interest in the space and a willingness to compete aggressively on price. And Dropbox has turned decidedly up-market from its consumer roots and is attacking that opportunity with advantages in both cash in the bank and consumer awareness. In other words, Box has a challenging road ahead.

With the long-term value of a pure-play cloud storage company in serious doubt, investors will need to answer whether Box has demonstrated a plan, and an ability to execute on such a plan, to offer more than just storage. Levie has said all the right things in the past by acknowledging Box’s need to offer value-added services like creation and collaboration tools. But the company has not yet released any new products to suggest that it can be a category leader in any of these areas. Any bet on Box’s post-storage ambitions is simply that, a gamble.

When looking at this situation in its entirety, Box emerges as a poster child for companies that raise too much money at ever-rising valuations, and in turn spend wildly chasing growth, without ever creating a business that justifies any of it. Box is a relatively good product and, as evidenced by its growing revenue, something people are willing to pay for. The problem is, the company’s income statement and balance sheet are badly out of sync with the degree to which that is the case.

Box is a perfect example of a company that could have been viewed as a success had it built itself at every step along the way targeting an exit of $1 billion to $2 billion. But, by raising late stage venure at $2 billion, and later what ammounted to an IPO-bridge round at $2.4 billion, the company set expectations that it would exit in the $4 billion-plus range. It’s a similar reality that Dropbox, Stripe, Square, and others could confront in time as their respective massive private market valuations are forced to reconcile with Wall Street.

Like so many other Valley darlings, Box went all-in chasing a massive outcome. The fact that it’s fallen short of achieving that result is as much poor execution and strategy, as it is poor timing and plain bad luck. It’s hard to call a $1.55 billion exit a failure – should it even achieve that outcome – but given the expectations that Box set, the time it’s taken the company to reach this point, the state of its business at this stage, and the acquisition offers it’s passed up, there’s really no other conclusion at which to arrive.

This is an IPO of last resort, plain and simple.

[Illustration by Brad Jonas for Pando.]