Box Tries to Escape the Curse of the Silicon Valley Midcap

(Bloomberg Businessweek) -- Even in Silicon Valley, it’s tough to be the middle child. Wedged between hot new startups and technology giants, midcaps must prove their mettle when the pace of growth dips and competition intensifies. Such is the dilemma of Redwood City, Calif.-based Box Inc., whose revenue growth lags those of its cloud-computing peers and is slowing, compounding investor concerns that the 14-year-old company has yet to turn a profit.

Chief Executive Officer Aaron Levie’s answer has been to diversify Box away from its roots as a single-product file-sharing provider and position it in the cloud content management market, with offerings to help businesses secure data and automate workflows. But he’s yet to show the strategy revamp is bearing fruit. Box’s shares are down more than a quarter since its 2015 initial public offering. Shareholder advisory firms have been raising concerns about the structure of the company’s board. And in the biggest blow to Levie yet, activist investor Starboard Value LP disclosed a 7.5% stake in Box—calling the shares “undervalued” in a September filing and saying it could seek changes, including business combinations, asset sales, and a board revamp.

Starboard’s entry could distract Box from dealing with its problems, according to John Barrett, an analyst at Morningstar Inc. “Sales execution remains the biggest issue for the company,” he says, pointing to Box’s difficulties delivering consistent revenue results. The company’s sales have been growing more slowly than its consumer-focused file-sharing rival Dropbox Inc. While two years younger than Box, Dropbox has more than double the revenue: It boosted sales by 26%, to about $1.4 billion, in the fiscal year ended Dec. 31, with Box’s revenue rising 20%, to $608 million, in the fiscal year ended Jan. 31. Box forecasts sales growth of 14% this year.

For Levie and fellow co-founder Dylan Smith, Box’s chief financial officer, Starboard’s involvement could lead to existential repercussions if a battle ensues. The hedge fund has successfully agitated for changes at a range of companies, including EBay, Papa John’s International, Symantec, and MGM Resorts International. Jeff Smith, Starboard’s CEO, became chairman of Papa John’s in February, and in August, the pizza maker said it would replace its chief executive after 18 months on the job.

The Box executives have put on brave faces amid early talks with Starboard. “We’re taking in a lot of their feedback, spending more time with them, understanding what their views are on the business, where do they think that we should and can be performing better,” Levie said on the sidelines of Box’s annual user conference, BoxWorks, this month in San Francisco. “We actually agree on most if not all of those dimensions around how do we drive more operating leverage and profit in the business while making sure that we’re still investing in growth and continuing to put up healthy growth.”

Starboard’s move follows criticisms of Box by two shareholder advisory firms, Institutional Shareholder Services Inc. and Glass Lewis & Co. ISS recommended against reelecting two directors to the board earlier this year, in protest against what it sees as corporate governance shortcomings: Only three directors are put up for election at any one time, and there’s a high threshold of shareholders required to vote to change bylaws. Glass Lewis said Smith shouldn’t be on the board, which now has nine directors, arguing a CFO’s control over company finances means the executive should report to the board. The board structure and set of rules aren’t unusual in Silicon Valley. Box plans to add more independent directors over time, says a person familiar with the matter who wasn’t authorized to speak publicly about the plan.

Levie, 34, once occupied an enviable role in Silicon Valley. He was the upstart who had an idea for a simple digital file-sharing system and took shots at established technology players such as Microsoft Corp. whose programs had grown stale. Levie delivered this message on the business-to-business tech conference circuit, where his enthusiasm, humor, and irreverence stood out, spurring Business Insider to call him a wunderkind and TechCrunch to say he brought “sexy back” to enterprise tech. Levie founded Box in 2005, joined by co-founders Smith, Jeff Queisser, and Sam Ghods. Queisser now has an engineering role at the company. Levie then reached out to billionaire Mark Cuban, who agreed to be an investor. They decided to keep Box focused on serving other companies rather than consumers. Box experienced fast growth but didn’t do much to consider what products should come next.

The young leaders ran into trouble when Box first tried to pursue an initial public offering in 2014. Some investors balked at the company’s securities filing, which showed that Box was spending more money on sales and marketing than it was generating in revenue. Wall Street’s concerns about Levie and Smith’s level of experience swelled. The IPO was delayed by nine months. “When we went public, it was definitely very apparent that we were early in our career,” Levie says. “The conviction of our vision sorta gave us some degree of moral authority on why we should be running it.”

Facing another challenge, the executives say they’ve got the same confidence in their plan. Levie discusses what he’s learned about running his business at his favorite Indian restaurant in Redwood City, where the waiters know his order without him uttering a word. “You’ll kind of just have to withstand periods of time where the business is gonna be viewed differently than what’s actually happening and what you’re building on the inside,” he says. “And so you have to have the fortitude and conviction to be able to push through that.”

Still, Starboard’s involvement has caused Levie to take a closer look at his strategy and consider what he could do differently, he said at the BoxWorks conference, noting that he’s looking at ways to cut more costs.

Levie reads business-management books before bed and receives mentoring from John Chambers, the former CEO of Cisco Systems Inc., who says he’s progressed as a leader. “He’s learned to listen better to both the people he trusts and agrees with but also his critics,” says Chambers. He declined to share his specific advice for Levie, but he says the Box CEO was “very much focused on continuing to reinvent his company, which in today’s world you’ve got to do every three to five years.” He pointed to Levie’s $180,000 base salary—low by Silicon Valley standards—as an example of his dedication. (Levie’s total compensation, including stock options, exceeds $3 million.)

For Box, the question has never been whether Levie cared enough about the company or was a serious enough person to run the business. It was about whether his best was enough. All of the company’s steps have failed to produce predictable growth. Levie says he still feels optimistic that he, Smith, and the rest of the management team can pull off a turnaround and meet financial targets, as new products are expected to start delivering more sales as soon as later this year. He says he doesn’t spend much time thinking about what might happen if things don’t go as planned. —With Scott Deveau

To contact the editor responsible for this story: Rebecca Penty at rpenty@bloomberg.net, Dimitra Kessenides

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