Box (BOX) – Expected Tender Offer – Upside TBD

Current Price: $20.74

Offer Price: TBD

Upside: 10%+ (expected)

Expiration date: May 2021

Press release

 

Box is one of the key players in the enterprise cloud content management market with an interesting setup – a large recent investment from KKR at higher prices, serious involvement of a prominent activist Starboard, and management incentivized to please shareholders before the potential proxy fight. Most importantly, management promised tender offer for about 15% of the outstanding shares and this tender will likely be done at a premium to current levels (pricing has not yet been announced).

On the 8th of April, Box released results of the strategic review – management decided to continue along the same path as before and revealed a $500m investment from KKR. KKR will receive preferred stock with 3% yield and convertible into common at $27/share – or 30% spread to current prices. Box will use the proceeds to launch a dutch tender offer:

Box anticipates using substantially all of the proceeds to fund a share repurchase through a “Dutch auction” self-tender of up to $500 million of its common stock, with specific amount and pricing of the self-tender to be determined based on market conditions and stock prices at the time when the self-tender is launched. The self-tender is expected to commence after Box releases its fiscal first quarter financial results in May 2021

Q1 earnings are scheduled for the 27th of May – tender price range should be announced within a few weeks and I believe that it’s likely to be above the current levels.

For 1.5 years now the management has been pressured by Starboard Value to increase its financial discipline. Some changes were made – the board was refreshed, one of the founders/CFO even gave up his seat, and the financial results have somewhat improved.

In March’21, rumors appeared that Box is exploring a sale amid pressure from Starboard. Share price went up from $18.50/share to $25/share. However, strategic review results and KKR investment revealed that the sale is no longer in the cards anymore and the board concluded that “partnership with KKR, along with the repurchase of shares, will best position the company to deliver value to Box stockholders in both the near- and long-term”. Box share price declined upon this announcement and currently is 16% below the March levels.

Recently, Starboard announced that due to poor company performance it will nominate its slate of directors for the upcoming shareholder meeting. The deadline for the nomination is the 11th of May. The board definitely feels threatened by the activist, and given the potential proxy fight should be strongly incentivized to please the shareholders with the upcoming tender offer. As criticized by Starboard:

The stated use of proceeds from this financing is solely to execute a $500 million share repurchase, which means the Company is issuing $500 million of convertible preferred equity in order to repurchase $500 million of common equity. The only viable explanation for this financing is a shameless and utterly transparent attempt to “buy the vote” and shows complete disregard for proper corporate governance and fiscal discipline.

Taking all of this into account, the board is now obligated to play it well and show that they “can” create value (i.e. buy the vote). Thus, it’s likely that the upcoming tender will come at a nice premium.

KKR involvement also adds confidence here as, given the rather low 3% yield of the preferreds, it’s $500m investment was clearly driven by the conversion option, signaling that KKR believes equity is worth much more than $27/share.

Finally, the company is slightly undervalued relative to its major peer (Dropbox) – revenue multiple 4.1x  vs 4.9x for DBX, and has room to significantly increase its operating leverage, which is likely the main thing that attracted Starboard and KKR.

 

Starboard Value

Starboard is a hedge fund that doesn’t need much introduction as it is considered to be the king of US activists (here and here), with numerous successful campaigns over the years (the most prominent being Papa John’s).

Quick timeline:

• Sept’19 – Starboard made its first 13D filing with Box unveiling a 7.5% ownership. Currently, the activist owns 8% of Box at an average price of $16.70/share.
• March’20 – Box entered into a standstill agreement with Starboard that it won’t challenge the board that year, however, will recommend three independent directors. Dylan Smith, one of the founders and CFO, gave up his seat.
• February’21 – after Box failed to make any significant changes and, unlike its peers, missed the opportunity to capitalize on the COVID tailwinds, rumors appeared that Starboard will challenge the board in the 2021 meeting. Box shares jumped 8% on the news, indicating that market is longing for changes within the company.
• March’21 – rumors that due to pressure from Starboard, the company is reviewing full sale.
• 8th of April’21 – Box announced strategic review results and investment from KKR.
• 3rd of May’21 – Starboard released a letter to Box shareholders saying that for two years it has been engaged with Box management advising it on growth opportunities, cost management, equity incentives, etc. Apparently, the activist was persuaded by the board to give it time to execute and so the standstill agreement (March’20) was signed. Unfortunately, the results fell short of expectation and Box didn’t manage to achieve profitability, boost topline or share price growth. The activist states that amidst significant industry tailwinds Box has considerably underperformed its peers and, moreover, continues to lack financial discipline raising unnecessary cash, despite its significant net cash position. As a result, Starboard will nominate its slate of directors for the upcoming 2021 elections.
• 3rd of May’21 – Box made a prompt response stating that it made some changes and improved financial performance. It also notes that the company “remains open to feedback from Starboard and other shareholders to drive long-term value”.

The activist has until the 11th of May to make its nominations.

 

Box

Box is one of the major content cloud platform providers with 67% of Fortune 500 companies as its clients. The company IPO’ed in 2015 at $14/share. CEO and CFO are the company’s founders.

More background on the company can be found in VIC articles here and here.

Box was one of the first multi-billion SaaS, which over the years transitioned its focus from file sync and share to enterprise content management. The other 3 major players in the space are Microsoft, Google, and Dropbox. Box and Microsoft are focusing more on large businesses, while Google and Dropbox – on SME and consumers.

The company is struggling with the competition and over the years saw its revenue growth decline from 30%+ to 11%. One of the key criticisms the company receives is poor financial discipline and highly elevated opex, which keeps it from reaching breakeven and generating meaningful cash flows. High stock-based compensation (around $150m – 30% of gross profit) adds further negative sentiment.

Historical Box performance over the last three years (ending January):

At the moment BOX trades at 4.1x EV/Revenues, marginally below its peer Dropbox (DBX) – the difference seems warranted given DBX larger size, higher revenue growth (15%-19%), higher gross margins (78%), slightly better profitability, and FCF.

However, simple revenue multiples valuation does not reflect the attractiveness of BOX. Long-term investment thesis (and likely why it attracted Starboard and KKR) lies in company’s potential to increase operating leverage by better managing opex and compensation. As explained by Starboard:

From the outset, we have been clear that in order for value to be created, Box needed to significantly improve both growth and profitability, as well as meaningfully lower its equity compensation expense and improve capital allocation […]

There is no good reason that Box should be unable to deliver improved growth and profitability, at least inline with better performing software companies, which, in turn, would create significant shareholder value.

A similar case could also be made for DBX, which also struggles with profitability and high equity compensation ($261m), however, DBX is well-protected from the activists due to its voting share structure.

In its response to Starboard’s letter, management has presented new guidance indicating revenue growth rate of 12%-16% with operating margins between 23%-27% by fiscal 2024. If these targets are reached, the company would become a cash flow machine. The targets look kind of achievable and may even be too conservative – in comparison, Box closest (albeit much much larger) enterprise peer Microsoft runs its Intelligent Cloud segment with 37% operating margins.