Summary
- Upland Software has managed to carve out a small niche in the SaaS and cloud-based industry.
- Lackluster performance is likely to not end soon, considering management's guidance and targets.
- I believe the M&A strategy is not effective, and the company is spending too much for what it's achieving.
- The company has a lot of competition, whether indirectly or directly, which may not incentivize prospective consumers enough to obtain a subscription for one of their products.
Introduction
Upland Software (UPLD) has not been the greatest performer over the past few years, and I do not see their fundamentals improving anytime soon. As we will see soon, I believe the company has too much competition, is not managed greatly and is lacking in performance as a result.
Company Profile
Upland Software is a company that builds cloud-based software applications made to help companies perform their move to the cloud, essentially.
Their set of solutions and applications are tailored to assist companies and their marketing, sales, information technology, human resources and legal departments, as well as help contact centers, project management and everyday business operations. In a way, Upland is a technology company that hosts their software on the cloud and offers a subscription of them to their consumers.
The majority of their consumers usually opt to have one product, however, and a lot of the applications that they have are likely acquired through their prior mergers and acquisitions (M&A), reminding me a lot of how Progress Software ( PRGS ) runs their business.
They have a wide range of uses and applications, and I'll list some of the keywords or descriptions listed in their 2021 10-K filing : Customer Experience Management ((CXM)), Voice of Customer Engagement (VoC), and Customer Data Platform ((CDP)) are just a few of the main keywords used in their filing.
Another way to look at it is through some examples shown on their main website:
Some of Upland's 31 Products (Upland Software)
All in all, it seems the main idea is to help streamline the operations of businesses by moving to the cloud, something that I believe is a highly competitive market with limited growth opportunity.
Overview of Problems
I honestly feel like two main problems are still consistently seen in their most recent earnings call and their Q3 2022 10-Q filing , which is the lack of effectiveness in their strategy and the high level of interest expenses hammering about 10% of their revenues. Those have decreased slightly, fortunately, but their revenue growth is still relatively stagnant and does not justify the amount of sales and marketing expense accrued if their dollar retention rate is now 95%.
I know their idea is to grow at a steady 5-10% rate, but it seems that the market was pricing in a growth rate that was untenable for the long term. Accordingly, the moment the market saw that their growth for 2023 would reverse by 1 year, they punished the stock by crashing it by almost 33% since the earnings report.
On top of that, the company cannot service new debt whether it be to acquire other companies or buy themselves extra time in a pinch as their interest expense is already high. It is good that they're shoring up cash and gently decreasing their debt load, as seen below.
However, unless they're paying off high interest notes, this speed is probably not enough to take down their interest expense and make it more reasonable.
I will, however, commend the company for taking action against contracts that were losing money, as shown in their latest earnings call:
As part of the thorough review of our business we did to build this comprehensive growth plan, we identified certain unprofitable customer contracts and products that don't fit our business strategy going forward. We have made the decision to sunset those assets.
This can easily explain the revenue decline as those assets and contracts consist of 10% of their total revenues. At least that question was written off the bearish thesis.
I still must question their M&A strategy. Here's another quote from CEO Jack McDonald:
We plan to continue to grow through M&A and opportunistically capitalize on accretive acquisitions of orphaned venture-backed companies over the next several years. We still see a great opportunity there.
I could trust them on their great opportunity, and of course the M&A strategy has not affected their customer retention in a negative way but considering that they could do much more with their 10000+ customers to truly streamline their businesses, I feel they are not going to their fullest potential.
Also, if we look at their balance sheet, we can see a similar problem I highlighted in other companies like Progress Software and Squarespace having a significant portion of their assets derived from Goodwill and Intangibles:
It's not as bad if it weren't for the fact that they got a goodwill impairment charge in Q4. While they do this every October, as shown in a quote from their 2021 10-K filing, it does carry a bit of a risk to those long the stock assuming it has a good balance sheet.
Goodwill is evaluated for impairment annually in October or more frequently when an event occurs or circumstances change that indicate the carrying value may not be recoverable
Finally, there is a possible risk that UPLD with be thrown in the same basket as other AI stocks, considering that management also announced their newest AI-powered offering for RightAnswers:
On the product front, in Q4, I'll note that we had a new RightAnswers release, a browser extension that powers the connected knowledge experience, seemingly -- seamlessly unlocking the possibility to deliver knowledge to every corner of the enterprise through AI-powered centralized search.
Now, I want to be clear: I don't have a problem with AI. I think AI can be used rather intelligently in ways like Microsoft ( MSFT ) is doing by incorporating it into their Bing search engine to further enhance its capabilities in ways that Google Search (GOOG) ( GOOGL ) does not yet. ChatGPT is also not too bad of an AI engine and I've seen and tested some AIs, namely for image creation, as that has also been causing a panic among artists . My main issue is when companies as of late are doing the same as in the dot com bubble trend and mentioning that they have AI capabilities, which causes investors to get so excited that stock prices rocket 10% or even 100% the likes that BuzzFeed ( BZFD ) has done back in January, for example.
This clearly blew up for any investors that bought any AI stock, and that's a risk that UPLD poses both to the upside and to the downside, which makes UPLD a less serious investment unless the AI hype dies. For now, though, the focus investors had is on earnings, which at least makes things a little more rational.
Ways to Fix it
The company is not unfixable. This isn't a Carvana ( CVNA ) or Bed Bath & Beyond ( BBBY ) we're talking about, this company can be treated as a fairly mature company with a strong set of customers and revenue that grow modestly over time. Pretty clearly not every business has moved onto the cloud and the company may still carve out a small niche.
Maybe their new RightAnswers release could help them garner some attention and make me eat my bearish thesis. The company cutting off unprofitable contracts and assets is already a great step in the right direction that does not involve layoffs. Management is aware that there is a chance of a recession ahead. Looking at their income statements and balance sheets, there are a few ways to improve GAAP profitability and at least begin to justify higher valuations, which would make a shorting stake a risky move with the current downside already performed.
We already mentioned Goodwill being a problem here, but the good news is that it gives some positive equity, which allows for the valuation to be rather reasonable if there aren't any more significant impairment charges due to Goodwill changing dramatically. While the prior charge is bad news on top of an already lackluster report, they don't get them often since 2019, 2020 and 2021 were all clean on that front.
Additionally, even if their intangibles make up a good chunk of their assets, their cash already is larger than their current market cap, which stood somewhere around $181 million.
There is also some hope in their income statement, which I'll have to use their Q3 2022 10-Q for reference.
UPLD Operating, Interest and Tax Expenses (Upland Software)
Hopefully, future reports will provide hopes of lower expenses; however, management already noted they want to increase expenses and become more aggressive with their growth, as highlighted here:
To achieve that growth, we're going to make targeted incremental investments of $15 million per year, $15 million per year incremental investments in marketing, in sales and product
However, if management decided to back off from increasing expenses and improving their net income more aggressively, they can easily do so by reducing their sales and marketing expense by at least 50%, depending on what those expenses account for.
Research and development can be reduced slightly to be more streamlined, especially since it's hard to imagine the company having developed any of their products, considering that they made 31 acquisitions and have 31 products. That's not much space for in-house development in my opinion.
Maybe General and Administrative expenses can be reduced. If it's possible to do more with less staff, sure, we can go for that, but if there are any unnecessary expenses that employees and the company can benefit without, then that would provide more value and continue eating down the bearish side.
The other alternative is that they may take out some of the debt that they issued if it's not a "held to maturity" kind of note. If the nature of the notes allows for more aggressive paydown of debt, they can afford to cut their cash slightly so they can reduce that interest expense slightly.
Finally, looking at the cash flows, there are maybe two points I can see that may improve the company's performance.
Cash Flow Statement Highlights (Upland Software)
While there is still work to be done before it takes a material effect, stock compensation has decreased from the prior year. I'm starting to get the hunch this is related to general and administrative expenses and the cash flow statements are merely reversing the required GAAP expenses, which may mean that the Cash Flow Statement offers more pieces of the income statement puzzle than I originally realized.
There aren't any share buybacks that I'm aware of that can offset this dilution, so I can say for certain that this will affect investors more than the company itself, while also hurting GAAP profitability.
The last thing I can think of that can improve the company's profitability is to cut back on M&A for a year entirely. Acquisition-related expenses are certainly holding back their GAAP profitability and it really has not been giving many results. Should the company attempt even further to tap into their existing consumer base and having some good people getting deeper into the business to try to upsell their own offerings, then it is possible to bring more revenues and improve brand loyalty.
If any of these methods were to be taken by management in the future, then my bearish thesis would no longer have legs and I would be neutral on the company.
2022 10-K Update
While doing necessary improvements on the article, the 2022 10-K for Upland Software released and is now available. I would suggest looking at the filing to get an updated view, but so far, not much has changed that would require changes to some segments. Most of the statements said here still apply.
However, I want to point to the new Income Statement released on February 28:
Upland's Operating, Tax, Interest, Depreciation and Amortization Costs (Upland Software)
As emphasized, there was a decrease in expenses that occurred in the general and administrative side of expenses. However, if you look closely, you can see net losses are worsening.
The good news is that as seen in prior quarters, interest expenses are decreasing, but so have their benefit for tax losses.
Still, excluding their impairment charge, their GAAP operations are improving, although very slowly. As shown before, if they continue performing M&A and spending too much for their inefficient results, there won't be any noticeable improvements.
Outlook
We already know what their Q4 results look like, and I already gave the notion that their outlook doesn't look fantastic. Let's digest the data:
There's a consistent view regardless of Q1 of 2023 or FY2023 that revenue will decline by 5%. Full year revenue is expected to be between $288 to $312 million. Considering the slow revenue growth the company has had and the measures they're taking to improve profitability, this is a fair guidance. With their high retention rate, the only way to exceed expectations is by improving the number of products that customers are subscribed to along with obtaining new customers. This may be difficult in a digitized world, but it is possible, considering they acquired 204 customers in Q4.
Their adjusted EBITDA is expected to come between $63 million and $75 million, which is a major decrease of 29% compared to the current year, which might have also been another primary catalyst to the company crashing down over 30%. It looks heavily correlated here, if you ask me.
All in all, the outlook might as well have been the catalyst for such a cataclysmic stock performance relative to what I've seen this earnings season.
Now, my take on the business itself might as well be the main driver of my bearish thesis. There are bullish signs that the company may be poised for modest growth, and the recent repricing of the stock may allow for an entry point barely seen since their first few years being a public company.
Other bullish signs are the projected market size of both the cloud market and the software-as-a-service (SaaS) market. For one, Markets and Markets shows us that the cloud computing market can grow from $545.8 billion USD in 2022 to $1.24 trillion USD in 2027. On another one, Fortune Business Insights says that the SaaS market can grow from $251.17 billion USD in 2022 to $883.34 billion USD by 2029. This, respectively, represents a Compound Annual Growth Rate of 17.9% and 19.7%, which shows that there is still plenty of room to grow in the field.
However, the company competes directly with other major competitors in the SaaS market like Google, Amazon (AMZN), Microsoft and IBM ( IBM ), all of which have shown better performance than Upland Software. Even among companies I am aware of that don't have a massive market cap, I believe Upland competes directly in CXM against Qualtrics International ( XM ), competes indirectly with Squarespace ( SQSP ) as Squarespace also offers customer experience management solutions to their consumers, and even competes with Progress Software for corporate software customers. All the aforementioned companies have at least shown more promising performance than Upland is showing lately.
A 5-10% consistent revenue growth is great for those who want a stable company, but my analysis has been pointing to me that Upland is more of a questionable choice of an investment, considering it is even underperforming the market growth displayed earlier. Considering that with a 5% revenue decline the company is basically going to be flat against 2021's revenue levels, I think there are better places to put money into, as tempting as Upland's apparent valuation seems.
Valuation
Speaking of valuation, it's time to cover this one. I don't have any usable net GAAP profitability metrics and I think attributing a 20x non-GAAP EPS multiple is too generous for this. Maybe if the company continued growing this year by some miracle this can be justified, but I'll use a 10x valuation multiple for non-GAAP forecast EPS.
I'll also use a 2.5x EBITDA multiple for part of the valuation process. I can use revenues instead too, however that would be a 2x multiple with what the company currently shows, and I feel even that is generous, which is why I likely won't take it into account for the calculation, but I'll note that it would imply a share price of $18.95 assuming $300 million in revenues.
For reference, here's the expected non-GAAP EPS estimate for 2023 and 2024 that analysts have given the company:
$1.02 for 2023 and $1.10 for 2024 certainly seems reflected in the stock price as analysts expect the company's growth and profitability to creep to a halt, and so they assign lower multiples. With that in mind, UPLD should be worth around $10.20 with my 10x multiple, which is higher than where the stock stands at $5.89 per share.
Based on management's guidance, I'll use a generous $65 million EBITDA as the expected EBITDA for 2023, which is honestly not the most demanding EBITDA margin considering their guidance range. A 2.5x multiple would give the company a valuation of $162.5 million, or a share price of $5.13.
Their current equity position as of writing is unknown, but their Q3 2022 equity position stood around $308.9 million. Do take this with a grain (or two) of salt due to their total goodwill value being $479.6 million. Even then, at a one-for-one equity valuation, that gives UPLD a target price of $9.75.
Giving EBITDA, equity and non-GAAP EPS expectations equal weighting, the target EPS would be $8.36, implying an upside of 42%.
However, keep in mind that this stock would be a great example of high risk, high reward. The business itself, in my opinion, doesn't justify that high risk very well for my tastes. It seems that the market agrees with me for now.
I will be honest, though, I can be wrong and end up seeing the stock actually trading higher than I can expect in the short-term, especially after such a big and dramatic move to the downside. However, I think that having low expectations and knowing what you're getting into can be a good idea. I would suggest doing your due diligence if you choose to take a risk, just make sure to incorporate as much information into your investment/short thesis (or lack thereof, aka just waiting), because it definitely helps. For me, I don't think I'll see myself investing in this company for anything other than speculative gambles, if even that.
Conclusion
To recap, the company has had okay performance. However, I believe there was a good reason the company was punished heavily when reporting their earnings and their fundamentals make it difficult for their non-GAAP EPS to be taken seriously.
Too many expenses seriously hampered their net profitability, and their M&A strategy leaves something to be desired. Their growth underperforms the overall market and is borderline stagnated with their new guidance, suggesting a major problem with their strategy.
Management is doing their best, of course, and there are signs of action to help improve the company's situation; however, it is very difficult to say that this is a buyable bottom when the worst might not have happened. I laid out some ideas of action based on my limited knowledge using the data they provided in their consolidated financial statements, but it is what it is.
My rating is a Sell, as much as I don't want to do so when the stock is already beat up badly. The lack of good fundamentals compared to competitors simply don't justify taking a risk to just maybe see an upside to $8 as my price target would suggest.
For further details see:
Upland Software: Excessive Ineffective Expenses Here