In investing circles, some things need little introduction. Take Nuance Communications (NUAN). Nuance is synonymous with voice recognition, and its technology is held in high regard worldwide. Mainstream investors became aware of the company a few years ago when its science was the backbone of Apple's (AAPL) Siri platform on the iPhone. When anything Apple was in vogue, Nuance shot up to $31, but has since fallen on hard times, and crosses the tape at $19.
In a nutshell, Nuance is in a transition period - from desktop to mobile computing, and from just plain old software to software as a service, or a subscription based model. Q1 was terrible. Q2 was like a sequel to a horror movie. In Q2's prepared remarks issued by the company, next quarter's revenue will be $480-$495 million and earnings per share are projected to be $0.30-$0.34. This is below a consensus of $554 million in revenues and EPS of $0.49. Full-year guidance also missed. Some of the blame was on poor execution in the sales department.
For the second time in three months, the stock dropped from the mid $20s to the high teens, and some investors took notice. Most notably, billionaire financier Carl Icahn who previously had accumulated a 9.3% stake in the company. After the conference call, it was disclosed he increased his holdings to 10.7%. Like Nuance, Mr. Icahn needs no introduction to those that follow the market. Whether it is a televised battle with Bill Ackman over Herbalife (HLF) or the killing Mr. Icahn made on Netflix (NFLX), Mr. Icahn is a financial celebrity.
One thing that is consistent with Icahn is that he's not in this for the consolation prize. He puts himself in a position to win. Many investors believe the atmosphere is poisoned for Nuance. It's a lost cause. I feel this is short sighted, and with the "passive" investment Icahn took in Nuance, he's giving the company a stay of execution. After all, the pressure Icahn can put on a company is the stuff of legend, even though he has not stated what his involvement will be with the speech recognition entity.
Even with the increased holdings for Icahn, if we do get an overall market correction, Nuance shares may go lower, but they seem to be forming a base in the current market melt-up. I prefer to bottom fish in good solid companies that hit speed bumps. This is why I took a position in Nuance at $19. However, the company may be stuck in neutral for the next few months, especially if comments during the conference call are any indication.
In playing Devil's Advocate as a shareholder in Nuance, let's look at some of the less than stellar statements that management published just three short weeks ago that caused the sell-off:
- Concerning the Healthcare Division: "Although recent acquisitions contributed to revenue growth, in some cases the contribution was below our expectations."
- In the Mobile And Consumer segment: "We experienced delays in revenues due to consolidation in the smartphone market, our increased focus on pricing and delayed royalty reports."
- In Enterprise: "We have recently under-performed in our enterprise on-premise license business and we expect that business to continue to face challenges."
- For the overall company: "In the second half of FY 13, we expect a continuation of the current market trends, and we expect that improvement in sales execution and acquisition performance issues will take some period of time."
Management believes that it will take until 2014 to show a resumption of organic growth. That Fiscal Year 2014 organic growth will be in the mid to upper-single digit range. So we're not talking about hyper-growth for at least two years, if at all. To increase shareholder value, the company has authorized the repurchase of up to $500 million of its outstanding shares subject to market conditions. A share buy-back is standard operating procedure for companies that have fallen out of favor.
However, you usually do a buyback when the company is selling for a discounted price. With a current P/E Ratio of 40, this is still an expensive stock. This makes me wonder what Mr. Icahn has paid for his stake. If it's over $19, he may not exercise patience for very long. The annual Nuance Communications' shareholder meeting next January could prove very interesting.
"Activist shareholders such as Mr. Icahn have become a major force for change in corporate America in recent years, frequently taking big stakes and pushing for improvement at underperforming companies. They have become so ubiquitous, bankers say, that in many cases companies make strategic changes preemptively when they fear they are an activist target."
In the Q&A session during the most recent conference call, Daniel Ives from FBR Capital Markets directly asked Nuance CEO Paul Ricci: "Can you confirm you've hired a financial adviser in terms of working with your strategic alternatives?" Mr. Ricci dodged the question, and stated: "I can say that Nuance is very well advised and we work with many firms." There was no follow up question, nor specific mention of Goldman Sachs.
The Bottom Line
With the possibility of being under the thumb of Icahn, coupled with residing in the upper echelon of technology, the Nuance breakup value could be more than a sum of its parts if current management can't get back to its previous growth trajectory. I've always liked this company, however, that doesn't necessarily translate into a rising stock price. I believe with the Icahn stake, the handwriting is on the wall for Nuance. In a year from now, shares could be considerably higher, from change within the organization, or pressure from outside the company.