Description

The bull case on UPLD, as written up a few months ago, is that it is an early stage version of Constellation Software.  I think that thought process is misguided and that UPLD is buying worse businesses, paying higher prices, and deploying cost-cutting strategies that drive them ex-growth.  With leverage now above 3.5x run-rate EBITDA (despite significant share issuance / dilution as well), acquisitions getting more expensive, and an attempted pivot to focus on organic growth to stave off the impact of deteriorating acquired businesses, I believe the UPLD strategy is primed to unravel.  At multiples that would reflect a poorly positioned, declining business (6-8x EBITDA, 2-3x revenue), I think the stock could have >75% downside to below $10/share, and perhaps be an eventual zero / liquidation given the rising leverage, anemic/deteriorating growth, and lack of cash flow.

1) UPLD is not the next Constellation Software, but more like Joe Liemandt paying 2-3x his normal price.

Upland’s acquisition strategy is very different from Constellation’s.  First of all, Constellation is buying niche, vertical market software businesses that have already been consistently profitable.  This is very different than the horizontal software businesses that UPLD is buying that often compete in very crowded markets against both small competitors as well as large players like Oracle, SAP and Salesforce.  Second, Constellation is looking for talented management to whom they can provide coaching and resources in order to enable them to improve their returns even further.  Constellation provides a good summary of their strategy here - https://www.csisoftware.com/about-us/being-acquired.  This is very different than UPLD’s model of drastically cutting costs by slashing headcount and closing offices (nearly all remaining employees work remotely), which impacts the ability to a) win new business, b) improve / maintain the product, and c) keep existing customers happy.  Lastly, Constellation pays ~1/2 to ~1/3 of the revenue multiple that UPLD pays for their acquisitions.  Yes, Constellation’s EBITDA margins are lower, but that is mainly because they maintain the resources to have stable to growing businesses.  They also generate FCF.

Upland cuts costs and I believe goes ex-growth like Joe Liemandt, but pays 2-3x both Liemandt and Leonard.  The previous write-up didn’t mention Joe Liemandt, who I think is important in order to frame what is going on here.  One can read about Joe extensively online (this 2018 Forbes article is an interesting window into Liemandt’s strategy - https://www.forbes.com/sites/nathanvardi/2018/11/19/how-a-mysterious-tech-billionaire-created-two-fortunesand-a-global-software-sweatshop/#2b7c3fe36cff), but in short, he has been extraordinarily successful by buying software businesses for ~1x revenues, essentially firing everyone, bringing back on skeleton crews on a 1099 basis, and harvesting cash as the businesses go to zero.  Constellation pays similar revenue multiples, but buys better businesses and doesn’t cut costs like Joe, therefore maintaining the business and terminal value.  The problem with the UPLD approach is that they’re paying a price (2-3x revenues) that suggests there is terminal value (not to mention the fact that UPLD itself trades for roughly double that, so public market investors are certainly under the impression that there is significant terminal value), when in fact they cut costs similar to Joe Liemandt / drive the company ex-growth and thus there is very little terminal value in their businesses.

In summary, I believe the market is pricing UPLD like the public market Constellation strategy, when it is in fact more akin to the private market Liemandt strategy.  Additionally, UPLD pays 2-3x what Liemandt pays for companies, and then the public market doubles those values under the umbrella of UPLD.

2) Financials show no growth and no cash flow.

UPLD’s reported organic growth rates have been a) low, and b) accompanied by a suspicious number of notes / caveats (see page 26 of their investor deck - https://s24.q4cdn.com/701845650/files/doc_presentations/Upland-Software-IR-Presentation-2.pdf).  Solving for organic growth based on acquired 2017-2019 revenues (using stated annual revenues for the Omtool through Altify acquisitions) reveals anemic levels around 2% on average.  Not only is this low, but it’s even more alarming when you consider that a) most of the companies are experiencing double-digit sales growth at acquisition (before the sales teams are cut drastically), and b) the company has acquired an increasing amount of revenue in each year.  I believe that given all of that, if UPLD were to stop doing acquisitions altogether, you could see negative organic growth within 12-24 months.

Cash flow also looks bad.  Despite reported EBITDA growing consistently over the past 3-4yrs, cash flow as consistently been anemic.  That’s despite SBC being a very large portion of expenses.  If you chart EBITDA, share count, and cash flow, EBITDA and share count have been rising steadily, while cash flow has been bouncing around zero.  Furthermore, while restructuring charges have been a consistent cash drain, debt service is increasing as leverage has gone up alongside share count and now stands at >3.5x management’s stated EBITDA run-rate (giving full year credit for recent acquisitions).

3) High leverage, increasing acquisition multiples, and attempted growth pivot could cause UPLD to unravel.

As previously mentioned, leverage is now >3.5x run-rate EBITDA, making it harder for the company to sustain this strategy.  With leverage at current levels, and an increasing focus on growth and cash flow, the company is attempting a pivot to more of a focus on organic growth, which would necessitate more investment / pressure on margins if successful.  As an indication of how hard I think it will be for them to execute this pivot, the company has a CMO that is only on a 6-month temporary agreement, and they are looking to hire a go-to-market head under the same deal.  I think this is indicative of how UPLD is in the process of trying to have their cake and eat it too – they acquire businesses and generate some margin (albeit non-cash) by slashing the sales and customer service organizations that were generating growth, and now they want to keep those margins but bring back the growth.  Meanwhile, investment in product has likely gone down significantly and competition has likely continued to rise.

Valuation:

·        I think that once investors realize that these kinds of levered roll-ups aren’t sustainable, the businesses usually trade down to 6-8x EBITDA (would equate to 2-3x revenue in this case), reflecting the lack of terminal value.  6x UPLD’s run-rate EBITDA on their levered balance sheet would result in a $10 stock and >75% downside.

Catalysts:

·        Reduced availability of incremental debt capacity.

·        Deterioration of core business.

·        Lack of free cash flow.

Risks:

·        These are better businesses than I believe.

·        Management are better operators than I believe and successfully pivot to organic growth.

·        Cash flow improves.

Catalyst

·        Reduced availability of incremental debt capacity.

·        Deterioration of core business.

·        Lack of free cash flow.