Description

As we wrote in our last posting on Vonage (“VG” or the “Company”) when the stock was trading at $6.08 per share that there was ~100% upside.  Today we can again put forth the same claim that at over $14 per share there is again an opportunity to see the shares go up by ~100%+ in the next year or so.

Vonage has undergone a multi-year transformation to become the world’s largest independent cloud communications company.  What was once known as a consumer VoIP brand is now a growing software company with accelerating growth and expanding margins, playing in a TAM expected to grow 60% by 2022 reaching ~$80 billion (per IDC).  While much attention has been paid to Vonage’s peers RingCentral, 8x8, Twilio, and others, we believe Vonage represents a differentiated play on the enterprise communications space ideal for value investors given current substantial profits / free cash flow generation.

Summary:

• Unique Position in Fast-Growing TAM.  Vonage is the largest player that can address the fast-growing enterprise communications ~$50 billion TAM which includes Unified Communications (UCaaS), Communications Platform (CPaaS), and Contact Center (CCaaS)

• Improving Financials. Mix shift to high quality enterprise cloud communications revenue (UCaaS, CPaaS, CCaaS) through organic growth and M&A – going from 50% of total revenue in 2017 to nearly 75% in 2020E

• Management Quality / M&A Track Record.  CEO Alan Masarek (ex-Google) has built an excellent and disciplined M&A track record at Vonage with highly accretive acquisitions of Nexmo (2016 deal - #2 CPaaS player), Tokbox (2018 deal - #1 Video CPaaS player) and New Voice Media (2018 deal – largest private CCaaS player)

• Estimated ~125% Upside to Stock.  VG is worth $31 per our estimates on a 2020 SOTP basis (year end 2019 valuation target) vs. ~$14 today

Recent Developments

Nexmo

• In May 2016, Vonage acquired Nexmo for $230m (cash and stock) – Nexmo is the #2 CPaaS player behind Twilio

• CPaaS provides communication application program interfaces (“APIs”) for text, voice and video communications, allowing developers and enterprises to embed contextual communications into their digital products (mobile apps, websites, social media, etc.) enabling better customer engagement for their business

• For example, the text notification “your Uber driver has arrived” or the automated voice call from your dentist’s office reminding you of an appointment – all of these are powered by CPaaS

• The leader in the space is Twilio (TWLO) which went public in mid-2016 at $15/share – today TWLO trades closer to ~$90/share.  We believe Twilio represents a direct comp to the Nexmo business and is a clear barometer on the health and prospects of the broader CPaaS space

• Per IDC, the TAM for CPaaS is growing from $3bn today (2018) to $18bn by 2022, representing the fastest growing portion of Vonage’s overall $50bn cloud communications TAM

• In 2018, Vonage is expected to generate over $200m of CPaaS revenue which represents $2-3bn of value per our estimates – this compares to Vonage’s entire enterprise value of ~$3.5bn today and the initial acquisition price of $230m

Tokbox

• Vonage completed the tuck-in acquisition of Tokbox in August 2018 for $35m (~2 EV / Revenue per management)

• Tokbox is the global leader in video CPaaS, adding a critical third stool of functionality to Nexmo (which already had voice and text) – we have confirmed the market leadership of this business with Twilio representatives, who indicate it is bigger than their comparable video offering

• With a more complete CPaaS offering and a leading position in video CPaaS, we believe the Tokbox acquisition will be highly accretive as its growth and synergy potential relative to acquisition price (~2x EV / Revenue) is very favorable

• In addition, video CPaaS functionality can be easily upsold to existing CPaaS customers, or cross-sold along with the broader CPaaS suite to Vonage’s extensive UCaaS customer base – the opportunities for revenue synergies are quite high in addition to the obvious cost synergies

New Voice Media

• New Voice Media represents Vonage’s largest acquisition ever at $350m (~3.8x 2019E Revenue)

• The acquired company is the largest private cloud contact center player globally and recognized as a “Leader” in Gartner’s CCaaS Magic Quadrant for Western Europe

• The deal allows Vonage to go after the entire cloud communications TAM across UCaaS, CPaaS and now CCaaS, enabling the Company to take advantage of customers’ desire to have one vendor with a unified, integrated offering for all their business communications needs

• Previously, Vonage relied on reselling inContact’s CCaaS solution (RingCentral does the same), but Company management clearly realized that having CCaaS in-house was critical for the long-run

• New Voice Media is growing ~30% y/y topline and carries 60%+ gross margins, higher than Vonage corporate average of ~59% (2018E)

• The acquisition is accretive to both growth and margins and represents a massive step in Vonage’s transformation to a high quality, high growth, high margin enterprise SaaS company

UCaaS Set to Reaccelerate

• RingCentral, long regarded as the preeminent pure-play leader in UCaaS, underwent an interesting phenomena over the past couple of years – despite years of high growth and an expected deceleration, revenue started to reaccelerate – how?

• The earliest adopters of UCaaS were, understandably, small companies with a limited number of lines (seats).  This SMB market (or even “micro-SMB” market) experienced fast growth but now that UCaaS is well penetrated within this segment due to its obvious economic advantage, growth amongst small firms has slowed

• However, UCaaS adoption began to rise amongst mid-market and enterprise companies – these firms not only sign up for larger UCaaS contracts to begin with (more lines), but subscribe to more advanced UCaaS features, buy additional products (i.e. CCaaS), and buy more over time as they start using RingCentral in their regional/global offices, too

• Aside from representing a bigger cross/up-sell opportunity, enterprise customers have far lower churn than SMBs, driving much higher lifetime revenues

• These larger customers represented a much larger and long-term opportunity for RingCentral to grow its revenues, leading the mix shift from SMBs to enterprise within its customer base and accelerating revenues

• We believe Vonage is in the early stages of the exact same phenomena, now having built out its direct sales force across numerous sales offices, and a renewed effort of building its channel program which will be a force multiplier for VG’s selling efforts

• Today, the micro-segment represents 40% of Vonage’s UCaaS revenue and the channel program represents 15-20% of revenue (compares to 30% for RingCentral and their channel revenue is growing ~100% y/y)

• As Vonage moves further “upstream” to mid-market and pushes channel sales, we believe their UCaaS revenue has the potential to accelerate to 20-30% y/y in a couple years (our forecast below assumes street estimates of modest acceleration into the mid-teens)

Financials / Valuation

• The resulting picture is a company moving from 50% consumer VOIP / 50% enterprise communications in 2017, to ~75% enterprise communications by 2020 with accelerating growth and rising margins (we are using estimates provided by Oppenheimer & Co. below)

• The improved efficiency of the business model, as measured by the Rule of 40 (revenue growth + EBITDA margin) would vastly improve from ~18% in 2017 to ~30% in 2020E – SaaS companies with higher efficiency warrant higher valuation multiples

• VG is currently trading at 2.5x 2020E EV / Revenue, but the improved efficiency forecasted should rerate the stock closer to ~6x EV / Revenue

  • Many growing profitable enterprise SaaS companies trade at 7-9x forward EV / Revenue

  • Assuming the midpoint (8x) and applying VG’s relative efficiency (30 on the Rule of 40 scale, or 75% of desired efficiency) would imply an overall EV / Revenue of ~6x

  • This translates into a $33 stock by 2020E, or ~140% upside

• A 2020E sum-of-the-parts valuation analysis supports a similar outcome where by the end of 2019 (using today’s forward multiples), VG stock should be ~$31/share, or ~125% upside

  • UCaaS: apply median EV / Revenue between RingCentral (RNG) and 8x8 (EGHT) – 6.7x

  • CPaaS: apply 30% discount to Twilio (TWLO) EV / Revenue given Nexmo’s lower margins – 7.2x

  • CCaaS: apply Five9 (FIVN) EV / Revenue – 8.6x

  • Consumer: apply distressed 3.5x EV / EBITDA on ~$200m of EBITDA

Catalyst

Stock should massively re-rate as shareholders begin to see growth of business segments.