IPO: Synchronoss Technologies Should Continue to Grow (SNCR)

On June 11, I wrote an analysis of Synchronoss Technologies (SNCR), which closed at $8.60 on June 26. The text of my original writeup follows:

Synchronoss Technologies (SNCR) plans on offering 8.75 million shares assuming over-allotment is exercised. The price range is $9- $11 and 1.25 million shares are being offered by insiders. Goldman Sachs and Deutsche Bank are lead managing the offering. Post- offering SNCR will have 25.3 million shares outstanding for a market cap at $10 of $253 million. IPO proceeds will be used for working capital and general corporate purposes.

From the prospectus:

“We are a leading provider of e-commerce transaction management solutions to the communications services marketplace based on our penetration into key providers of communications services.”

I always reprint the lead sentence in the prospectus as usually it is a succinct overview of the business. This one doesn't really clear anything up though! SNCR is essentially a back- office communications software company. Their customers are the large communications providers and SNCR's platforms allow communications service providers to take, manage and provision orders and other customer-oriented transactions. SNCR is an e-commerce software company servicing the communications industry, specifically wireless and VoIP.

Growth focus is wireless and VoIP communications companies. Current customers include most of the large communications providers: Cingular Wireless, Vonage Holdings, Cablevision Systems, Level 3 Communications, Verizon Business, Clearwire, 360 networks, Time Warner Cable, Comcast and AT&T. Note that while the customer base is wide, Cingular accounts for the bulk of SNCR's revenues. Cingular has accounted for approximately 75% of SNCR's revenue the previous 15 months.

Cingular, Vonage, and Cablevision accounted for roughly 95% of revenues the past 15 months.

Thus far the bulk of SNCR's business has been selling the software platforms that allow Cingular wireless to quickly automate new customer internet orders into new customer activations. SNCR generates revenues from fees on each transaction that utilizes their software platforms.

SNCR is attempting to expand their services to include automated transaction processing through increasing on-demand avenues including bundled services, VoIP etc.... Over the past few years, communications providers have shifted customer interaction more and more to internet 'on-demand'. More and more customers are shopping for services, shifting services and signing up for services without speaking to an actual customer service person. SNCR is attempting to set themselves up for this shift by becoming the standard new customer activation back office software platform. Instead of a customer service person taking and activating new customers, SNCR's software automates the process.

SNCR's revenue driver product line is called 'ActivationNow.' As with most software platforms of this kind it is scalable allowing quick efficient automatic handling of a large volume of data. SNCR's selling point with ActivationNow appear to be its 'exception handling' component. It has the ability to handle automated transaction with incomplete data, “Our solution identifies, corrects and processes non-automated transactions and exceptions in real-time. Importantly, as exception handling matures within a service, an increasing number of transactions can become automated, which can result in increased operating leverage for our business.”

A few features ActivationNow automates for communications providers are: 1)New account setup and activations-- including credit checks, address validation and equipment availability, 2) Feature requests-- adding new functionality to existing services, 3) Contract renewals-- for consumers and enterprises, 4) Number port requests-- local number portability, 5) Customer migration-- between technologies and networks, 6) Equipment orders-- wireless handsets, accessories, etc...

Currently SNCR's main competition is the internally developed systems at various communications providers. Thus far SNCR has been able to penetrate substantially only Cingular and Vonage. While most communications providers have utilized SNCR's software in small measure, they've continued to rely on their own internally developed systems and software to automate new customer on-demand orders. Whether SNCR becomes a successful public company depends on their ability to 'sell-in' their product as a full replacement over internally developed systems. While they've been able to gain a foothold with many providers, thus far SNCR has not been able to accomplish this outside of Cingular and more recently Vonage.

SNCR currently processes hundreds of thousands of wireless transactions every month and has grown their VoIP transaction base monthly for the past year. SNCR sees VoIP as being a future revenue driver, specifically automating Vonage transactions.

Contracts are typically 12 to 48 months in length. SNCR's systems integrate with the communications provider's own networks. This means that when SNCR is able to sell in to a new provider, there is a very good chance of a long lasting relationship.

Financials

$3 a share in cash post-offering, no debt.

3 X's book value at $10 a share.

Essentially in start-up revenue stage 4 years ago, SNCR has seen their revenues grow strongly the past 2 years. From $16.5 million in revenues in 2004 SNCR grew 65% in 2004 to $27.1 million. SNCR doubled revenues in 2005 to $54 million. Pretty impressive.

Gross margins have been 44% past 15 months. For a software company not the strongest gross margins, but also not surprising here as SNCR's main competition is the communications providers own systems. 2005 was the first year of profitability for SNCR with net margins of 10%. Earnings per share in '05 were 23 cents. At $10 a share, SNCR will be trading 43 X's trailing earnings. Revenues look to grow strongly again in 2006. SNCR has had 12 straight quarters of sequential revenue growth, growth that should continue in 2006. I always like to see this sort of continued quarter to quarter revenue growth. The 3/06 quarter was the strongest in SNCR's operating history.

I think SNCR can grow revenues another 33% in 2006 to approximately $72 million. Net margins should improve slightly to the 11% range. Net income estimates for 2006 are $0.30- $0.33 cents. At a $10 pricing, SNCR would be trading at 32 X's 2006 estimates.

The trends are solid here. Communications providers are seeing a higher % of new customers generated from internet orders. SNCR is positioned well to capitalize on this trend as evidenced by the strong revenue growth. The question here is not whether automation cuts down on expenses. It does. The big question for SNCR is whether they will be able to shift communications providers to SNCR's ActivationNow and away from the communications providers own internally developed automated systems. If SNCR is able to generate substantial revenues from just one new communications provider the valuation in range is quite attractive.

The big risk here is losing Cingular. If SNCR loses that account, they're overpriced in range substantially so. I doubt that will occur as SNCR has had a relationship with Cingular since 2001 and the current contract with Cingular runs through January 2008. Whenever an IPO relies so substantially on one company for the bulk of their revenue, losing said company is always the biggest risk going forward.

I like this offering in range. No, I don't believe they're cheap in range, but I like the strong revenue growth and the fact SNCR has been able to effectively develop automated software platforms for internet wireless and VoIP transactions. SNCR has 13 straight quarters of revenue growth and has shown an ability to gain a foothold into major wireless and VoIP providers. Really all if will take is another deal similar to the current deals with Cingular/ Vonage. If SNCR is able to more fully penetrate just one more communications service provider, I think SNCR could easily be a $15+ stock. I like the risk/ reward of that occurring sometime over the next year.

SNCR first 10 days chart:

Full disclosure: I currently own shares of SNCR.