2. The Economy
As of December 14, 2015, The S&P and DJIA YTD are down 7.67% and 1.67%,
respectively. The 3-month for both the S&P and DJIA are 4.63% and 7.05%, respectively. Since
these indices give a wide representation of current market conditions (especially the S&P), it is
certainly a difficult time to invest given the volatility. Its becoming increasingly important to
conduct due diligence and find undervalued securities. According the Morningstar, the market is
fairly valued to overvalued. Further, Morningstar estimates GDP to be stuck at roughly 2-2.5%
growth for the year. The U.S. economy is experiencing a slow down in manufacturing as well as
a slow housing recovery. There is an increase in M&As and buybacks amongst companies, not
capital investment, which is reducing the overall growth prospect. Inflation is expected to be
higher in 2015 (1.8%) than 2014 (1.2%).
Unemployment is expected to drop to 5%, however the Labor Force Participation Rate
(LFPR) is falling in addition to retiring baby boomers, perhaps creating a misleading
unemployment figure. With an expectation of a 5-6% increase in the housing sector for 2015,
demand is better, yet supply is lacking. Home sales in 2014 were down 3.9% and are expected to
increase 8.2% in 2015. Industrial production in the U.S. increased 4.5% in 2014 and is estimated
to only increase 3% in 2015. These economic drivers, among many more, are keeping the 2015
estimated GDP growth at 2-2.5%.1
Technology Sector
The market cap for the tech sector is roughly $4.7 trillion dollars, with almost $1.5 trillion in
revenue. Morningstar views the sector as overvalued by 5%, which is a sign to be selective. In
relation to RingCentral, improving sales and marketing for SaaS (Software-as-a-Service)
companies will drive operating leverage. As a matter of fact, expenditure on cloud applications is
expected to grow 20% annually, and reach $62 billion by 2019. Close to half of this will be for
the CRM management segment. For SaaS firms, the cost of maintaining customers are usually
cheaper than acquiring them. SaaS companies may be able to bring sales and marketing costs
below 25% of sales. R&D costs for cloud applications are high, which obviously reduces cash
flow and potential profitability, but spending in R&D will decrease once the products develop
and full functionality is realized. Further, SaaS providers with high switching costs are unlikely
to be affected by price competition, and pricing is expected to increase. On-site software firms
have had the power to increase pricing for maintenance and support services, and cloud
application pricing is expected to have a similar path.2
1
Morningstar 2015 Q3 Industry Report
2
Morningstar 2015 Q3 Technology Sector Report.
3. Software Industry3
Industry Revenues
Cloud computing is the most important theme impacting the software business. Since 2010
the industry’s revenues per share have slowly increased, which reflects the global economic
recovery. S&P Capital IQ expects this to continue in the future. Revenues per share grew 47% in
2014 and a gain of 11% is estimated for 2015, and the compounded annual growth rate is 10%
from 2010 to 2015. One thing to note is that the 11% estimate may be overly optimistic, with
concerns over the economy and the strong dollar. Commercial software revenues fell in Europe,
the Middle East, Africa, and the Asian pacific region in 2013. S&P Capital IQ sees recovery in
those areas, with growth in 2015 (even with currency weakness against the USD). The
international Data Corporation (IDC) predicts by 2018, cloud software is expected to account for
$1 of every $5 spent on software; up from $.55 for every $5 in 2013.
Industry Margins
Each year since 2010 average gross margins for the industry have decreased from 75.2% in
2010 to 71.4% in 2014. S&P Capital IQ believes this is due to increased competition and pricing
pressures, as well as the costs of revenue associated with the shifts to cloud based models. Cloud
software is more straightforward than traditional enterprise software. Further, it is more cost
effective for customers, as it allows them to pay on the number of users and type amount/type of
usage of the product or service. Also, prices are generally lower for cloud software.
For providers, cloud based models require more related costs than traditional enterprise
software. This includes an increased technological build out for continuous support, growing
access, functionality, and storage. EBITDA and EBIT margins have not widened since 2011, and
the trend has lowered in 2015, as perhaps companies are looking for ways to expand.
Industry Earnings
The industry’s net income per share has tripled from 2009 to 2012. There was a sharp
double-digit decline in 2013 at around 36%, and a healthy rebound of around 46% in 2014.
Industry Balance Sheet
Software companies are often profitable and generate sizeable cash flows. The software
industry’s cash and short-term investments per share more than tripled between 2009 and 2014.
S&P Capital IQ believes this is due to continued revenue growth and healthy margins. On the
other hand, total debt per share has also increased, but a lot less than cash and short-term
investments. The increase in debt may be due to greater confidence on macro and micro
economic conditions along with low global interest rates, and the desire to be more flexible, as
companies are holding more in cash and investments overseas.
3
S&P Capital IQ Software Industry Surveys July 2015
4. Industry Valuation
From January 2009 to April 2015, the S&P 500 Software Index rose 155% compared to a
124% gain in the S&P 500 during the same timeframe. The software index outperformed through
most of this time period.
Capital Markets
The leading M&A in the industry occurred between Permira Advisors and the Canada
Pension Plan Investment Board who declared plans to acquire Informatica for $5.3 billion on
April 6, 2015. In 2014, the number of M&As within the S&P 1500 rose by 203 in 2014, up from
191 in 2013. The completion rate of M&As rose 89.2% in 2014 as opposed to 85.9% in 2013.
Industry Trends
Software is one of the most competitive industries, however technology changes have
allowed newcomers to emerge and become significant competitors. The companies with the most
revenues are Microsoft, IBM, Oracle, and SAP, which collectively account for three quarters of
the industry’s revenues. What’s worth noting though is that IBM and SAP are not in the S&P
1500 software industry, and the international data corporation (IDC) estimated that the
companies previously mentioned accounted for 39% of the worldwide commercial revenues in
2013. Overall, the industry can be views as having a healthy level of competition.
For new entrants, it can take time to gain traction as it may be easy to raise capital early on,
but gaining clients and ultimately revenues and profits can take longer. On one hand, substitution
in the industry can be a hassle for consumers as systems, process, platforms, applications, and
content are built atop one another, operating under certain software. Thereby, switching to
different providers can come with many problems. On the other hand, cloud applications are
more appealing to consumers, as they can be deployed quickly and cost effectively. Obviously
the risks with cloud-based services are reliability, security, and more. Over time, S&P Capital IQ
sees more substitution to third party cloud software.
RingCentral, Inc. (RNG)4
Overview
RingCentral (RNG) was founded in 1999, and its IPO was in September 2013. RNG is a
provider of SaaS (Software-as-a-Service). More specifically, they provide solutions for employee
communication in business. The company’s cloud based approach disrupts traditional methods,
as it provides flexible and cost effective services that help support widely spread workforces,
mobile employees, and “bring your own” communication devices.
The company is integrating all ways employees can communicate; voice calls, text
messaging, audio/video web conferencing and more with a simple SaaS platform built from
scratch. RNG is developing application programming interfaces (APIs) to integrate into their
cloud platform. APIs are a set of routines, protocols, and tools for building software applications.
4
RingCentral Annual 10-K form post date 2/27/2015
5. The API integration will reduce implementation time and total cost of ownership for customers.
In addition to lowering costs, this could improve employee productivity by allowing businesses
to tie together all of their locations and mobile employees under an umbrella of a single, simple
cloud based system.
RNG subscriptions do not require significant investment in physical set-up at customer
locations. Services are delivered to customers using existing broadband connections via a RNG’s
proprietary infrastructure that reduces time and cost to purchase, activate, and begin using.
Products
RNG currently offers three products, RingCentral Office, RingCentral Professional, and
RingCentral Fax. Ring Central Office is the most popular product, which come in 3 editions;
standard, premium, and enterprise. Standard edition includes call management, mobile
applications, voice, business SMS, business analytics and reporting, audio, video, and web
conferencing capabilities, and integration with other cloud based applications such as Box,
Dropbox, Google, Microsoft Office, etc. The premium and enterprise editions include all
functionality from standard, together with integration into other cloud based business software
such as Saleforce CRM, Zendesk, and Desk.com, high definition voice, and more.
RNG generates revenue by selling subscriptions to their services. The company focuses on
retaining customers and increasing customer spending through additional users, upselling
products, and providing additional features and functionality. RNG markets and sells through
their website and inside sales teams, as well as over 2,200 sales agents and resellers, such as
AT&T. RNG has also signed agreements with TELUS in Canada and British Telecom in the UK
as resellers. RNG’s customer base includes multiple industries from finance to healthcare, and
many more. Key benefits of the RNG’s solutions include location independence, device
independence, instant activation (easy account management), scalability, lower cost of
ownership, and seamless integration with other cloud based applications.
R&D
R&D is critical to RNG, with a majority of R&D resources going to software development.
The engineering team has experience in disciplines involving voice, text, audio, video and fax
processing, mobile application development, IP networking and infrastructure, user experience,
security, and multi-level cloud based system architecture. R&D spending has risen in the last 3
years; $25.4, $33.4, and $44.6 Million in 2012, 2013, and 2014, respectively.
Intellectual Property
The company has 54 issued U.S. patents that expire between 2026 and 2033. 52 additional
patent applications are pending for review in the U.S. RNG also holds 22 patent applications
waiting for review in foreign jurisdictions, all related to U.S. applications.
Competition
Given that the software industry is largely competitive, competition is expected to increase
in the future. The market for business communications services is rapidly changing, complex,
6. and defined by changing technology and changing consumer needs. Completive factors for the
market include:
• Subscription features and capabilities
• System reliability and performance
• Ownership/control of technology
• Mobile integration
• Brand awareness
• Price model simplicity
• Cost of ownership
Competitors to RNG include:
• Hardware business communications providers (Cisco, Siemens Enterprise
Networks, etc.)
• Software providers that license software presently on the cloud, or may do so in the
future (Microsoft, Broadsoft)
• Communications providers (AT&T, Verizon, Comcast)
• Other cloud companies (Vonage, Nextiva)
• Large internet companies that could launch their own cloud based business
communications services, or acquire cloud based businesses (Google, Yahoo,
Amazon)
Risk Factors
Sustainability is a risk factor for RNG, as the company has incurred significant losses and
negative cash flows in the past and may in the future. Also, its limited history as a publicly
traded company makes it difficult to evaluate current business and future forecasting. Other risk
factors include, but are not limited to:
• To deliver subscriptions to customers, RNG relies on third parties for network
connectivity and (for certain features in the subscriptions) co-location facilities.
• Interruptions and/or delays in service from the third party data center and co-
locations facilities could impair connectivity to subscriptions and ultimately harm
business.
• Many customers can terminate subscriptions at any time without penalty. This
could lead to increased customer turnover and costs provided to retain customers
(i.e. marketing, sales cost).
• Most revenue comes from small to medium sized companies, which may increase
loss in an economic downturn.
• A security breach is a key risk, and a possibly destructive scenario for RNG and its
reputation.
• Possible inability to protect IP rights
• RNG relies heavily on a network of resellers to push subscriptions; failure to
develop and maintain their indirect sales method could negatively affect revenues.
7. Fundamentals
RNG has only been a publicly traded company since September 2013, therefore it is a
highly speculative stock with a vast potential for growth. It’s a small cap company with a market
cap of $1.8 billion, no beta, or price/earnings ratio. Being a newly publicly traded company,
RNG understandably does not offer any dividends. Looking at its 3 month chart below,
Courtesy of Morningstar Research
Courtesy of Yahoo Finance
8. the stock has had an impressive 30% return in the past 3 months. Looking at a consolidated
income statement, balance sheet, and cash flow below:
RNG has grown revenues significantly since 2012, however operating income and net
income has grown further into the red. In looking at the consolidated balance sheet, its current
and total assets have increased greatly, at a higher rate than its current and total liabilities (ratio
analysis further down), so its liquidity looks under control. Its good to see that RNG’s
operational cash flow is moving closer to positive figures. Its capital expenditures have validly
risen negative as perhaps due to the increased expenditure on R&D each year. In terms of total
cash flow, it’s not great to be in a negative position, but it is reasonable with a fairly young
public company. It’s good to see that cash flow has moved toward positive figures the past year.
Courtesy of Morningstar Research
10. Market Value:
TTM 2014 2013 2012
P/E - - - -
Forward P/E 303.0
M/B 16.9 10.2 -45.2
In addressing RNG’s liquidity, the company has a healthy current ratio with current
assets more than double current liabilities the past three fiscal years. RNG has decent asset
management ratios, and although A/R turnover has decreased the last few fiscal years, it is still a
suitable figure, as the company may be efficient in collecting accounts. It would be worth
monitoring this ratio to see if it decreases further in the future, which may indicate a problem.
RNG’s fixed asset turnover has increased for the last three fiscal years, which is a good sign that
fixed asset investments are being put to good use in generating revenue. RNG’s total asset
turnover is a reasonable figure, and should be monitored to be sure it stays above 1.0. Although
total asset turnover has decreased since 2012, RNG has greatly increased its assets in comparison
to its revenues, so its acceptable.
Looking at RNG’s debt management ratios, its debt to equity has decreased since 2013,
with 16% for the trailing twelve months, meaning RNG is shying away from financing its growth
with debt. RNG’s TIE ratio is discerning due to the fact that the company does not have enough
money to pay off its current debt, which can a major problem moving forward. It’s important to
monitor this figure to see if it lowers in the future. Given that the company has not made any
money yet, its understandable that the company’s profitability ratios are negative. It’s a good
sign that the ratios have drastically reduced since 2012, meaning that the company may reach the
green in the medium term.
Being a fledgling public company, and not turning a profit yet, RNG does not have any
reported P/E values in its existence. What’s astounding is the forward P/E ratio of 303 times
earnings. Obviously earnings are estimated, but it shows the potential growth for the company,
even though a figure like this is not sustainable.
Intrinsic Value
I attempted to calculate the intrinsic value for RNG via discounted cash flow (DCF) method,
however it proved to be more difficult than imagined and unfortunately beyond my skillset at
this point. Even calculating the cost of capital proved to be challenging due to an unknown tax
rate, along with no beta, and other factors. With my assumptions, I was able to calculate a
WACC of 13.66%, which I believe should be higher, given speculative nature of the company.
11. Current News6
Oppenheimer raised its price target on RNG from $25 to $29 early in the morning on
12/16/2015. The firm echoed its previous “outperform” rating on RNG as well. Oppenheimer
believes RNG is the leader in the quickly growing Private Branch Exchange (PBX) hosting, or in
other words, the private telephone enterprise network segment of business communications.
Investment Decision
For the risk loving investors, I would recommend RingCentral as a buy. As mentioned
before, the company is a speculative growth stock that has not turned a profit yet since its IPO in
September 2013, so one should be in the aggressive stage of their investment years. The founder
and current CEO of the company, Vlad Shmunis, has built a strong and loyal management team
behind the company, and I believe RNG is moving in the right direction in terms of growth
potential and eventually a profit. The key objective with RNG is to keep monitoring its ratios and
cash flows to see further improvement in operations. The cloud based application market is
growing exponentially, and I believe RNG has the potential to capitalize on cloud integration
into business communication, and become a leader in that segment. Otherwise, the company
would also be a great takeover target for larger firms such as Cisco, Comcast, and even Amazon,
due to the proprietary nature of RNG’s business model, and ultimately offer shareholders a
shorter-term gain from a buyout.
6
http://www.thestreet.com/story/13399521/1/ringcentral-rng-stock-price-target-raised-at-
oppenheimer.html?puc=yahoo&cm_ven=YAHOO
