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Dropsuite Trajectory Impresses

Small Caps | Oct 25 2023

This story features DROPSUITE LIMITED. For more info SHARE ANALYSIS: DSE

Already enthusiastic analysts have lifted their enthusiasm regarding Dropsuite's outlook following impressive third quarter results.

-Dropsuite remains a key broker pick after third quarter results
-User growth, strong cash flow & rising recurring revenue
-Partner-centric approach delivers multiple benefits
-Super efficient operating model, notes Shaw and Partners


By Mark Woodruff

Ongoing growth in paid users and a strong rise in recurring revenue over the third quarter has bolstered already bullish analyst commentary for data backup, archiving and compliance vendor Dropsuite ((DSE)).

Supplying to small and medium sized businesses (SMB) globally, the company remains a key “growth software pick” for Shaw and Partners, while Canaccord Genuity suggests metrics for annual recurring revenue (ARR) and free cash flow (FCF) margin are some of the best on the ASX.

The company’s suite of backup solutions covers websites, email, servers and productivity tools including Microsoft 365 and Google Workplace.

Stockbroker Shaw labels Dropsuite a rare combination in the ASX software space of impressive growth, combined with both profitability and positive cash flows.

Cash flows remained strong in the third quarter, notes Canaccord, with FCF of $1.4m representing an FCF margin of 17%, while the gross profit margin of 68% remained within management’s target range.

A key differentiator, in this broker’s view, is a partner-centric approach and a base of over 3,200 transacting managed service providers (MSPs), around 10% of target partners.

This approach delivers three benefits for Dropsuite. It provides scope to grow into a substantially larger business, explains Shaw, and allows value to be driven through M&A, along with a super-efficient operating model.

Dropsuite benefits as its MSP partners grow their own end-user customer bases, adds the broker, and MSP spend is growing at 2-3 times the rate of overall IT spend for SMB, an area which is still only around 20% penetrated.

Third quarter ARR increased by 44% on the previous corresponding period to $33.4m and by 10% quarter-on-quarter (qoq), with the incremental quarterly increase of $3m beating the prior three-year trend of $2m per quarter. 

Average revenue per user (ARPU) increased by 9% qoq supported by currency tailwinds, an ongoing shift to archiving (i.e. a higher ARPU product mix) and the churn of a low-ARPU legacy customer, explains Canaccord Genuity.

Churn for this customer resulted in net user additions of 33,000, compared to gross additions of 86,000, a near record for Dropsuite. On a gross basis, the company is exhibiting around 7.5% growth per quarter so far in FY23.

Management explained the remaining 40,000 users from the legacy customer will be deactivated in the fourth quarter, which provides a short-term headwind, cautions Shaw.

The MSP partner churn remains less than -3% per year. With the addition of 35 partners in the third quarter, total direct MSPs increased to 594, with incremental indirect/transacting partners increasing by 209 to around 4,000.

The network effect from MSP partners should become increasingly valuable as user penetration expands within this partner network, explains Canaccord.

In a move likely to support FY24 growth, in this broker’s view, TD Synnex is now fully integrated after a partnership was announced in July, and first customers have been on-boarded. 

US-listed TD Synnex is one of the world’s largest distributors, with more than 20,000 reseller partners.

The “super efficient” operating model

Dropsuite is adding over $1.00 of ARR for every $1.00 invested in total employee and marketing costs, though Shaw and Partners would argue this is more in the range of $2.00-$3.00 of ARR, based purely on a sales and marketing view.

The company’s super-efficient partner-centric operating model has allowed the business to compound ARR at 70% while still being profitable. Consequently, the broker anticipates material gross margin and cash earnings (EBITDA) margin expansion over the longer-term.

Opportunities and outlook

Cannacord Genuity anticipates a valuation multiple re-rate for Dropsuite shares as management monetises recently launched products such as Govcloud and Quickbooks, and cycles the legacy user churn. Reinvestment into sales and marketing is also expected to reap benefits.

With further new products in the pipeline and a share of global MSP’s still less than 3%, this broker’s positive outlook remains intact.

In the wake of third quarter results, Petra Capital forecasts ongoing momentum from strong market demand, market share gains, new product releases, as well as the potential for mergers and acquisitions.

Over the next few years, this broker believes Dropsuite has the products, business model and capital to exceed system growth of around 25% per year within the data back-up and archiving markets.

While net hiring is expected for both the fourth quarter and into FY24, flat staff costs and headcount in the third quarter indicates to Shaw and Partners the operating leverage potential of Dropsuite’s business over the longer-term.

Shaw and Partners, Canaccord Genuity and Petra Capital all have Buy ratings and an average target of 35c, up from just under 35c prior to third quarter results.

The new average target price suggests around 46% upside to the current 24c share price.

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