Earlier this month Dropsuite (ASX: DSE) released its quarterly update, reporting annualised recurring revenue (ARR) growth of 34% versus the prior corresponding period, to $42.6 million. This was a record $2.7 million AUD gain quarter-on-quarter, and even after taking into account currency impacts, Q3 CY2024 saw a “record US$2.3m of incremental ARR added.” You can see Dropsuite’s impressive top-line growth represented in the chart below from the investor presentation.
Less impressive was operating cash flow, at $780k, down considerably on the record prior corresponding quarter of $1.39 million, but up a bit on Q2. Cash at hand increased by about $350k to just under $25.5m. Dropsuite is tracking a bit below last year on operating cash flow after the last three quarters, keeping in mind it reports on the calendar year. However, the December quarter was quite weak last year, so it still could achieve a better result this year, with a bit of luck.
Dropsuite maintains its guidance of positive cashflow and profit, but on the conference call, the Dropsuite CEO Charif El-Ansari declined to give anything but the vaguest guidance, commenting that “once you start giving guidance, you start acting in a very irrational way, just to deliver the numbers.” This is completely accurate and demonstrates good decision-making. Earnings before interest and tax have been around $1m for the last couple of years, and I would like to see a slight improvement this year, but I don’t have much hope of that, given the weak first-half profit result. The CEO’s lack of regard for bottom-line growth reflects his oft-stated preference for investing as much as possible in top-line growth.
Dropsuite CEO Share Sale
Notably, the Dropsuite CEO recently sold 8.76% of his shareholding in the company at $3.40 per share. The CEO share sale does make me a bit nervous, even though it was less than a tenth of his holding.
However, it did not stop the Dropsuite share price from rising strongly after this quarterly result. At the current share price of $4.08, Dropsuite has a market capitalisation of $285 million, about 56.7x ARR. If we give Dropsuite credit for its $25m cash kitty, the enterprise value is about $260 million, or about 6.1x annualised recurring revenue.
Is The Dropsuite Share Price Still Attractive?
When I recommended the stock at (the equivalent of) $2.30 per (consolidated) share, it had ARR of $28.2 million and an enterprise value of about $140m, being about 5x annualised recurring revenue, around 18% “cheaper” than today. Therefore, the ~70% gain since I bought shares (I paid a slightly higher price than $2.30) is partly due to revenue growth, and partly due to improved market sentiment.
The good news is that I see no evidence to suggest the company is taking anything other than a sensible long-term view of the business.
Of course, risks around the potential for increased competition certainly remain, and Dropsuite is clearly very reliant on its Microsoft backup product. Furthermore, it is likely very reliant on its top couple of MSP customers.
Given these risks, I wouldn’t want to have an overly large position. On top of that, Dropsuite’s gross margins are only about 67%, and it hasn’t proven it can grow profit and revenue simultaneously. Therefore, I’m not sure it deserves a particularly high multiple of ARR, even despite impressive 34% ARR growth.
Of course, if the market is merely willing to maintain the current multiple of 6x ARR, then the strong ARR growth will generate strong returns for shareholders.
But, more conservatively, if ARR growth drops to 25%, and the EV to ARR multiple drops to 5x, then today’s buyer would barely be making money.
Given the share price rise of late, Dropsuite shares are clearly less appealing than they were when I released the initial buy recommendation. But given the strong ARR growth and consistent gross margins, I hesitate to downgrade the stock to Hold too early, especially while I maintain my trust in management.
Disclosure: The author of this article owns shares in DSE and will not trade DSE shares for at least 2 days following the publication of this article. This article is not intended to form the basis of an investment decision and is not a recommendation. Any statements that are advice under the law are general advice only. The author has not considered your investment objectives or personal situation. Any advice is authorised by Claude Walker (AR 1297632), Authorised Representative of Equity Story Pty Ltd (ABN 94 127 714 998) (AFSL 343937).
The information contained in this report is not intended as and shall not be understood or construed as personal financial product advice. You should consider whether the advice is suitable for you and your personal circumstances. Before you make any decision about whether to acquire a certain product, you should obtain and read the relevant product disclosure statement. Nothing in this report should be understood as a solicitation or recommendation to buy or sell any financial products. A Rich Life does not warrant or represent that the information, opinions or conclusions contained in this report are accurate, reliable, complete or current. Future results may materially vary from such opinions, forecasts, projections or forward looking statements. You should be aware that any references to past performance does not indicate or guarantee future performance.