Like most business activities, mergers and acquisitions (M&A) took a hit with the onset of the COVID-19 pandemic. Uncertainty about any given company’s survival and growth prospects made many a corporate take pause with regard to M&A deals. However, economic activity  started to rebound in the third quarter, with August 2020 alone seeing the execution of nine M&A deals worth $5 billion or more. Because the economic recovery is expected to continue, such deals should increase as stronger companies try to position themselves to advantage of an anticipated favorable business environment.

The sky-high stock valuations of major tech companies could lead to more deal making on their part because they will suffer minimal share dilution in acquiring weaker companies in exchange of their shares. Moreover, with interest rates at historic lows, any borrowing needed to fund deals is now cheaper than ever.

With a favorable environment, we think there should be a wave of M&A in the coming quarters. As such, investors could keep an eye on Dropbox, Inc. (DBX) and Yelp Inc. (YELP).

Dropbox, Inc. (DBX)

DBX provides a collaboration platform worldwide. The company’s platform allows individuals, teams, and organizations to share files and cloud content for free through its website or app, as well as upgrade to a paid subscription plan for premium features. DBX has more than  600 million registered users across 180 countries worldwide.

DBX launched its IPO in March 2018. The  offering was 25 times oversubscribed. The company raised $756 million in its IPO. The initial euphoria around the offering  drove the stock to a high at $43.50 in mid-June 2018. However, DBX has been suffering post IPO blues. The stock has since  lost more than 22% versus its IPO price. DBX’s revenue has grown  at a CAGR of 21.3%, over the past three  years, but the company was not profitable until 2020. It  has earned $1.86 billion in the trailing 12 months and posted EPS of $0.19. However, DBX’s paying users, the primary source of its revenue, are growing too slowly. As of September 2020, the company had 15.25 million paying users, representing a mere 2.5% of its total user base. Despite focusing on remote workflow optimization and adding new product features such as HelloSign, Passwords, and Spaces, DBX has been unable to convert free users into premium customers.

With coronavirus-induced disruptions forcing most businesses to adapt their operations to be more remote friendly, DBX was in a prime position to gain market share. But in fact, the company lost market share as new competitors entered the space and capitalized on the trend, ramping  up new features faster than DBX. In fact, DBX now plans to cut about 11% of its global workforce.

Based on DBX’s uncertain prospects thanks to the cloud boom, the company now looks undervalued versus other software-as-a-service providers. However, DBX  is being crushed in the crowded market. According to The Information, DBX could possibly be a target for Oracle (ORCL) or ServiceNow (NOW).

Wall Street analysts estimate DBX’s full-year 2020 revenue and EPS to increase 14.9% and 78%, respectively, year-over-year. Additionally, it has an impressive history of beating consensus estimates in each of the trailing four quarters. However, DBX is down 10.7% over the past month.

Yelp Inc. (YELP)

YELP operates a platform that connects consumers with local businesses in the U.S., Canada, and internationally. The company’s platform covers various local business categories, including restaurants, shopping, home and local services, beauty and fitness, health, and other categories. It provides free and paid advertising products to businesses, as well as enabling businesses to deliver targeted search advertising to local audiences through its website and mobile application and business listing products.

Over the past three  years, YELP’s revenue has grown at a CAGR of 3.2%. The company generates its core revenue from advertising sales . As a result, YELP is suffering from the pandemic-induced slowdown in restaurant businesses. Its web search traffic has declined significantly because the demand for reading or posting online recommendations have fallen as consumers  have opted to stay at home or make delivery orders.  Consequently, the firm has reported losses in the trailing three quarters.

YELP has more than 220 million cumulative reviews on its platform with nearly 507,000 paying advertising locations. However, YELP’s business model relies on reviewed companies rather than on consumers for its revenues. That raises serious doubts over the credibility of its reviews among consumers.

The termination of Section 230, which protects websites or services that host content from egal liable for content posted by its users, could severely impact YELP’s operations. Hence, even though as the pandemic abates, YELP faces major political headwinds coupled with a weak business model. Moreover, YELP has been seeing sales of its stock by insiders. CEO Jeremy Stoppelman recently sold $10.4 million worth of shares. Stoppelman also sold $11.4 million worth of shares in December.

In September 2019, it was speculated that hat Facebook (FB) could or would  potentially acquire Yelp, but the deal did not materialize. FB does not now seem like a potential suitor because it is currently in the crosshairs of the New York State Attorney General for antitrust reasons. So, that leaves Alphabet (GOOGL) as a potential big-name suitor for YELP, to synergize its Ad segment and products like Google Maps. And even advertising giants like Omnicom Group (OMC) might express interest.

Analysts expect YELP’s full-year 2020 revenues and EPS to decline 14.3% and 205.8%, respectively. The stock has lost 11.8% over the past year. However, it has gained 13.7% in the past month because  investors expect a revival in customer advertising spend.

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DBX shares were trading at $22.07 per share on Tuesday afternoon, up $0.05 (+0.23%). Year-to-date, DBX has declined -0.54%, versus a 2.91% rise in the benchmark S&P 500 index during the same period.

About the Author: Sidharath Gupta

Sidharath’s passion for the markets and his love of words guided him to becoming a financial journalist. He began his career as an Equity Analyst, researching stocks and preparing in-depth research reports. Sidharath is currently pursuing the CFA program to deepen his knowledge of financial anlaysis and investment strategies. More...

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