2023-09-27 13:08:43 ET
Summary
- Hold rating recommended for RingCentral due to near-term weakness and CEO transition.
- Recent quarters show significant growth slowdown and executive management turnover.
- Long-term prospects are positive with strong competitive position and potential for growth acceleration once macroeconomic conditions stabilize.
Overview
My recommendation for RingCentral (RNG) is a hold rating, as I expect the business to see near-term weakness due to the macro climate. In addition, I believe the change in CEO should continue to weigh on the stock sentiment as investors await on the sidelines until the new CEO proves his execution abilities.
Business
RNG offers cloud-based solutions for corporate communication needs. The company empowers users to engage in digital interactions using voice, text, video, web conferencing, and fax services across a variety of devices such as smartphones, tablets, and computers. Essentially, RNG facilitates seamless digital connections among multiple participants, enabling efficient communication, including business meetings and collaborations.
Recent results & updates
Just to give a brief history of the business operations, RNG was considered a high-growth software company over the past decade as the business consistently printed 30+% growth, growing revenue from ~$80 million in 2011 to $2 billion in FY22. Growth even saw an acceleration in FY21 (from 31.1% in FY20 to 34.6% in FY21) as businesses benefited from the work-from-home situation (businesses needed a digital tool to communicate with each other). The pressing point about the business was that growth came at the cost of profitability over the same period but has finally flipped to positive adj. EBITDA performance over the last 12 months and is expected to surge higher (according to consensus). While performance was strong over the past decades, growth has shown a significant slowdown in recent quarters. In 2Q23, total and subscription revenue were $539 million and $514 million, respectively, growing only by 11% year over year, which is a stark difference from the historical growth rate. The same weak performance was also seen in the ARR metrics, which grew by only 12% to $2.2 billion, slowing from 14% y/y in 1Q23. The net new ARR of $59 million also declined by 31% compared to last year.
I anticipate that longer sales cycles will continue to have a negative effect on performance in the near future as a result of increased scrutiny of projects (which also affects RNG's ability to upsell within the existing base). The slowdown in ARR growth, especially within the upmarket/enterprise, was fairly obvious in 2Q23, I think, as reflected in ARR performance. As a result, the 33% revenue growth seen in Q1-22 has slowed to just 11% in Q2. The announcement of yet another executive-level management shakeup (this time at the CEO level) does nothing to boost investor confidence in an already shaky stock in my opinion. An increased wave of C-level turnover has been one of RNG's biggest overhangs in recent years. For instance, RNG had 3 Chief Operating Officers, 2 Chief Financial Officers, and 2 Chief Technology Officers in just 7 years. I can't say this is indicative of anything seriously wrong with the company, but it's also not the norm. I believe these two factors will continue to weigh on RNG stock performance in the near term until the market gains confidence in the new CEO's strategies and execution abilities.
However, I am not bearish on the business over the long term. My view is that RNG operates in a large market with a solid competitive position . Importantly, the value proposition of RNG has significantly improved due to COVID and the rise of remote work. I see RNG as the leading player in the industry, highlighted by its multiple strategic partnerships with legacy PBX ( private branch exchange ) incumbents. This strategic advantage effectively provides RNG access to a large pool of users. While the near-term is likely to be weak, as seen from the breakdown of subscription growth expectations to 11% from 27% in FY22, I believe the business could see growth acceleration once the macro situation normalizes.
Valuation and risk
Author's valuation model
I have structured my model to show both the near-term and medium-term price targets, reflecting my view above. In the near term, RNG is valued at $29 as RNG grows according to guidance and the macro-negative impacts linger for FY24. In the medium term, I believe RNG is worth $36 as the business sees an acceleration in growth once the macro turmoil ends.
In both scenarios, I expect RNG to continue trading at the current multiple of 1.8x forward revenue, as I remain conservative on valuation re-ratings. That said, I point out that RNG has turned profitable and should be a catalyst to drive valuations higher. Also, once the "worry" about the new CEO's execution ability passes and growth reaccelerates, valuation could see a positive upside too.
I believe competition from Zoom (ZM) and Microsoft (MSFT) Teams, which have better distribution and more competitive pricing, is the key risk to RNG's ability to grow in the long term. While RNG has done very well so far, these bigger players (Zoom has twice the revenue size of RNG, and Microsoft is way larger) can replicate RNG offerings on a like-for-like basis if they wanted to in my opinion.
Summary
I recommend a hold rating for RNG. While the company's long-term prospects appear positive, the near-term outlook is clouded by macroeconomic challenges and the recent CEO transition, which has left investors cautious. Historically, RNG experienced robust growth, transitioning from $80 million in revenue in 2011 to $2 billion in FY22, although profitability lagged. However, recent quarters have shown a significant growth slowdown, with 2Q23 revenue growing only 11% YoY. Longer sales cycles and increased scrutiny on projects are likely to continue impacting performance. Additionally, I think executive management turnover has unsettled investors. Despite near-term challenges, RNG holds a strong competitive position and benefits from the remote work trend. In the long term, once macroeconomic conditions stabilize, the company could experience growth acceleration.
For further details see:
RingCentral: Should Do Fine Long Term, But I'm Negative Near Term