Description

Summary

• NICE Ltd is well-positioned to capitalize on the growing demand for customer engagement and compliance solutions. 

• Recurring revenue streams, switching cost and the mission-critical nature of its solutions provide earnings stability.

• The company’s strong revenue growth and robust free cash flow generation support a valuation that is 34% higher than current stock price. 

Company Overview

NICE is an enterprise software company that operates in the Customer Engagement (CE) and Financial Crime and Compliance (FCC) markets. It delivers data analytics-based solutions through both cloud platforms and on-premises infrastructure. CE accounts for 83% of 2023 revenue and FCC represents the remaining 17%.

Customer Engagement 

CXone is NICE’s flagship product for the CE market. It is a unified, cloud-native Contact Center as a Service (CCaaS) platform that integrates omni-channel routing, workforce engagement management, analytics, and AI capabilities. 

CXone allows businesses to manage customer interactions across various channels such as voice, email, chat, and social media. Clients use CXone to optimize call center efficiency, including forecasting call volumes, scheduling agents, and analyzing performance. It also provides advanced tools for customer interaction management and predictive analytics.

Financial Crime and Compliance

NICE offers solutions for risk management, fraud prevention, anti-money laundering, and compliance under its Actimize platform. It primarily serves the financial services industry.

Why does this opportunity exist?

Despite reporting solid 1Q24 results, the unexpected announcement of CEO Barak Eilam would be stepping down at the end of 2024 caused the stock to drop from $230 to $162. It has stayed near this level since despite an investor day that reiterates FY24 outlook and growth prospects.

Eilam is credited with engineering the successful pivot to cloud-based solutions with the InContact acquisition in 2016 which became CXone, the company's flagship product.

Investment Thesis

Strong, Sustainable Growth

Growth is supported by the transition from on-premises to cloud-based solutions. Cloud offers numerous advantages over on-premise solution:

• Quick setup time and lower upfront costs as there is no need to purchase, build and configure local infrastructure.

• Better reliability as cloud providers have more robust infrastructure and redundancy than on premise solutions.

• Companies can leverage cloud to easily set up contact centers in multiple locations without the need for local infrastructure, enabling remote work and expanding the talent pool.

• Cloud solutions are priced on subscription or pay-as-you-go basis,.making it easier to manage costs and budget effectively.

NICE is well-positioned to capitalize on this cloud migration trend with its CXone platform and its AI capabilities. Cloud revenue has reached a critical mass, comprising 67% of 2023 revenue, up significantly since 2017, the first full year after the InContact acquisition.

The shift to cloud solutions should continue to drive double-digit growth in revenue and unlevered FCF (defined as EBITDA minus capex and software development costs) in the next 3 to 5 years.  I expect profitability to improve further as it continues to scale its cloud services and optimize its operations. NICE’s investment in AI and automation is also expected to drive efficiency and reduce costs.

High Switching Cost

NICE’s software solutions are deeply integrated into clients’ business processes, making it expensive to switch. Moreover, customer engagement and financial compliance are mission-critical to clients, and thus the risk of disruption would usually outweigh any potential benefits, leading to strong customer retention.

Investor Day Highlights

NICE held its Investor Day in June.  It reiterated its financial guidance for the year, projecting significant revenue growth and strong performance at CXone.

Key Question: Can AI replace call center agents?

I think the answer is no. Conversation isn't just about taking turns speaking. In addition to what is being said, humans use tone of voice and context to understand each other’s thoughts and resolve ambiguities.  

Knowing when to speak, listen, or comprehend subtext is just as important as the words said and it is not something that AI models can do because the billions of written words the LLMs train on do not capture the nuances of spoken conversations. I view AI as useful tools that help but will not replace human agents.

Risks

While NICE successfully pivoted to cloud,, the credit goes to Eilam.  Now that he is retiring, there is always a risk that the company cannot adapt to new, disruptive forces.

Valuation and Earnings Power

I expect NICE to generate at least $806mm of UFCF (EBITDA = $2,715 * 33% = $896, capex = 11% of EBITDA = $90mm).  

Assuming 23% tax, zero interest income, and 66.2m shares (including unvested shares) outstanding,  FCF/share = $9.37. 

Using 10% discount rate, 6% long term earnings growth - which I think is very punitive given NICE’s growth and margin profile - the stock is worth $234/share.

Below are US listed software peers with consensus revenue growth between 12 - 14%. Note that NICE guided to 14-15% revenue growth last month.  Relative valuation underscores how attractive the stock is. 

Using the lowest multiple (PWSC is under contract to be acquired by Bain) of 18.4X, NICE is worth $271.6/share.

Using the 75th percentile multiple of 24x, NICE is worth $348/share.

Catalyst

Continued cloud adoption, revenue growth and margin expansion.