BroadSoft (BSFT) stock has corrected nearly 50% since reporting its fourth quarter where it gave much lower guidance for Q1'13 and full year 2013. BSFT has suffered a couple, similar quarterly sell offs over the past few years due to its heavy exposure to carriers lumpy ordering patterns. The prior two times the stock was in the low 20s (i.e. July/August 2011 and May 2012) following weak outlooks the stock bounced back to near the $40 level within only a few months. Exacerbating the downward move this quarter was the run up in the stock due to Oracle's (ORCL) acquisition of Acme Packet (APKT) and general optimism related to carrier capex recovery in 2013. BSFT surprised most analysts by labeling 2013 as a "transition year" that will see them accelerate S&M and R&D spend in excess of revenue growth that is being depressed by timing issues in services and transition to VoLTE on the consumer side.
After the correction, BSFT is now an extremely attractive investment with limited downside as it has de-risked numbers for the entire year and trades at trough levels. Catalysts are continued strong growth in unified communications (UC), VOLTE investment cycle by carriers, margin expansion in 2014, and a possible buyback. While never a reason to invest on a standalone basis, at current levels BSFT is extremely attractive to acquirers especially given the consolidating nature of the sector. My upside price target is $40 based on 20x 2014 eps $2.00 representing nearly 50% upside from current levels. Downside risk is 10% to $20 based on 2.5x EV to revenue, under 8x EV to maintenance/subscription revenue and 16x '13 p/e.
The principal cause of the weak 2014 guidance is the slowdown in revenue growth while expense growth accelerates. The two core areas of revenue weakness are consumer and professional services declines. Consumer decline y/y is a pause ahead of a big VoLTE spend by carriers in 2014 and beyond where this segment should show accelerating trends. Professional services weakness is primarily due to timing and
revenue recognition as significantly less revenue comes off the balance sheet. On the expense side, subscription and maintenance margins will decline 4-5 points because of a continued investment in their BroadCloud hosted offering. Professional services margins will be particularly depressed, down high single digits, due to a ramp in head count in anticipation of "several projects that will become revenue in 2014 and lower revenue." It is particularly bullish that in the face of weak professional services revenue that the conservative management team is ramping its head count for the group. In addition, R&D and S&M growth will exceed revenues as they expand the salesforce and go to market efforts. Bottom line, these drags on revenue are temporary, semantic, and opportunistic. Meanwhile margins are being depressed by actions designed to fuel growth in the very near future, i.e. 2014.
VoLTE is a major phenomenon that carriers are embracing in order to: free up much needed capacity, reduce latency, reduce transmission costs, and ultimately allow a move to a single architecture. It's a question of when not if the carriers move ahead with VoLTE. Verizon announced that consumer trials will begin in late 2013 with commercial service in 2014. Verizon (VZ) initially planned on a late 2012/early 2013 rollout but likely because of network issues the rollout was pushed out. AT&T (T) and Sprint (S) are planning deployment sometime in late 2013 or early 2014 while T Mobile and Metro PCS are waiting for their merger to be complete before rolling out VoLTE. Note Metro PCS was the first carrier to roll out LTE in the US and the first to launch a VoLTE handset in August 2012. Their efforts have likely been delayed due to the pending merger with T Mobile but once finalized I would expect them to be aggressive in this area. Japanese, South Korean, and Hong Kong carriers also plan to rollout VoLTE in the 2014 timeframe. The general consensus from Mobile World Congress according to carriers was 2014 would be the inflection point for VoLTE. As such, BSFT appears to be gearing up for the windfall in 2014. In addition to the VoLTE spending push out, their two largest consumer wireline customers Verizon and France Telecom plan to reduce their residential VOIP spend in 2013. BroadSoft predicted consumer falling to 10% of total revenue in 2013 vs. its typical range of 10-15%. 2014 and 2015 should see a sharp acceleration in consumer spending to 15%-20%.
Largely ignored in the wake of the weak 2013 guidance and precipitous stock selloff is the consistently impressive performance of the core enterprise communications application server business that represents 80% plus of the overall business. The two core enterprise segments are SIP trunking and hosted PBX/hosted Unified Communications. The 5 year projected growth rate for this segment is 20% annual growth. Unified Communications benefits are manifold but include one mailbox for a user's business and personal voicemail or one phone number for mobile and landline phones. Unified communications is clearly a focus area for major technology companies as seen with major M&A moves such as: Microsoft (MSFT) (Skype and Lync), Cisco (CSCO) (Webex and Jabber), and Oracle (Acme Packet). The one negative this year for the enterprise segment is the large project win talked about on their Q3 call will likely not be recognized in 2013 as previously disclosed, rather first half of 2014. Nonetheless the core segment of the company appears to be executing on all cylinders.
BSFT currently trades like a broken, ex-growth software company at 3.0x and 2.6x EV to '12 and '13 revenue, respectively. On a p/e basis, stock trades at 14.6x trailing earnings and 17x 2013 earnings that assume expanding expenses and artificially depressed revenue in professional services and consumer before snapping back in 2014. When giving 2013 guidance, BSFT management was clear to be overly conservative by assuming no contribution from long term deferred revenue (i.e. $10 million large contract announced in Q3 and modeled by Street for 2013), services falling 20% y/y, and no revenue contribution from VoLTE. The yearly numbers have clearly been de-risked and the bias is to the upside. BSFT has a reputation for being overly conservative in the face of uncertainty. Carriers are unpredictable creatures when it comes to predicting timing of capex especially when faced with architectural transitions. BSFT took its medicine and de risked 2013 numbers in every possible facet in one fatal swoop. 2014 looks to be a big year for BSFT where earnings likely come in at $2.00 + as one time expenses recede and consumer and professional services bounce back. My price target of $40 assumes 20x this conservative 2014 eps estimate and assumes no buyback.
Given the drubbing of BSFT's stock, it would not be surprising for an acquirer to follow Oracle's lead in acquiring APKT and scoop up BSFT. At a very manageable enterprise value of just under $500 million, BSFT would be an ideal acquisition that would bring a company a bonafide unified communications solution consistently growing 20% plus a VoLTE solution ahead of carriers splurge starting in 2014. Possible acquirers in addition to ones already making a splash in UC are IBM, SAP, or JNPR just to name a few. BSFT has net cash of $107 million or $3.77 per share. Management was recently given a share grant that will cover the next two years. I wouldn't be surprised if management props the stock up from here with a buyback.