Ring Central Investment Thesis
The short thesis, in short: the story is a delicate balance between revenue growth, FCF generation and debt management. Pressures are mounting on the cracks that could tip RNG's story out of balance.
Investment summary
Ring Central (RNG) is a $3.3bn market cap cloud communications platform that allows companies to communicate across branches by phone, video meetings, messaging, contact centres from 1 single platform.
Helped by supportive macro and the structural migration to cloud based services over the past 5 years, RNG has been able to keep revenue growth, FCF generation and debt management in balance.
However, I see upcoming pressures that would tip over this delicate balance, or Achilles heel. Growth is slowing by more than consensus forecasts appreciate; RNG “buys” growth by paying strategic partners upfront to sell its products, so slowing organic growth puts extra pressure on FCF generation to maintain growth guidance. The company excludes these upfront payments from its FCF definition so the pressure is masked, and thus not in consensus numbers. This matters because RNG has a material debt burden (both in absolute and relative to peers) with maturities in 2025 & 2026, and the upcoming cash strain is not fully appreciated.
The Industry
The global Communications market is worth $272bn (source: Synergy Research Group), and is expected to grow at a +20% CAGR to 2030 (source: Gartner). Traditionally, businesses have used on-premise hardware communications systems (Private Branch Exchanges, PBXs) that require specialist and expensive hardware at each business location. A structural tailwind is underway where corporations are adopting cloud based UCaaS solutions to replace the legacy PBXs as workforces are spread across multiple locations, devices and applications. There are 400m potential PBX seats to replace globally.
The UCaaS TAM is worth $32bn (source: Gartner) and is projected to grow at a +15% CAGR to $86bn by 2030 (source: Fortune Business Insights) . Cloud penetration is currently 12% (source: Global Market Insights) and market expectations are that this could reach 20% (source: Morgan Stanley Research) by 2030E with the secular tailwind of replacement.
The Company
RNG is a UCaaS provider with 7m seats, mostly in the US. RNG offers businesses a single communications platform with messaging, conferencing, call and contact centre (CCaaS) features. RNG also offers a large ecosystem of third party applications (eg. Google Drive, Dropbox, Salesforce, Teams) that can seamlessly be integrated onto the platform.
90% revenues are from North America, and RNG is focused on international expansion particularly in Western Europe where cloud penetration rates are relatively immature compared to the US.
RNG generates 95% revenues from subscriptions at prices varying by specific functionalities, services and number of users. The remaining 5% revenues relates to hardware product sales such as desk phones.
Key KPIs:
Annualised Recurring Revenues (ARR) – a leading indicator of RNG’s anticipated subscriptions revenues, and a function of ASP and seats. ARR was $2.3bn in Q4 2023, and growth has slowed from 32%+ y/y over 2019-2021 to 11% in 2023. This is due to commoditisation dampening pricing power, Covid pull forward effects and a challenging macroeconomic backdrop whereby many companies are focused on cost optimisation (e.g. sticking to existing systems) &/or survival (in the case of SMBs).
Net retention rate – measures RNG’s ability retain and grow subscriptions revenue. The annual retention rate has remained stable at ~91%.
The largest cost is sales & marketing spend on acquiring and retaining customers, at 40% sales (peer group average: 37% sales). Marketing spend includes direct and indirect (resellers, distributors and strategic partners) channels. Strategic partners include Mitel, Amazon, Avaya and Atos. These partners provide access to large installed bases, and over half of the globally available seats:
Overall the traction to date on converting these partnership-installed bases to contracts has been underwhelming; just 10% of RNG’s seats are from strategic partners. This suggests 1) a slow pace of cloud migration and 2) intensifying competition for an increasingly commoditised service.
Competitive landscape
RNG competes with core cloud companies such as 8x8, Nextiva, Twilio, Vonage, and Zoom. Major tech companies such as Microsoft (Teams), Google (Google Suite), Salesforce (Slack) and Cisco are also competitors in that they have large installed bases and are developing competing UCaaS and CCaaS solutions.
RNG primarily competes on product features and pricing although as the UCaaS market matures, there is an increasing degree of commoditisation which has put downward pressure on average selling price (ASP). RNG’s monthly ASP has declined from $37 in 2018 to $22 in 2023, and I expect this to trend lower towards the price points from competitors (Eg. Zoom and Microsoft Teams).
RNG also competes on incumbency where prospective customers must be persuaded to take on the switching cost of migrating to a cloud solution away from a legacy PBX. This can be costly to the customer and can involve significant down time for larger, complex organisations. Microsoft Teams benefits from Microsoft’s 330m installed base and a better distribution which supports a low friction cross-sell motion, which is likely a competitive challenge to RNG in the medium and long term.
Investment Thesis
Growth is slowing more than consensus appreciates…
RNG has been a topline growth story - with 30%+ growth from 2018-2021, 25% in 2022, and 10% in 2023. Management has guided for +8% in 2024 and consensus forecasts optimistically extrapolate that this can be sustained out into the medium term.
Inflation and higher interest rates have caused uncertainty for businesses which has elongated sales cycles for RNG. Management has flagged more cautious buying behaviour from larger customers leading to smaller deployments. Many corporates are focused on cost cutting so are likely to be less open to upgrading systems, which limits RNG’s upselling opportunities within the existing installed base in the short to medium term. Corporates have materially reduced workforce sizes amidst cost cutting measures which reduces the number of seats per contract for the near to medium term for RNG, contributing to slower subscription revenue growth. I therefore expect companies to continue to delay/ downsize deals with RNG for at least the next year.
RNG is 40% exposed to SMB clients, which makes it vulnerable to cyclicality. The chart below shows that SMB optimism is at the March 2020 Covid lows which likely translates into halted decisions to take on cloud migration projects and upgrading existing systems:
I expect revenue to decelerate from 10% y/y growth in 2023 to LSD-MSD% over the next 2 years.
Management need to provide incremental proof points that RNG can re-accelerate the business as macro headwinds ease, in order to restore conviction in RNG’s longer term structural prospects in a highly competitive market.
… Leading to FCF pressures
RNG interestingly uses prepaid commissions costs to “BUY” growth. These are upfront costs to partners to sell the RNG solution. Given the above headwinds to organic growth, there is increasing pressure to buy growth especially as the market expects RNG to be a topline story. This means RNG will need to pay up more in these prepaid commission costs.
This can already be seen in the numbers; prepaid days have increased from 20 to 30 days over the last 2 quarters. I model prepaid days steadily increasing to reflect the buying pressure but consensus forecasts miss the changing cash cycle dynamic.
Conveniently, RNG’s FCF definition excludes prepaid commission costs so it seems as though FCF is growing, and masks that true FCF is insufficient to repay debt..
Mounting debt burden
RNG has an extremely high debt burden worth 48% market cap gross, is 3x levered versus the average 0.5x for SaaS companies, and this debt is junk rated. And, material components are maturing in March 2025 and 2026.
RNG now has $200m left of cash. In March 2025, it will need to repay/ refinance $161m. RNG needs to at least reach the top end of 2024 guidance to service the upcoming dues. However this then leaves little FCF to “buy” growth via prepaid commissions costs and therefore fuel revenue growth.
I think the outcome is likely to be that RNG issues more debt, at a higher cost of capital which would leave the balance sheet even more stretched than its current state. Yes, interest rates are likely to be cut this year but RNG’s borrowing rate will most certainly increase materially with new debt issuance. I don’t believe consensus estimates sufficiently reflect the upcoming cash strain.
Illustratively, RNG issued 8.5% coupon debt last August to pay off 0% coupon debt, and the market was taken by surprise causing a -24% sell off. This to me is a poor but forced capital deicision.
Management
RNG has seen 2 CEOs, 2 CFOs, 2 CTOs and 3 COOs all in just 7 years. Surely this is a distraction from a focused strategy.
Since its inception, RNG’s founder Vlad Shmunis has held the CEO and Chairman positions. This in itself a red flag for corporate governance as there is no independent oversight and challenge of management. Under Shmunis’ leadership, RNG was allowed to grow top line with a growing GAAP loss for 24 years and the share price has fallen from peak to trough by 95%.
A new CEO, Tarek Robbiati, was appointed last August even though he had never worked in the software industry before. Robbiati was described as a “turnaround specialist” by Sprint’s Marcello Claure as he was instrumental in Sprint’s merger with T Mobile. His previous roles at other companies have focused on improving financial health to prime the company for a PE sale.
Concerningly, Shmunis returned as CEO again (whilst still also being Chairman) in December 2023 which to me indicates that he disagreed with Robbiati’s turnaround plans and so used his Chairman position to remove him. This then reduces the probability of RNG becoming a PE takeout target.
I also raise a red flag over management compensation. The Bonus Plan includes a criterion of “achieving quarterly revenues at least equal to consensus estimates after public disclosure of guidance”. As above, RNG can “buy” growth and they have a history of beating and raising guidance. This combination close to guarantees the bonus condition will be met.
Overall, the catalysts for this thesis are any combination or one of the following:
Debt issuance, at a more expensive cost of capital
Weak revenue performance in 2024 quarterly results leading to a profit warning
Consensus forecasts for topline growth are cut to reflect a slower growth environment.
Risks
This thesis would be broken if:
Businesses resume IT infrastructure investment sooner than expected, which would accelerate the slowing cloud migration trend.
But - macro data points and surveys show that business sentiment is still cautious and that companies intend to focus on margin protection for at least the short to medium term.
RNG was taken out by a larger player such as Microsoft or Cisco.
But - RNG carries disproportionately high levels of debt, which in my view makes it unattractive as a takeout candidate.
Valuation
RNG currently trades at 1.8x EV / Sales and 7.3x EV / EBITDA (where I use non-GAAP given the negative GAAP figures). The table below sets out a UCaaS peer comparison:
I view EV / Sales as the most relevant metric because each company has a differing level of SBC as a % sales which materially impacts EBITDA, and non-GAAP EBITDA is negative.
Whilst RNG appears to trade just below the group average, I believe the most comparable company is 8x8 given the overlap in markets, geographies, growth rates and margin profiles. RNG is a larger player than 8x8, however 8x8 has greater and more advanced exposure to the nascent, higher growth CCaaS market. I therefore believe that RNG should be valued at a lower premium than the 100% on EV / Sales currently. Assuming the fair multiple of RNG is 1.3x as a base case (at a 40% premium to 8x8), this implies -35% downside. I flex this premium assumption below:
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