NUANCE COMMUNICATIONS INC NUAN
April 14, 2017 - 5:09pm EST by
frankie3
2017 2018
Price: 16.38 EPS 1.58 1.69
Shares Out. (in M): 292 P/E 10.3 9.7
Market Cap (in $M): 4,783 P/FCF 10.2 9.6
Net Debt (in $M): 1,843 EBIT 592 625
TEV ($): 6,626 TEV/EBIT 11.2 10.6

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Description

After going through years of disappointment (about 10), Nuance may be showing signs of growth as demonstrated by recent results.  It is trading at below historical multiples with a few secular tailwinds behind it.

 

Investment Summary

 

Nuance is a technology company with recurring revenues of over 70% that is currently trading at a cheap multiple of cash flow (10x) due to various reasons.  However, it appears that the company is near an inflexion point where it can show bookings and sales growth on a sustainable basis.  There are end markets which show strength namely Artificial Intelligence and Automobile.  If Nuance can show continued progress this year, the shares could re-rate to an appropriate multiple bringing the stock to $24/share, a 50% return.

 

Brief Business Description

 

Nuance Communications is the leader in speech recognition, dictation and imaging software and services.  It is a leading company in medical transcription services.  It’s products utilize speech recognition to interact with other products and services including autos, telecom, medical, office and home entertainment.  Please take a look at the 10-k for a further elaborate business description.



The Negatives on Nuance

 

There are many negatives on Nuance, and I will mention some of the bigger ones here.  They have been contributing to the stock performing so badly.  Some things the company can put behind them and some things they won’t.

 

  1. Nuance is made up of many acquisitions over the years, and clearly they haven’t paid off with earnings stagnant and sales growing at mid single digits.  

  2. CEO not well liked.

  3. Carl Icahn threw in the towel due to mis-execution.

  4. There are a lot of moving parts to its business that are unrelated.  They serve different customers with different products, and this is detrimental to Nuance being viewed as a takeover candidate.

  5. Not clean financials.  There are a lot of adjustments to get to a non-GAAP earnings number, including stock comp, amortization of intangibles, non-cash interest, non cash taxes etc.

  6. Declining legacy business in healthcare.



Brief Description of Business End Markets

 

Healthcare represents about ½ of the company’s total revenues.  Of that, approximately $350mm of revenue represent Transcription services which is undergoing a continued decline in business.  It is declining about 8-10% per year due to its displacement to other technologies that Nuance such as Dragon Cloud.  Net Net this is causing the largest segment of Nuance’s business to be stagnant.  However, it appears that we are in the beginning of an inflexion point where revenue declines from transcription are offset by faster growing products in Healthcare.

 

The Mobile business segments include products and services to automobile manufacturers, mobile telecommunications customers, and device manufacturers.  Nuance has been seeing solid growth in this category recently in the automobile vertical as car manufacturers seek to make their cars more safe using hands free technology.

 

The Enterprise Segment represents the second largest business segment, and probably the most annoying to customers worldwide.  Nuance’s technology enables Articficial Intelligence offering using its voice recognition and speech capabilities.  Its technology is used in call centers, as well as voicemail.

 

The imaging business sells technology that enables the scanning and organization of paper documents into digital format.  Their customers include the largest printer and copier manufacturers including HP, Samsung etc.




Earnings Model

 

There is a couple of things to note with NUAN’s earnings model.  First off, there is a lot of pro-forma to GAAP reported earnings.  Stock Comp, Amortization of Intangibles, etc.  While not ideal due to the non-precise nature of this, I do believe that the company needs to be analyzed on a pro-forma number.  

 

The other thing to note is that the company has been undergoing a shift from offering perpetual licenses to a recurring revenue model.  3 years ago, over 25% of the business was perpetual product and licenses, while today it is only about 14%, with recurring revenue representing nearly 75% of total revenue.

 

Earnings Model

     
       

Segment Revenue

FY 9/2017

FY 9/2018

YOY Growth

Healthcare

965

990

2.60%

Enterprise

480

495

3.10%

Mobile

375

390

4.00%

Imaging

235

240

2.10%

Total Revenue

2055

2115

2.90%

       

Cost of Revenue

     

Product Cost

70

60

 

Services Cost

645

675

 

Maintenance Support

50

40

 

Total Costs

765

775

 
       

Gross Profit

1290

1340

 

Gross Margin

62.80%

63.40%

 
       

R&D

235

238

 

Sales and Marketing

352

363

 

G&A

111

114

 

Total Opex

698

715

 
       

Operating Profit

592

625

 

Operating Margin

28.80%

29.60%

 
       

Net Interest Expense

100

100

 
       

Pretax Profit

492

525

 

Tax

30

32

 

Net Income

462

494

 

EPS

1.58

1.69

 
       

D&A

60

60

 

EBITDA

652

685

 

Capex

55

55

 
       

FCF

467

499

 



Balance Sheet

 

The company has been taking on leverage to repurchase stock.  Currently the company is leveraged at about 3x.  Recently it issued a convertible bond to retire existing convertible debt and repurchase additional stock.

 

Balance Sheet

 

Cash

1096

Debt

2939

Net Debt

1843

   

Price

16.38

Shares Out

292

Market Cap

4783

   

Enterprise Value

6626



Valuation

 

Currently NUAN is trading at about a 10X multiple of earnings and free cash flow.  If the company can start to show steady mid single digit growth in sales, and double digit in earnings, NUAN’s multiple will rerate to about 15X or $24-25/share.

 

Multiples

   

EV/EBIT

11.2

10.6

PE

10.3

9.7

P/FCF

10.2

9.6




Why Invest Now??????

 

It appears that the stock is not responding to pretty strong bookings growth in the last two quarters.  This is probably due to skepticism given the company’s history.  But it’s end markets are showing strength in artificial intelligence and automotive.  The health care business is finally showing signs of stabilization.  The company believes that the segment will actually show growth this year as new products outstrip the decline in transcription services.  While last quarter revenues declined in all segments besides Enterprise,  bookings for the entire company was up 23%.  This compares to annual bookings guidance of 3-6%.  While bookings can be inconsistent, It would appear that the company is set up for beating earnings this year.  



Risks

Continued decline in transcription business.

A return to mis-execution by management.  

Leverage.



Catalysts

Execution on recent bookings growth.  

New CEO in March of 2008.

 

 

I do not hold a position with the issuer such as employment, directorship, or consultancy.
I and/or others I advise do not hold a material investment in the issuer's securities.

Catalyst

Execution on recent srong bookings.

    sort by    

    Description

    After going through years of disappointment (about 10), Nuance may be showing signs of growth as demonstrated by recent results.  It is trading at below historical multiples with a few secular tailwinds behind it.

     

    Investment Summary

     

    Nuance is a technology company with recurring revenues of over 70% that is currently trading at a cheap multiple of cash flow (10x) due to various reasons.  However, it appears that the company is near an inflexion point where it can show bookings and sales growth on a sustainable basis.  There are end markets which show strength namely Artificial Intelligence and Automobile.  If Nuance can show continued progress this year, the shares could re-rate to an appropriate multiple bringing the stock to $24/share, a 50% return.

     

    Brief Business Description

     

    Nuance Communications is the leader in speech recognition, dictation and imaging software and services.  It is a leading company in medical transcription services.  It’s products utilize speech recognition to interact with other products and services including autos, telecom, medical, office and home entertainment.  Please take a look at the 10-k for a further elaborate business description.



    The Negatives on Nuance

     

    There are many negatives on Nuance, and I will mention some of the bigger ones here.  They have been contributing to the stock performing so badly.  Some things the company can put behind them and some things they won’t.

     

    1. Nuance is made up of many acquisitions over the years, and clearly they haven’t paid off with earnings stagnant and sales growing at mid single digits.  

    2. CEO not well liked.

    3. Carl Icahn threw in the towel due to mis-execution.

    4. There are a lot of moving parts to its business that are unrelated.  They serve different customers with different products, and this is detrimental to Nuance being viewed as a takeover candidate.

    5. Not clean financials.  There are a lot of adjustments to get to a non-GAAP earnings number, including stock comp, amortization of intangibles, non-cash interest, non cash taxes etc.

    6. Declining legacy business in healthcare.



    Brief Description of Business End Markets

     

    Healthcare represents about ½ of the company’s total revenues.  Of that, approximately $350mm of revenue represent Transcription services which is undergoing a continued decline in business.  It is declining about 8-10% per year due to its displacement to other technologies that Nuance such as Dragon Cloud.  Net Net this is causing the largest segment of Nuance’s business to be stagnant.  However, it appears that we are in the beginning of an inflexion point where revenue declines from transcription are offset by faster growing products in Healthcare.

     

    The Mobile business segments include products and services to automobile manufacturers, mobile telecommunications customers, and device manufacturers.  Nuance has been seeing solid growth in this category recently in the automobile vertical as car manufacturers seek to make their cars more safe using hands free technology.

     

    The Enterprise Segment represents the second largest business segment, and probably the most annoying to customers worldwide.  Nuance’s technology enables Articficial Intelligence offering using its voice recognition and speech capabilities.  Its technology is used in call centers, as well as voicemail.

     

    The imaging business sells technology that enables the scanning and organization of paper documents into digital format.  Their customers include the largest printer and copier manufacturers including HP, Samsung etc.




    Earnings Model

     

    There is a couple of things to note with NUAN’s earnings model.  First off, there is a lot of pro-forma to GAAP reported earnings.  Stock Comp, Amortization of Intangibles, etc.  While not ideal due to the non-precise nature of this, I do believe that the company needs to be analyzed on a pro-forma number.  

     

    The other thing to note is that the company has been undergoing a shift from offering perpetual licenses to a recurring revenue model.  3 years ago, over 25% of the business was perpetual product and licenses, while today it is only about 14%, with recurring revenue representing nearly 75% of total revenue.

     

    Earnings Model

         
           

    Segment Revenue

    FY 9/2017

    FY 9/2018

    YOY Growth

    Healthcare

    965

    990

    2.60%

    Enterprise

    480

    495

    3.10%

    Mobile

    375

    390

    4.00%

    Imaging

    235

    240

    2.10%

    Total Revenue

    2055

    2115

    2.90%

           

    Cost of Revenue

         

    Product Cost

    70

    60

     

    Services Cost

    645

    675

     

    Maintenance Support

    50

    40

     

    Total Costs

    765

    775

     
           

    Gross Profit

    1290

    1340

     

    Gross Margin

    62.80%

    63.40%

     
           

    R&D

    235

    238

     

    Sales and Marketing

    352

    363

     

    G&A

    111

    114

     

    Total Opex

    698

    715

     
           

    Operating Profit

    592

    625

     

    Operating Margin

    28.80%

    29.60%

     
           

    Net Interest Expense

    100

    100

     
           

    Pretax Profit

    492

    525

     

    Tax

    30

    32

     

    Net Income

    462

    494

     

    EPS

    1.58

    1.69

     
           

    D&A

    60

    60

     

    EBITDA

    652

    685

     

    Capex

    55

    55

     
           

    FCF

    467

    499

     



    Balance Sheet

     

    The company has been taking on leverage to repurchase stock.  Currently the company is leveraged at about 3x.  Recently it issued a convertible bond to retire existing convertible debt and repurchase additional stock.

     

    Balance Sheet

     

    Cash

    1096

    Debt

    2939

    Net Debt

    1843

       

    Price

    16.38

    Shares Out

    292

    Market Cap

    4783

       

    Enterprise Value

    6626



    Valuation

     

    Currently NUAN is trading at about a 10X multiple of earnings and free cash flow.  If the company can start to show steady mid single digit growth in sales, and double digit in earnings, NUAN’s multiple will rerate to about 15X or $24-25/share.

     

    Multiples

       

    EV/EBIT

    11.2

    10.6

    PE

    10.3

    9.7

    P/FCF

    10.2

    9.6




    Why Invest Now??????

     

    It appears that the stock is not responding to pretty strong bookings growth in the last two quarters.  This is probably due to skepticism given the company’s history.  But it’s end markets are showing strength in artificial intelligence and automotive.  The health care business is finally showing signs of stabilization.  The company believes that the segment will actually show growth this year as new products outstrip the decline in transcription services.  While last quarter revenues declined in all segments besides Enterprise,  bookings for the entire company was up 23%.  This compares to annual bookings guidance of 3-6%.  While bookings can be inconsistent, It would appear that the company is set up for beating earnings this year.  



    Risks

    Continued decline in transcription business.

    A return to mis-execution by management.  

    Leverage.



    Catalysts

    Execution on recent bookings growth.  

    New CEO in March of 2008.

     

     

    I do not hold a position with the issuer such as employment, directorship, or consultancy.
    I and/or others I advise do not hold a material investment in the issuer's securities.

    Catalyst

    Execution on recent srong bookings.

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