NVDA - RingCentral: Deserves Better In View Of Innovation And Conversational AI

2023-07-31 23:01:53 ET

Summary

• RingCentral's share price has dropped to a level lower than in 2019 after having outperformed as a beneficiary of Covid-led digital transformation.
• The deployment of the RingSense AI platform and other innovations could drive growth for the company.
• RingCentral's business model, based on integration and partnerships, has helped it maintain a leadership position in the UCaaS market.
• On top, it remains undervalued with respect to the IT sector.
• The bullish position is backed by productivity figures and market opportunities while also making sure to address some of the risks.

Considered one of the beneficiaries of Covid-led digital transformation, RingCentral ( RNG ), a provider of unified communications for customer contact centers, saw its share price surge by more than 300% in 2020-2021, but has since plunged to about $40, which is even lower than in 2019.

Presently the company's quarterly revenue growth of around 15% is less than two times what it was two years ago, but, it remains significantly undervalued relative to the IT sector. Thus, given that it is expected to report second-quarter (FQ2) results on August 7 , the aim of this thesis is to assess whether the deployment of its RingSense AI platform together with other innovations could constitute growth drivers.

In order to moderate expectations in view of the hype factor, I start by providing insights into how AI can increase the labor productivity of customer call (or care) centers.

Leveraging Conversational AI as a Growth Driver

While most of us are familiar with the text-based format of Open AI's ChatGPT, there is also the voice part where algorithms are able to respond to voice queries with elaborate answers. I already touched upon this topic with publications on Kaleyra ( KLR ), which uses conversational AI to partially automate certain types of customer calls. Another company, Presto Automation (NASDAQ: PRST ) which specializes in voice solutions for the Drive-Thru has gone a step further in the degree of automation with Voice AI . This is enabling restaurant owners to be more productive as they have to use fewer manhours of work to fulfill a customer order.

Looking for concrete figures, Boston Consulting Group estimates that Generative AI, once adopted by most customer service operators, could increase productivity by 30% to 50% . Now, as for adoption, both by the general public and corporations, the rapid rise in the number of ChatGPT's monthly active users shows that this flavor of AI which uses LLMs or large language models is being accessed by many.

This means that RingCentral does not need to do marketing as it drives RingSense for Sales .

This product uses AI to turn conversational data into insights. In other words, it aims to make consumer-to-sales team communication more productive, by automating follow-ups, generating AI-driven summaries, and tracking insightful keywords or phrases.

This said is also essential to monetize the service.

Monetization while Exercising Moderation in View of Risks

First, looking at the global picture, 95% of customer service leaders already expected an AI bot (software robot) to be part of their client interactions in 2022. This should just be accelerated by ChatGPT.

Second, one of the advantages of RingCentral is its platform approach on which its own development teams can build applications for customers directly, and third, by releasing its APIs (application program interfaces), other companies can also leverage the platform with the company getting revenues in return.

Third, RingSense for Sales is only the first instance of the RingSense AI platform and others dedicated to other industries like healthcare are likely to emerge, and, since they will be monetized separately (from RingCentral's other product offerings), it can become a growth driver for one of the world’s major UCaaS (Universal Communications as a Service) providers.

However, at this stage, it is important to inject a dose of realism.

For this purpose, RingSense was in the testing phase ( open beta ) at the time of the May 9 earnings call. Moreover, with such implementations, there is a technology-digestion phase which is particularly relevant for AI, as its algorithms first have to learn using existing data before actually being able to provide insights on live conversations. This can take time as salespeople adjust inputs from algorithms with their own manual way of doing things implying that the implementation approach is likely to differ in different corporate environments. This implies that there may be stock volatility risks in case high investor expectation is built in the stock after an initial uptake of RingSense fails to be sustained.

Still, two of RingCentral's advantages are that it is not starting from scratch since it is already known for its use of advanced analytics in addition to providing third-party integration capabilities. Additionally, it has not only positioned its products earlier on in the AI race with RingSense but is also leveraging NVIDIA's (NASDAQ: NVDA ) GPUs to fine-tune language models for video conferencing purposes.

Therefore, taking into consideration the above points, AI-related sales could benefit the topline this year and my optimism also stems because of RingCentral's capability to scale based on other product innovations as pictured below.

One of the innovations pertains to RingCentral for Teams 2.0, and in a way illustrates the capacity of the business model to grow based on two factors: integration and partnership.

Integration and Partnership Instead of Competing Head-On

First, by integrating its cloud PBX product features with Microsoft's (NASDAQ: MSFT ) Teams collaborative suite directly (without the need for a third-party application), RingCentral makes the adoption of its own product faster. In this respect, UCaaS is very often closely linked to other corporate applications such as customer relationship management proposed by the likes of Salesforce ( CRM ). As such, there is a requirement for these to work together, and, to facilitate this task, RingCentral's advantage compared to others like Nextiva is that it provides flexible integration options including pre-built connectors. On top, it has been able to gain the trust of over 80K software developers globally who are instrumental in rapidly embedding RingCentral's telephony components into the core applications used in many companies today.

Second, by prioritizing a partnership approach with other players who are well-established in certain other geographies rather than betting head-on against them, as exemplified by partnerships with Mitel (as pictured below), RingCentral is able to expand while the partner is remunerated on a recurring basis over the life of the contract.

This way of scaling, namely through product integrations and partnerships is crucial in a UCaaS market where there is competition from much larger players like Zoom ( ZM ) and Microsoft and has helped RingCentral maintain its leadership position with around 20% - 21% market share in the 2020-2022 period. Now, given it further managed to grow sales by 24.7% YoY in 2022 and is expecting 10%-11% for FY-2023, it means that it is still gaining market share and maintained its leadership position together with the software giant in April this year.

Furthermore, the topline guidance for 2023 is more or less aligned with the 11% growth in the number of subscribers for Microsoft Teams. Along the same lines, after the Covid windfall gains of 2020-2021, the CPaaS market has matured, and the above-20% CAGR growth rates mentioned by certain market surveys cannot be used as a reference.

Valuation and Key Takeaways

In these circumstances, RingCentral's more subdued revenue growth is justified and given that its trailing Price-to-Sales multiple trades at a discount of more than 36% , I have a target of $44 (40 x 1.1) based on applying a 10% upside to the current share price of $40. This is a moderate target and is based on the above innovations, including RingCentral Overlay developed in partnership with Vodafone ( VOD ) Business. This enables hybrid teams to utilize its messaging and video collaboration tools on top of legacy telephone networks.

Coming back to the $44 target, it may appear to be on the low side and is because the total debt level has stayed around $1.68 billion level while cash and equivalents have slightly decreased by about $25 million in the same period to $275 million.

This in turn shows the need to invest money to generate revenues, which makes it imperative to assess whether RingCentral's business model can be sustainable, notably in terms of profits and cash. In this case, the executives mention that they are optimizing the cost base to free up cash while decreasing customer acquisition costs, ultimately meaning lower operating expenses. Checking for progress in the orange chart below, this has indeed been the case as the downtrend in the operating income now seems to be under control as a result of driving efficiencies in sales and marketing and performing vendor rationalization. For this matter, non-GAAP operating margin guidance for FY-2023 has been upgraded by 18% to 18.5% .

Noteworthily, to help further progress on the profitability front, Ring Central can rely on a sustained uptrend in gross profits (pale blue chart). For this matter, its gross margins of 68.5% are 40.8% higher than the median for the IT sector. Looking further, progress has also been made on the free cash flow as seen by the deep blue chart above, with FCF margins of 16.6% which are above the sector median by a whopping 137.5% .

Conclusion and What to look for during FQ2's Results

Thus, this thesis has a bullish position on RingCentral, but since there is only about one week for the second quarter's results to be announced, some may adopt a more cautionary instance and instead wait for relevant management updates. One of these would be the interest and adoption of RingSense for Sales by customers in general.

Shifting to metrics, checking whether the non-GAAP operating margin of 17.5% as per FQ2's guidance below is delivered would be useful to assess whether the company is on track to sustain cost optimization efforts and achieve its year-end target of 18.5%.

Furthermore, in view of the high-interest rates in North America which contributed to 91% of revenues in the first quarter (FQ1), one of the items to scrutinize is subscription growth, which is normally synonymous with more stable revenues.

In conclusion, by going through RingCentral's RingSense which also allows for the injection of voice AI features across the company's portfolio, this thesis has shown that the stock deserves to be valued better after considering some risks. To support this bullish position, the conversational AI market for platform-based customer interaction is expected to expand at a CAGR of 23.6% from 2022 to 2030 to reach $41.39 billion. Additionally, productivity figures in the customer service domain have been used to justify the uptake of the technology while the company can also rely on other innovations to drive growth. Finally, this thesis has shown that RingCentral is also able to generate cash while reducing operating expenses.

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