CCSI - Consensus Cloud Solutions: Neutral As Uncertainties Remain

2023-06-26 18:56:36 ET

Summary

• I maintain a neutral stance on CCSI due to uncertainties surrounding the business and stock, but may turn positive if EBITDA margins improve as expected.
• A weak macro environment impacts the company, causing a prolonged sales cycle and labor shortages, but I believe CCSI can recover once the economy improves.
• I will monitor the execution of strategies such as customer mix shift, up-selling, and the VA deal, which could potentially improve the company's performance.

Overview

I continue to stay neutral on Consensus Cloud Solutions ( CCSI ) as I still see several uncertainties with the business and the stock, but would turn positive if EBITDA margins moves in the trajectory I expect. One of the key problems is the weak macro impact on the business – elongating the sales cycle – which is not seeing any signs of recovery. On the point of EBITDA margin improvement, if management can make sure there's no problem with its financials, and improve margin (cleanly), I think the stock might see some positive traction. Until then, I am reiterating my hold rating .

Weak macro is a problem

A prolonged sales cycle has continued to pressure the business in 1Q, and this trend is expected to last into the rest of the fiscal year, as is reflected in the FY23 guidance. In the case of CCSI in particular, slow implementation timelines are being caused by macro uncertainty and a lack of available labor. Management's comments that the problem lies in the length of time it takes to put plans into action are encouraging, I think, because it shows that demand is still coming in—it's just not being converted into revenue and profits quickly enough (due to lack of labor). Since neither of the aforementioned causes (slower sales cycle and lack of labor) is intrinsic to the company, it stands to reason that CCSI will bounce back once the economy improves.

EBITDA margin

How the EBITDA margin will change from here on out is the metric I am concentrating on more and more. I anticipate an increase in margin as a result of a change in the product mix and the end of audit-related expenses. With regard to the former, I anticipate that the ARPA for the corporate segment will continue to fall as SoHo customers migrate upward, but that this will have a positive effect on the ARPA for the consolidated segment as a whole. After the separation, one of CCSI's primary objectives was to locate suitable SoHo clients for upselling and migration to the Corporate market. Since this strategy results in a shift in customer mix, with more low-paying customers being added to the Corporate customer base, it may appear to be a bad one at first glance because it does not screen well. In the long run, though, I expect this change in customer mix to improve consolidated ARPA as CCSI generates additional revenue by up-selling products to its legacy SoHo customers. This seems to be working well, especially in the healthcare sector, as more customers are moving to the company's Corporate segment, where they have access to more robust products better suited to their needs, as noted by management. The biggest win here is the potential for a massive increase in profit from upselling while incurring minimal additional expense. However, I am skeptical because the migration's expected positive margin implication hinges on up-sells and if up-sells fail, then, nothing really changes fundamentally except lower corporate APRA. As such, there is some form of execution risk there that I would need to monitor moving forward. In addition to these positive trends, I believe that CCSI's EBITDA margin will improve through FY23 as one-time audit costs are no longer a drag on the business. Put together, the easing of one-time audit expenses plus high incremental margin from up-sells could lead to an acceleration in EBITDA margin in FY24 which will comp against an easy 1H23. This could spark a positive momentum around the stock in my view.

VA deal

CCSI's ECFax service has successfully commenced operations at two out of the five facilities within its initial group of sites for the VA partnership . The remaining three facilities are anticipated to launch in the near future, aligning with statements made during the 1Q earnings call. From my perspective, the current partnership arrangement serves as a preliminary phase, and favorable outcomes are likely to pave the way for further advancements.

Considering the nature of such endeavors, the VA deal is not expected to yield immediate financial gains in the short term as it requires time to scale. However, I anticipate a consistent growth trajectory in the upcoming quarters. Management has indicated that the VA's contributions, surpassing initial projections, may result in CCSI's financial results exceeding the upper limit of its FY23 guidance range, which is highly encouraging.

“One is, the question came, is anything from the VA contract or Japanese expansion revenues that John mentioned including our guidance the answer or what I would say, our budget? The answer to that is no. Obviously, our guidance is a wide range. So, the expansion of the range, particularly to the upside, you could argue part of the way to achieve. An outperformance would be contributions from the VA contract with Japan, but I noted earlier, I don't expect the VA contract this year to be a major contributor and I would say the same as group Japan, but they're not in our budget.” CEO Scott Turicchi

Conclusion

In conclusion, my stance on CCSI remains neutral due to existing uncertainties surrounding the business and its stock. However, if EBITDA margins show the anticipated improvement, I may shift to a positive outlook. The weak macro environment continues to impact the company, resulting in a prolonged sales cycle that is expected to persist throughout the fiscal year. Nonetheless, management's acknowledgment of the issue and the underlying demand provides some reassurance that CCSI can recover once the economy improves. Overall, I reiterate a hold rating, monitoring the execution of the aforementioned strategies and their impact on the company's performance moving forward.

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