RBBN - Ribbon Communications: Waiting For Better Margins Before Upgrading

2023-08-15 07:37:37 ET

Summary

• Ribbon Communications has a valuation of around 12x P/E and lacks solid margins, making it a hold.
• The company operates in the communications technology sector, offering solutions in Cloud and Edge, and IP Optical Networks.
• RBBN has access to a combined TAM of over $10 billion and expects strong demand in the second half of 2023.

Investment Rundown

With a massive run-up in the share price earlier on in 2023 the valuation has since come down and right now sits at a p/e of around 12. Ribbon Communications Inc ( RBBN ) engages in providing communications technology to an international customer base. The company has gathered up an impressive set of customers, which has bolstered the company's reputation in the industry.

What keeps me from rating RBBN a buy despite the drop in valuation we have seen is the lack of solid margins. The company still has a negative TTM net margin, and the last quarter from the company didn't seem to indicate any improvements are coming here in the short term. I do like the position the company holds, however, and rating it a hold is what I will be doing.

Company Segments

RBBN operates in the communications technology sector, offering its service solutions to an international customer base that has been growing impressively over the years. The company's operations are organized into two various segments: Cloud and Edge, and IP Optical Networks.

Within its Cloud and Edge segment, RBBN offers various communication methodologies. This encompasses a broad range of software and hardware products, along with an array of solutions and services. One of its critical contributions lies in facilitating Voice over Internet Protocol ((VOIP)) communications, an essential component of the contemporary telecommunications landscape. Engaging in this market has done very well for the company as they have managed to set up partnerships with some of the largest companies in the industry.

RBBN's abilities extend to the industry of Voice over Long-Term Evolution (VoLTE) and Voice over 5G communications. As the markets develop, more and more demand seems to be placed on RBBN and their technologies. RBBN has managed to diversify its markets though and has around 51% of its revenues from the United States and the rest from Europe and Asia and a quite equal distribution.

One of the appealing parts for investors in RBBN seems to be the TAM the company has access to. With a combined TAM of over $10 billion including markets like IP Routing, Optical Transport Secure VoIP, and SDN what RBBN offers is a great exposure play to all of these. Looking at the market of IP Routing which is the largest one for RBBN it's expected to grow at a solid yearly rate of 8.6% between 2022 and 2027. Some of the growth drivers for the market seem to come from the further development of 5G and a rising consumer preference for smart devices is also helping the market. In the last report from the company, the CEO Bruce McClelland said that they continue to expect strong demand going into the second half of 2023. Strong markets fueling these projections are both the United States and Japan. But it seems that an emerging market for RBBN is India where shipments continued to grow, and enterprise customers grew by 94% YoY in the last report .

Earnings Highlights

Diving deeper into the last earnings report from the company, there are some key things to highlight.

Where I remain quite concerned is the fact that share dilution is still very much present in the company. On a year-over-year, the shares grew by 13% That has severely harmed any investors in the company as their stock has been worth less essentially.

I don't think this is a practice that will stop until the margins of the business improve. The GAAP diluted EPS came in at a negative $0.13 for the company, however, it seems that the coming reports are to be an improvement. I am looking especially at the Q4 report for the company, where expectations are for a non-GAAP EPS of $0.16. This would be a solid improvement and set the company on the path to growth at a higher single digit in the coming years.

Risks

RBBN has a long-term debt of $216 million, which has notable implications for its financial landscape. This debt load translated into interest payments amounting to $24 million in the last 12 months, indicating a substantial financial commitment toward servicing its debt obligations. While debt can be a useful tool for companies to fund growth and expansion, the weight of interest payments can pose challenges to profitability, which seems to be the case there for the short-term, or until interest rates start to decrease again.

Seeing the debt decreasing at a substantial rate is reassuring, however, as it further deleverages the company and enables them to be making strong investments into new ventures. The risk is that growth might be muted for the short term, and it seems likely that shares are going to continue being diluted as the company battles paying down debts. That is sufficient for the buy case to disappear, but the prospects of growth remain strong enough for a hold case at least.

Final Words

As for the prospects of RBBN, it seems to heavily rely on maintaining partnerships with current customers and raising the margins to a better state. I don't think the dilution of shares and leveraged balance sheet is sufficient for making the company a buy anytime soon. I do think it's wise to have some exposure to the growing markets it's in, meaning a sell rating would be unadvised. In conclusion, I am rating RBBN a hold right now and maintain a neutral view of the business.

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