The publicity is out in full force with Box’s IPO hours away. With an expected issuance of 12.5 million shares at a price range of about $11 to $13, many investors are leery about the file storage company’s hefty $1.6 valuation. Investors have a right to be skeptical. “Software as a Service” (SaaS) businesses are being valued at irrational premiums due to growth expectations. Box’s IPO isn’t an exception. 80% top-line growth is going to be hard to maintain within an increasingly commoditized service. The hype is just that: hype.

The Company

Box is an enterprise Content Management SaaS company which is part of the cloud collaboration & storage market. The company offers cloud-based Enterprise Content Collaboration platforms that allow corporations of different sizes, industries and needs to manage data, while being able to collaborate and share. In a nutshell, Box is a cloud file sharing service which allows users to securely access their content online regardless of operating system, device, or file format.

The majority of Box’s clientele are medium to large companies, including 40% of clients from the Fortune 500 and 20% from Global 2000. This provides the company with a reliable and recurring income stream.

Positive Trends

There has been a significant shift from on-premise applications to cloud-based applications, allowing the delivery of SaaS. Advances in technological architecture have permitted cost effective, yet reliable applications to be delivered over the internet. Research from Gartner predicts that global spending on cloud based technology will increase to $244 billion in 2017 from $132B just a year ago, equating to CAGR of 34%.

The increased compatibility and functionality of mobile devices will act as a tailwind to Box moving forward. IDC is projecting that the number of smart phone shipments will increase to 2.3 billion in 2017, a 35.3% jump from this year.

Data security is increasingly becoming an important topic of discussion and a high priority concern for individuals and businesses alike. The recent headlines in security breaches, digital attacks and governmental data revelations have augmented the need for data security. Box’s enterprise grade security and the tools that they provide IT administrators will be an important selling point in the future. This distinguishable feature is what Box prides itself on.

The recent explosion in data volume in recent years due to the large increase in data intensive application usage is seen as the most important industry trend that is driving cloud-based applications such as Box. IDC expects volume of worldwide data will grow by a factor of 300 from 2005 to 2020.

The numbers

Box has experienced exceptional top-line growth (below). For the first nine months of 2014, sales grew nearly 80%, almost double the SaaS industry average of 47%. Company gross margin hover around the 80% range.

However, bottom line leaves investors with much to be desired. Since inception in 2005, the company has not been profitable. Substantial investments have been made to acquire new customers and develop Box’s service, a norm for SaaS companies. However, the company intends to continue scaling the business to increase the user base and offering. This will lead to further losses for the “foreseeable future”.

Box has a burn rate of $23M per quarter or roughly ~$ 95M/year. Given a $12/share offering, cash balance is expected to be around $300M. Assuming that costs stay constant, which is unlikely, Box has a maximum run rate of about three years.

The company will use proceeds for sales and marketing activities, product development, capital expenditures and day to day operations. If Box has proven anything, it’s that the company is not shy to spend. This leaves investors exposed to further dilution down the road if cannot be reached within the three year run rate.

Sales and Marketing expenses take up the majority of capital. For the first 9 months of 2014 (FY 2015), Box allocated 99% of revenue on Sales and Marketing. Generally, SaaS businesses spend $1.07 of marketing/sales to get $1 of revenue. Initially, money is spent to acquire customers that will repay the expenses, and then some, over the lifetime of subscription. This brings up the question: What long term value will customers bring to justify the high marketing costs?

From the above, graph, Box is generating about $1.03 of revenue for every $1 spent on sales and marketing. This is near the SaaS average for companies still considered to be growing.

The competitive cloud-based storage environment will act as a headwind against Box. Giants with deeper pockets, such as Google, IBM and Dropbox, all will be vying for market share. For Saas companies, revenue growth is a function of sales and marketing expense. The deeper the pockets, the more potential for growth. Due to this, competitors mentioned above could have an advantage over Box moving forward.

Box’s operating losses are expected to continue as the company develops and acquires new customers. Investors will be paying a hefty 6x P/S, assuming the company can continue to show 80% growth in the next quarter. Such growth expectations will be difficult to meet for a company in an increasingly commoditized market with fewer resources than comparable peers.

The appeal of this new IPO just isn’t there.