RINGCENTRAL INC RNG S
March 09, 2016 - 10:40am EST by
icebreaker25
2016 2017
Price: 18.25 EPS .04 .19
Shares Out. (in M): 71 P/E 456 96
Market Cap (in $M): 1,300 P/FCF NM NM
Net Debt (in $M): -119 EBIT 10 25
TEV ($): 1,180 TEV/EBIT 118 47
Borrow Cost: General Collateral

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Description


Summary
RNG is riding a secular shift in business telephony, as it moves from traditional on-premises private
branch exchange (“PBX”) solutions to cloud-based solutions. RNG provides over-the-top (this is a critical
point that we will discuss below) Voice over IP services bundled with proprietary software to provide
Unified Communications as a Service (“UCaaS”) (messaging, conferencing, mobile, etc.) that especially
caters to the increasingly mobile employee.
Industry experts estimate only 10% of traditional PBX services have transitioned to VoIP for businesses.
As on-premise equipment ages (life span of 7-10 years) and comes up for replacement, the existing
installed base will increasingly move to UCaaS offerings, resulting in high top line growth estimates for
the industry.
The market has recognized this and awarded RNG a SaaS-like revenue multiple (3.5x 2016E sales)
despite its lack of cash flow or net income. What it hasn’t recognized is:
- the increasing competition in the space from better capitalized companies
- the risk of increasing churn (the death knell for a telephony provider) as the company deemphasizes its
core SMB customer to move up-market, exposing itself to customers who will be disappointed with
RNG’s poor quality of service (“QoS”)
- most importantly, the likelihood that its largest reseller (AT&T, who represents 12% of FY2014
revenues) is discontinuing their joint offering (RingCentral Office@Hand from AT&T), calling into
question the value of RNG’s carrier relationships.
As the unit economics of their business deteriorate and growth slows due to the ending relationship
with AT&T, investors will question why RNG should trade at such a healthy multiple of sales. We see
downside to $11/share.
 
Business Overview
Businesses small and large are going through a change in the way they communicate, both internally
and externally. The desktop phone is increasingly becoming less important as employees get
comfortable with using messaging platforms to communicate and improve work flow and use their own
mobile phones as their main telephony device. Traditional on-premises PBX providers like Avaya, Cisco,
Mitel, ShoreTel, etc. are being replaced with VoIP offerings that do not require large upfront capex or
expensive annual maintenance contracts. A recent Jefferies report estimated the savings of switching to
VoIP telephony as up to 70% off of the monthly bill, with the most savings going to SMBs who lack the
scale to make an on-premises PBX affordable.
RNG began offering services, primarily basic inbound call routing and e-fax, but pivoted to UCaaS in
2009. By the time of its IPO in September 2013, the Company was coming off sales growth of 57% and
45% in the prior two fiscal years. Its core customer outlined in the S-1 was the SMB space.
Today, RNG offers its flagship RingCentral Office which provides VoIP capability along with software for
mobile integration, team messaging, conferencing, contact center solutions, and third party application
integration all over the customer’s internet connection, or “over-the-top” (OTT). The three offering
levels Standard, Business and Enterprise highlight a recent shift up-market away from its core SMB
customer.
Revenues are generated by monthly subscription rates per line under contracts that range from 1 to 36
months. Until 2009, sales were driven by online advertising. The Company established a direct sales
force in 2009 to sell its Office product. It also began establishing channel partners that now include
2,500 agents and resellers, including carrier partners like AT&T and recent contracts with TELUS and BT.
Sell-side research universally point to RNG’s carrier partnerships as a differentiated strategy and
believes it will lead to outsized growth.
Sales are predominantly in the US and Canada, with a small presence in the UK. The Company also has
product revenues, though those are primarily to facilitate its service revenues. In 4Q15, they announced
a distribution partnership with WestCon that will significantly reduce product revenues, making FY2016
sell-side estimates look like they expect growth to slow materially, which isn’t the case.
 
Competitive Landscape
RNG is highly thought of by Gartner, though there are a myriad of competitors in the space (EGHT,
SHOR’s cloud offering, VG’s business segment, and a host of private companies like Thinking Phones,
Nextiva, etc.). (https://www.westuc.com/about/pr/press-releases/ucaas-gartner-magic-quadrant-
names-west-leader)
However, competition is increasingly fierce, especially in RNG’s core SMB market. We believe the reason
RNG and EGHT have decided to move up-market is due to increased competition, making the lifetime
value economics less appealing. At the Needham conference in January 2015, when asked why sales
growth wasn’t faster if it was so appealing, EGHT CEO Vikram Verma said he “was not willing to invest to
grow the SMB market in a material way” due to the expected lifetime value. EGHT’s CFO also has
admitted in recent investor meetings that the economics don’t make much sense anymore in the SMB
space. Recently, VG has decided to redeploy its free cash flow from its declining consumer business into
multiple sizeable acquisitions in the UCaaS space, one of which was directed primarily at the SMB space
(Vocalocity). Since then, VG has rebranded these acquisitions as Vonage for Business and is using its
highly recognizable brand, leading domain authority (potentially resulting in lower customer acquisition
costs) and its industry-low termination rates to take market share.
As RNG moves up-market, it is running into a host of new competitors that it didn’t have to deal with
before: carriers that are powered by Broadsoft (BSFT) or Cisco (CSCO) software and MSFT’s new Skype
for Business. Carriers like AT&T, Verizon, CenturyLink, etc. have historically relied on BSFT or CSCO
software to provide UCaaS functionality when selling to enterprise-grade customers. Recently, BSFT has
discussed winning some large network transformation deals, whereby carriers are using them to migrate
their legacy TDM networks to all IP-based networks. As enterprises look to switch to VoIP, BSFT is the
arms dealer to the carriers to help them retain these customers.
Another of VG’s purchases (Telesphere) is aimed up-market with a nationwide network of both
backbone and 21 local Points of Presence (“PoPs”), enabling the company to more reliably ensure QoS.
In comparison, RNG has two PoPs serving North America.
 
Increased Churn Potential
Whereas SMB customers are typically less concerned with QoS, enterprise grade customers are used to
five 9s of uptime, which means that 99.999% of the time your phone is available (5 minutes of
downtime a year). RNG is purposefully misleading in their IT Buyer’s Guide online by saying their
datacenters have five 9s reliability (http://netstorage.ringcentral.com/guides/it_buyers_guide.pdf).
Their datacenters may have that kind of uptime, but their service decidedly does not. As an OTT
 
 
 
provider, they do not control the pipe providing the Internet connection to their customers. Thus, it is
very difficult for them to ensure uptime of their service, hence the misdirection to a statistic that
doesn’t matter. In fact, recent complaints on RNG’s Facebook page resulted from a large outage caused
by a software update pushed out to Polycom phones where some users were without service for up to
five days. Channel checks confirmed this was system-wide and resulted in one month’s credit to affected
users. Since RNG only resells two phone systems (Cisco or Polycom), this was a widespread outage and
could lead to increased churn going forward. Just glancing at Visitor Posts on
www.facebook.com/ringcentral/ shows the QoS issues and less than stellar reviews of its Philippines
based customer service. We even spotted customer accounts being referred to EGHT by other users on
RNG's Facebook page.
RNG has also been very cagey when disclosing churn relative to peers, especially as it has moved up-
market. While mid-market churn should theoretically be lower than for SMBs (who have a higher rate of
failure), the company provides zero information on account churn by customer (a basic and necessary
metric for evaluating subscription-driven businesses) and discloses only its revenue-dollar retention rate
of >99% each quarter. This includes increases in ARPU for up-sells to existing customers, thus masking
true churn. It has recently disclosed gross revenue churn annually, improving from 14% in FY2014 to
11% in FY2015. However, given the growth and increase in long term contracts (highlighted by a growing
deferred revenue balance), this gross revenue churn reduction could prove temporary as larger cohorts
of up-market customers begin to be able to churn.
 
Relationship with AT&T
“And over time we were able to convince [AT&T] to not look at us as a mobile only solution, definitely
mobile first solution, that never went away, but not as a mobile only solution, but more of a full [up] you
know system replacement. And you know it took a few years to get there, but about two years ago they
expanded?-- you know they started offering our entire suite and sales went through the roof, which is
why they are now over 10% of our revenues.”
- CEO Vlad Shmunis (Goldman Sachs Technology & Internet Conference February 2015)
 
RNG began a relationship with AT&T in 2010, which was formalized in 2012 with a five year agreement.
In 2014, it was disclosed that AT&T accounted for 12% of RNG’s revenue. Given that AT&T was a less-
than-10% customer the year prior, AT&T boosted revenue growth by at least 300 bps. This has
continued in 2015 with “AT&T increas [ing] its share of… total revenue to over 12% even while
RingCentral as a whole grew at 35%."
The odd reality is that, by wholesaling RNG’s service, AT&T cedes to RNG parts of the customer
relationship and most of the revenues from the customer’s voice service, a somewhat unnatural act for
a telecom provider. RNG’s CEO has commented in meetings that “we manage the entire relationship,
from soup-to-nuts.” However, when calling to sign up for Office@Hand service we were told that to add
lines or cancel we would need to talk to an assigned AT&T Business representative. For service issues we
would contact RNG.
At AT&T’s analyst day in August 2015, they discussed Domain 2.0, their TDM-to-IP network
transformation whereby they were in-sourcing their provision of UCaaS and collapsing seven VoIP
providers down to one, which will be powered by BSFT as confirmed on BSFT's 3Q15 call. This suggests
that RNG’s Office@Hand by AT&T will no longer be emphasized once Domain 2.0 reaches commercial
 
launch around 2H16. AT&T commented in Q&A that the RNG relationship was “non-core, a specific thing
they do that really was brought on to help us sell mobile phones to small business, and you should
expect that we will not grow that platform.” A bear case would be that AT&T tries to port Office@Hand
customers to its BSFT-enabled solution once it launches. In any case, it seems safe to assume that there
will be little to no growth coming from AT&T once Domain 2.0 launches. Most estimates from AT&T
analysts peg this as a 2H16 rollout.
Bulls in RNG’s stock have suggested that their recent announced partnerships with TELUS and BT in 2014
will provide meaningful upside, which could come to fruition, but it took AT&T 4+ years to reach $25mm
in revenue and become a >10% customer, so the ramp will be relatively gradual and be less impactful
due to the current size of the company. BT and Telus are also in much smaller geographies than AT&T,
with considerably smaller TAMs. At some point, these carriers will also likely go through the decision
process AT&T went through to 1) in-source their VoIP business and 2) consolidate their various VoIP
offerings. Certainly, AT&T’s actions will force sell-side analysts and investors to scrutinize the value of all
of RNG’s wholesale relationships with carriers.
 
“As we move up market to larger customers and you can look at CIO, Director of IT, and you could say to
him that his employees are going to run on the same network, the same platform as AT&T's customers,
that changes the mind share a lot. And that's why we have so much success moving up market.” - CFO
Clyde Hosein (Bank of America Merrill Lynch Global Tech Conference June 2, 2015)
 
The relationship with AT&T helped RNG move up-market and created outsized growth in FY2014 and
FY2015. Since we know AT&T was below 10% of revenues in FY2013 and approximately 12% in FY2014
($25.3mm), we can calculate that AT&T revenues grew no less than 66% in FY2014 and boosted total
revenue growth by over 300 bps.
In FY2015, AT&T grew 46% to $37.0mm and boosted revenue growth by another 150 bps. Assuming
AT&T ramps down Office@Hand in anticipation of a 2H16 launch of Domain 2.0, we estimate FY2016
AT&T revenue will likely be $36.3mm when factoring in churn. If this were the case, to meet FY2016
revenue guidance of $357mm, subscription revenue ex AT&T would need to grow by 32% after 34%
growth in FY2015. More importantly, Office revenue (the growth segment) ex AT&T would need to grow
43% after slowing from 57% to 49% growth in FY2015. We are using the high end of guidance for this
analysis, but since this has been a beat and raise story since IPO and they have handily beat guidance
each quarter, we believe they must come in above the high end to sustain its valuation. Furthermore,
unless the Company is able to come in at the high end of their guidance, AT&T will likely dip below a
10% customer, which if disclosed would also scare investors and sell side analysts.
In a bear case where AT&T ports customers to their new Domain 2.0 offering, we see very little chance
of the company meeting guidance.
 
Valuation
Sell-side is very keen on comparing RNG to SaaS companies due to its high top line growth and recurring
revenue base. However, most SaaS businesses are providing business-critical services with a high degree
of reliability, with low churn and solid operating margins. RNG’s service scores poorly on these metrics.
Given RNG’s QoS issues – particularly in a service still considered mission-critical to most businesses --
we believe a SaaS multiple is not warranted. Moreover, it is far too soon to call RNG’s business model a
success, as better-capitalized competitors flock to the enterprise VoIP business. With limited barriers to
entry, RNG’s early market leadership is at risk. User economics seem to have been degraded in RNG’s
core SMB market and look even more challenged in the enterprise space, where a direct salesforce,
high-end customer service, and demonstrable QoS are prerequisites for success. Given that RNG
attributes their success in moving up-market to being able to leverage their relationship with AT&T and
piggyback off of that association, when AT&T launches their Domain 2.0 offering, new enterprise wins
may also slow.
Should AT&T’s business stop growing, RNG’s subscription revenue growth could slow to low 20s%. VG
has recently been purchasing VOIP providers that are growing organically in the teens at 1.3x revenue.
Assuming a more generous 2x multiple of our expected 2016 revenue for RNG of $347mm, we see
downside to below $11/share for the company’s shares. This would be generous as it is valuing the
$36.3mm AT&T revenue in FY2016 at the same multiple as the rest of the business, even though in the
long run that revenue is at great risk of being ported to AT&T’s Domain 2.0 platform.
 
Risks
Key risks to the thesis include:
- Secular growth outweighs increased competition and AT&T headwind, as industry is still in a “land
grab” phase
- TELUS/BT relationships ramp faster than AT&T historically, or additional carrier partnerships are
announced
- Slowing growth raises margins as subscriber acquisition costs are expensed in period, though we
believe the company’s growth is the reason for its valuation premium
- Takeout or merger with peer the company has only very limited network assets such as some
equipment at leased datacenters, thus its value consists of 1) its customer relationships and 2) its
technology platform. There are literally dozens of smaller, less expensive private companies that would
provide similar intellectual property and a technology platform, and the likely buyers of a VoIP platform
would have more scale at customer acquisition than RNG given 75% of new business is still SMB and
mostly generated via online paid SEO marketing
 
I do not hold a position with the issuer such as employment, directorship, or consultancy.
I and/or others I advise hold a material investment in the issuer's securities.

Catalyst

- Launch of AT&T's competitive offering and decline of revenue stream that currently represents >12%
total revenues
- Increased churn and competition
    sort by    

    Description


    Summary
    RNG is riding a secular shift in business telephony, as it moves from traditional on-premises private
    branch exchange (“PBX”) solutions to cloud-based solutions. RNG provides over-the-top (this is a critical
    point that we will discuss below) Voice over IP services bundled with proprietary software to provide
    Unified Communications as a Service (“UCaaS”) (messaging, conferencing, mobile, etc.) that especially
    caters to the increasingly mobile employee.
    Industry experts estimate only 10% of traditional PBX services have transitioned to VoIP for businesses.
    As on-premise equipment ages (life span of 7-10 years) and comes up for replacement, the existing
    installed base will increasingly move to UCaaS offerings, resulting in high top line growth estimates for
    the industry.
    The market has recognized this and awarded RNG a SaaS-like revenue multiple (3.5x 2016E sales)
    despite its lack of cash flow or net income. What it hasn’t recognized is:
    - the increasing competition in the space from better capitalized companies
    - the risk of increasing churn (the death knell for a telephony provider) as the company deemphasizes its
    core SMB customer to move up-market, exposing itself to customers who will be disappointed with
    RNG’s poor quality of service (“QoS”)
    - most importantly, the likelihood that its largest reseller (AT&T, who represents 12% of FY2014
    revenues) is discontinuing their joint offering (RingCentral Office@Hand from AT&T), calling into
    question the value of RNG’s carrier relationships.
    As the unit economics of their business deteriorate and growth slows due to the ending relationship
    with AT&T, investors will question why RNG should trade at such a healthy multiple of sales. We see
    downside to $11/share.
     
    Business Overview
    Businesses small and large are going through a change in the way they communicate, both internally
    and externally. The desktop phone is increasingly becoming less important as employees get
    comfortable with using messaging platforms to communicate and improve work flow and use their own
    mobile phones as their main telephony device. Traditional on-premises PBX providers like Avaya, Cisco,
    Mitel, ShoreTel, etc. are being replaced with VoIP offerings that do not require large upfront capex or
    expensive annual maintenance contracts. A recent Jefferies report estimated the savings of switching to
    VoIP telephony as up to 70% off of the monthly bill, with the most savings going to SMBs who lack the
    scale to make an on-premises PBX affordable.
    RNG began offering services, primarily basic inbound call routing and e-fax, but pivoted to UCaaS in
    2009. By the time of its IPO in September 2013, the Company was coming off sales growth of 57% and
    45% in the prior two fiscal years. Its core customer outlined in the S-1 was the SMB space.
    Today, RNG offers its flagship RingCentral Office which provides VoIP capability along with software for
    mobile integration, team messaging, conferencing, contact center solutions, and third party application
    integration all over the customer’s internet connection, or “over-the-top” (OTT). The three offering
    levels Standard, Business and Enterprise highlight a recent shift up-market away from its core SMB
    customer.
    Revenues are generated by monthly subscription rates per line under contracts that range from 1 to 36
    months. Until 2009, sales were driven by online advertising. The Company established a direct sales
    force in 2009 to sell its Office product. It also began establishing channel partners that now include
    2,500 agents and resellers, including carrier partners like AT&T and recent contracts with TELUS and BT.
    Sell-side research universally point to RNG’s carrier partnerships as a differentiated strategy and
    believes it will lead to outsized growth.
    Sales are predominantly in the US and Canada, with a small presence in the UK. The Company also has
    product revenues, though those are primarily to facilitate its service revenues. In 4Q15, they announced
    a distribution partnership with WestCon that will significantly reduce product revenues, making FY2016
    sell-side estimates look like they expect growth to slow materially, which isn’t the case.
     
    Competitive Landscape
    RNG is highly thought of by Gartner, though there are a myriad of competitors in the space (EGHT,
    SHOR’s cloud offering, VG’s business segment, and a host of private companies like Thinking Phones,
    Nextiva, etc.). (https://www.westuc.com/about/pr/press-releases/ucaas-gartner-magic-quadrant-
    names-west-leader)
    However, competition is increasingly fierce, especially in RNG’s core SMB market. We believe the reason
    RNG and EGHT have decided to move up-market is due to increased competition, making the lifetime
    value economics less appealing. At the Needham conference in January 2015, when asked why sales
    growth wasn’t faster if it was so appealing, EGHT CEO Vikram Verma said he “was not willing to invest to
    grow the SMB market in a material way” due to the expected lifetime value. EGHT’s CFO also has
    admitted in recent investor meetings that the economics don’t make much sense anymore in the SMB
    space. Recently, VG has decided to redeploy its free cash flow from its declining consumer business into
    multiple sizeable acquisitions in the UCaaS space, one of which was directed primarily at the SMB space
    (Vocalocity). Since then, VG has rebranded these acquisitions as Vonage for Business and is using its
    highly recognizable brand, leading domain authority (potentially resulting in lower customer acquisition
    costs) and its industry-low termination rates to take market share.
    As RNG moves up-market, it is running into a host of new competitors that it didn’t have to deal with
    before: carriers that are powered by Broadsoft (BSFT) or Cisco (CSCO) software and MSFT’s new Skype
    for Business. Carriers like AT&T, Verizon, CenturyLink, etc. have historically relied on BSFT or CSCO
    software to provide UCaaS functionality when selling to enterprise-grade customers. Recently, BSFT has
    discussed winning some large network transformation deals, whereby carriers are using them to migrate
    their legacy TDM networks to all IP-based networks. As enterprises look to switch to VoIP, BSFT is the
    arms dealer to the carriers to help them retain these customers.
    Another of VG’s purchases (Telesphere) is aimed up-market with a nationwide network of both
    backbone and 21 local Points of Presence (“PoPs”), enabling the company to more reliably ensure QoS.
    In comparison, RNG has two PoPs serving North America.
     
    Increased Churn Potential
    Whereas SMB customers are typically less concerned with QoS, enterprise grade customers are used to
    five 9s of uptime, which means that 99.999% of the time your phone is available (5 minutes of
    downtime a year). RNG is purposefully misleading in their IT Buyer’s Guide online by saying their
    datacenters have five 9s reliability (http://netstorage.ringcentral.com/guides/it_buyers_guide.pdf).
    Their datacenters may have that kind of uptime, but their service decidedly does not. As an OTT
     
     
     
    provider, they do not control the pipe providing the Internet connection to their customers. Thus, it is
    very difficult for them to ensure uptime of their service, hence the misdirection to a statistic that
    doesn’t matter. In fact, recent complaints on RNG’s Facebook page resulted from a large outage caused
    by a software update pushed out to Polycom phones where some users were without service for up to
    five days. Channel checks confirmed this was system-wide and resulted in one month’s credit to affected
    users. Since RNG only resells two phone systems (Cisco or Polycom), this was a widespread outage and
    could lead to increased churn going forward. Just glancing at Visitor Posts on
    www.facebook.com/ringcentral/ shows the QoS issues and less than stellar reviews of its Philippines
    based customer service. We even spotted customer accounts being referred to EGHT by other users on
    RNG's Facebook page.
    RNG has also been very cagey when disclosing churn relative to peers, especially as it has moved up-
    market. While mid-market churn should theoretically be lower than for SMBs (who have a higher rate of
    failure), the company provides zero information on account churn by customer (a basic and necessary
    metric for evaluating subscription-driven businesses) and discloses only its revenue-dollar retention rate
    of >99% each quarter. This includes increases in ARPU for up-sells to existing customers, thus masking
    true churn. It has recently disclosed gross revenue churn annually, improving from 14% in FY2014 to
    11% in FY2015. However, given the growth and increase in long term contracts (highlighted by a growing
    deferred revenue balance), this gross revenue churn reduction could prove temporary as larger cohorts
    of up-market customers begin to be able to churn.
     
    Relationship with AT&T
    “And over time we were able to convince [AT&T] to not look at us as a mobile only solution, definitely
    mobile first solution, that never went away, but not as a mobile only solution, but more of a full [up] you
    know system replacement. And you know it took a few years to get there, but about two years ago they
    expanded?-- you know they started offering our entire suite and sales went through the roof, which is
    why they are now over 10% of our revenues.”
    - CEO Vlad Shmunis (Goldman Sachs Technology & Internet Conference February 2015)
     
    RNG began a relationship with AT&T in 2010, which was formalized in 2012 with a five year agreement.
    In 2014, it was disclosed that AT&T accounted for 12% of RNG’s revenue. Given that AT&T was a less-
    than-10% customer the year prior, AT&T boosted revenue growth by at least 300 bps. This has
    continued in 2015 with “AT&T increas [ing] its share of… total revenue to over 12% even while
    RingCentral as a whole grew at 35%."
    The odd reality is that, by wholesaling RNG’s service, AT&T cedes to RNG parts of the customer
    relationship and most of the revenues from the customer’s voice service, a somewhat unnatural act for
    a telecom provider. RNG’s CEO has commented in meetings that “we manage the entire relationship,
    from soup-to-nuts.” However, when calling to sign up for Office@Hand service we were told that to add
    lines or cancel we would need to talk to an assigned AT&T Business representative. For service issues we
    would contact RNG.
    At AT&T’s analyst day in August 2015, they discussed Domain 2.0, their TDM-to-IP network
    transformation whereby they were in-sourcing their provision of UCaaS and collapsing seven VoIP
    providers down to one, which will be powered by BSFT as confirmed on BSFT's 3Q15 call. This suggests
    that RNG’s Office@Hand by AT&T will no longer be emphasized once Domain 2.0 reaches commercial
     
    launch around 2H16. AT&T commented in Q&A that the RNG relationship was “non-core, a specific thing
    they do that really was brought on to help us sell mobile phones to small business, and you should
    expect that we will not grow that platform.” A bear case would be that AT&T tries to port Office@Hand
    customers to its BSFT-enabled solution once it launches. In any case, it seems safe to assume that there
    will be little to no growth coming from AT&T once Domain 2.0 launches. Most estimates from AT&T
    analysts peg this as a 2H16 rollout.
    Bulls in RNG’s stock have suggested that their recent announced partnerships with TELUS and BT in 2014
    will provide meaningful upside, which could come to fruition, but it took AT&T 4+ years to reach $25mm
    in revenue and become a >10% customer, so the ramp will be relatively gradual and be less impactful
    due to the current size of the company. BT and Telus are also in much smaller geographies than AT&T,
    with considerably smaller TAMs. At some point, these carriers will also likely go through the decision
    process AT&T went through to 1) in-source their VoIP business and 2) consolidate their various VoIP
    offerings. Certainly, AT&T’s actions will force sell-side analysts and investors to scrutinize the value of all
    of RNG’s wholesale relationships with carriers.
     
    “As we move up market to larger customers and you can look at CIO, Director of IT, and you could say to
    him that his employees are going to run on the same network, the same platform as AT&T's customers,
    that changes the mind share a lot. And that's why we have so much success moving up market.” - CFO
    Clyde Hosein (Bank of America Merrill Lynch Global Tech Conference June 2, 2015)
     
    The relationship with AT&T helped RNG move up-market and created outsized growth in FY2014 and
    FY2015. Since we know AT&T was below 10% of revenues in FY2013 and approximately 12% in FY2014
    ($25.3mm), we can calculate that AT&T revenues grew no less than 66% in FY2014 and boosted total
    revenue growth by over 300 bps.
    In FY2015, AT&T grew 46% to $37.0mm and boosted revenue growth by another 150 bps. Assuming
    AT&T ramps down Office@Hand in anticipation of a 2H16 launch of Domain 2.0, we estimate FY2016
    AT&T revenue will likely be $36.3mm when factoring in churn. If this were the case, to meet FY2016
    revenue guidance of $357mm, subscription revenue ex AT&T would need to grow by 32% after 34%
    growth in FY2015. More importantly, Office revenue (the growth segment) ex AT&T would need to grow
    43% after slowing from 57% to 49% growth in FY2015. We are using the high end of guidance for this
    analysis, but since this has been a beat and raise story since IPO and they have handily beat guidance
    each quarter, we believe they must come in above the high end to sustain its valuation. Furthermore,
    unless the Company is able to come in at the high end of their guidance, AT&T will likely dip below a
    10% customer, which if disclosed would also scare investors and sell side analysts.
    In a bear case where AT&T ports customers to their new Domain 2.0 offering, we see very little chance
    of the company meeting guidance.
     
    Valuation
    Sell-side is very keen on comparing RNG to SaaS companies due to its high top line growth and recurring
    revenue base. However, most SaaS businesses are providing business-critical services with a high degree
    of reliability, with low churn and solid operating margins. RNG’s service scores poorly on these metrics.
    Given RNG’s QoS issues – particularly in a service still considered mission-critical to most businesses --
    we believe a SaaS multiple is not warranted. Moreover, it is far too soon to call RNG’s business model a
    success, as better-capitalized competitors flock to the enterprise VoIP business. With limited barriers to
    entry, RNG’s early market leadership is at risk. User economics seem to have been degraded in RNG’s
    core SMB market and look even more challenged in the enterprise space, where a direct salesforce,
    high-end customer service, and demonstrable QoS are prerequisites for success. Given that RNG
    attributes their success in moving up-market to being able to leverage their relationship with AT&T and
    piggyback off of that association, when AT&T launches their Domain 2.0 offering, new enterprise wins
    may also slow.
    Should AT&T’s business stop growing, RNG’s subscription revenue growth could slow to low 20s%. VG
    has recently been purchasing VOIP providers that are growing organically in the teens at 1.3x revenue.
    Assuming a more generous 2x multiple of our expected 2016 revenue for RNG of $347mm, we see
    downside to below $11/share for the company’s shares. This would be generous as it is valuing the
    $36.3mm AT&T revenue in FY2016 at the same multiple as the rest of the business, even though in the
    long run that revenue is at great risk of being ported to AT&T’s Domain 2.0 platform.
     
    Risks
    Key risks to the thesis include:
    - Secular growth outweighs increased competition and AT&T headwind, as industry is still in a “land
    grab” phase
    - TELUS/BT relationships ramp faster than AT&T historically, or additional carrier partnerships are
    announced
    - Slowing growth raises margins as subscriber acquisition costs are expensed in period, though we
    believe the company’s growth is the reason for its valuation premium
    - Takeout or merger with peer the company has only very limited network assets such as some
    equipment at leased datacenters, thus its value consists of 1) its customer relationships and 2) its
    technology platform. There are literally dozens of smaller, less expensive private companies that would
    provide similar intellectual property and a technology platform, and the likely buyers of a VoIP platform
    would have more scale at customer acquisition than RNG given 75% of new business is still SMB and
    mostly generated via online paid SEO marketing
     
    I do not hold a position with the issuer such as employment, directorship, or consultancy.
    I and/or others I advise hold a material investment in the issuer's securities.

    Catalyst

    - Launch of AT&T's competitive offering and decline of revenue stream that currently represents >12%
    total revenues
    - Increased churn and competition
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