2023-12-21 16:49:07 ET
Summary
- RingCentral, Inc. growth rates are slowing down, and its balance sheet is overleveraged, leading to a neutral stance on the stock.
- The company faces near-term challenges, including macroeconomic trends and reduced customer upsells.
- RingCentral's revenue growth rates have moderated to a 10% CAGR, and its balance sheet troubles pose a risk to its financial health.
Investment Thesis
RingCentral, Inc. ( RNG ) provides communication services, offering tools like voice, video, and messaging to businesses for seamless collaboration and connectivity.
The stock has two main issues weighing it down and keeping me neutral on this name. Not only are the business' growth rates meaningfully slowing down, but also, its balance sheet leaves little room for flexibility. Therefore, I'm sticking to the sidelines here.
Rapid Recap,
Back in September, I concluded my neutral analysis by saying,
[...] the company's growth rates have slowed, and profitability remains a concern, with stock-based compensation accounting for a significant portion of expenses. Despite efforts to improve profitability, RingCentral's valuation has been on a downward trajectory, which makes it somewhat interesting, but then we circle back to the question of its overleveraged balance sheet .
Author's work on RNG
Since then, the stock has moved higher and has in fact outperformed the S&P 500 (SP500). Neverthelss, I maintain that there's little value in this name and that this stock doesn't offer investors a positive risk-reward.
RingCentral's Near-Term Prospects
RingCentral is a provider of cloud-based communication and collaboration solutions. The company specializes in Unified Communications as a Service (UCaaS) and Contact Center as a Service (CCaaS), offering a comprehensive suite of products that includes voice, video, messaging, and conferencing tools. RingCentral a bit like Zoom ( ZM ) or Microsoft Teams ( MSFT ).
RingCentral's focus on product diversification, particularly its transformation into a multi-product company with offerings in UCaaS, CCaaS, Conversation Intelligence, Sales Analytics, and Events, Webinars, and Meetings, positions it well in the competitive market.
However, RingCentral faces certain near-term challenges that, including macroeconomic trends, have led to prolonged sales cycles. The slowdown in customer upsells within the existing base due to reduced hiring and workforce rationalization adds complexity to the near-term outlook.
While the company has seen success in certain key verticals like healthcare and education, there is a need to further capitalize on opportunities within these sectors.
With this context in mind, let's discuss its financials.
Revenue Growth Rates Moderate to 10% CAGR
RingCentral was once a company that investors relied on for more than 20% annualized CAGR. Today, even as its comparables with the prior year have eased up, RingCentral is delivering decelerating revenue growth rates.
Furthermore, when RingCentral reports Q4 2023 results ( expected mid-February), it will hopefully deliver at least 10% CAGR. But it's not realistic to expect much more than double-digit growth rates in the near term.
In fact, let's make the assumption that next year, in 2024, as RingCentral's prospects improve and its comparables get easier, this business will see around 12% to 14% CAGR. Is that sort of growth rate going to be sustainable? Or is it possible that even 14% CAGR is too high a hurdle for RingCentral?
I wonder if this discussion, while important, doesn't distract from the main risk factor facing RNG?
The Bear Case: Balance Sheet Troubles
RingCentral will enter 2024 with a net debt position of approximately $1.3 billion. This means that investors paying a $3 billion market cap for the company are getting about half of it as debt.
Given this consideration, I'll highlight a line from the Q3 press release ,
Announced in August 2023 the issuance of $400 million aggregate principal amount of senior notes due 2030 (the “2030 Senior Notes”) in a private offering. The 2030 Senior Notes are senior unsecured and bear interest at a rate of 8.5% per annum. We intend to use the net proceeds from the 2030 Senior Notes to repurchase a portion of our outstanding convertible senior notes and the remainder of the net proceeds, if any, for general corporate purposes.
What this means, is that RingCentral is issuing debt at 8.5% to pay off debt at 4.7%. That's a very poor capital decision that RingCentral has been forced to make.
To further complicate matters, after the recent repurchases of its convertible notes, RingCentral has less than $200 million left of cash. Why is that a concern?
Because in March 2025, RingCentral will have to pay back or refinance its remaining $160 million of its convertible notes. And even though RingCentral is free cash flow generative and will be able to renegotiate its debt, the debt is likely to be refinanced at 8.5%, in line with its most recent raise, rather than 4.7% in line with what this debt was originally issued at.
This will leave this business' balance sheet even more stretched than it already is.
RNG Stock Valuation -- 10x Forward Free Cash Flows
RingCentral will deliver about $300 million of unlevered free cash flow in 2023. Meanwhile, looking ahead to 2024, if we presume that its free cash flows increase by 15% y/y, this would see the company reporting $350 million of unlevered free cash flow. However, recall that unlevered free cash flows means before interest payments.
Assuming a blended cost of capital of somewhere around 7%, I believe that RingCentral's interest expenses will amount to approximately $90 million in 2024. A figure that is roughly flat with 2023.
In other words, it's clean free cash flows will probably be around $300 million in 2024. This leaves this stock priced at 10x forward free cash flows. A valuation that isn't compelling enough, to be on the receiving end of an unencumbered balance sheet, and a business that's barely growing in the double digits.
The Bottom Line
In my assessment of RingCentral, I'm adopting a neutral stance due to two key concerns: a noticeable slowdown in growth rates and a constrained balance sheet. Despite RingCentral, Inc. stock's recent outperformance, doubts persist about its value proposition.
The company's decelerating revenue growth rates, expected at 10% CAGR, raise questions about sustained growth. The crux of the issue lies in RingCentral's overleveraged balance sheet, with a net debt position of about $1.3 billion.
The decision to issue debt at 8.5% to pay off debt at 4.7% adds financial strain. Additionally, the upcoming repayment of convertible notes in March 2025 poses further challenges. In terms of valuation, with an anticipated $300 million in levered free cash flow in 2023, the current 10x forward free cash flow valuation appears unconvincing given the financial hurdles and a modest growth outlook. As an investor, I see little appeal in RingCentral's current circumstances, questioning the market's optimism amid these challenges.
For further details see:
RingCentral's Growth Concerns And Financial Strain