RingCentral (RNG) made its public debut on Friday, September 27. Shares of the provider of SaaS solutions for business communications ended their first day with gains of 40.0% at $18.20 per share.
Even after these great returns, I am cautiously optimistic on the back of high gross margins, solid revenue growth and a relative modest sales multiple valuation.
Dependent upon the outcome of additional research, especially regarding the competitive position of RingCentral's products, I might initiate a position in the stock.
The Public Offering
RingCentral is a software-as-a-service provider for business communications offering an innovative, cloud-based approach for business communication; providing flexible and cost-efficient services for distributed workforces and mobile workers.
Through RingCentral Office, the flagship service of the company, the company offers multi-user communication solutions through voice, text and fax through all common devices such as smart phones, tablets and PCs.
Traditional communication networks involve quite some upfront investments and are expensive to maintain, as they focus on employees which work on one spot. These new technologies are based on cheaper hardware, more online connectivity and making networks more agile and cost-effective.
RingCentral sold 7.5 million shares for $13 apiece, thereby raising $97 million in gross proceeds. Nearly all shares were offered by the company, as selling shareholders offered some 80,000 shares in the offering, hardly 1% of the offer size.
Bankers and the firm set an initial price range of $11 to $13 per share. Shares were eventually sold at the high end of this range.
Some 12% of the total shares were offered in the public offering. At Monday's closing price of $18.02, the firm is valued at $1.09 billion.
RingCentral solutions are developed with a mobile-centric approach and can be configured, managed and used from smartphones or tablets. The lack of significant upfront investments in hardware, or large maintenance costs, make the appeal of RingCentral's solutions high to businesses.
The high quality and reliability allow for easy scaling and can often be provided through existing broadband connections. RingCentral estimates that the North American market is large, seeing a $15 billion replacement market for business communications.
RingCentral sells through the website, sales representatives and a network of over 1,000 agents and resellers. At the moment, the company has a customer base of over 300,000 businesses across all industries. While the company has focused on small and medium sized businesses, it sees potential for large companies as well.
For the year of 2012, RingCentral generated annual revenues of $114.5 million, up 45.2% on the year before. Net losses increased from $13.9 million to $33.8 million in the meantime.
For the first six months of 2013, RingCentral generated revenues of $73.2 million up 41.3% on the year before. Losses rose from $18.7 million to $23.9 million.
The company operates with $19.3 million in cash and equivalents and $21.0 million in total debt. Adding gross proceeds of $97 million from the offering, and RingCentral should operate with a net cash position of around $85 million.
This values operating assets of the firm at $1.00 billion. As such, operating assets of the firm are valued around 8.7 times last year's revenues.
As noted above, the offering of RingCentral has been a huge success. The company priced the offering at $13 per share, some 8.3% above the midpoint of the preliminary offering range.
Add to that opening day returns of 40.0%, and shares are trading with gains of 51.7% above the midpoint of the preliminary offering range.
While you might be under the impression that RingCentral has only been founded recently, as revenues more than doubled from $50 million in 2010 to $114 million last year, the firm has actually been founded back in 1999 already. Its flagship product RingCentral Office, launched in 2009, has been the major driver behind recent revenue growth.
The company is the latest public offering focusing on companies which are outsourcing technology infrastructure to the cloud. Prominent investors in the firm are key executives but also Sequoia Capital and even Cisco Systems (CSCO).
Obviously there are some key risks as well, which includes the increasing pace at which the company is reporting losses. Other risks include the reliance on network service providers, notably Level 3 Communications (LVLT) and Bandwidth.com. The industry is very competitive, with low upfront investment create lower cost of switching to competitors.
Traditional competitors include the likes of Alcatel-Lucent and Cisco, but also communication firms like AT&T (T) and Verizon Communications (VZ). It it not unthinkable that large internet companies might make an entry in the market as well.
On a positive note, gross margins improved by some 43 basis points to 61.2% of total revenues in the first half of this year, compared to the full year of 2012. Other good news is that the current revenue rate is close to $150 million per annum, while the company achieves impressive 99% retention rates.
Revenue growth is solid as well, coming in at 43.2% in the first quarter compared to a year earlier. Second quarter growth of 39.6% was solid as well. Operating expenses kept increasing to almost 92% of total revenues in the first half of the year.
The company has all the right characteristics to create long term value. Revenue growth and gross margins are solid, so are retention rates, a strong shareholder base end experienced management. While I understand that investments are needed to drive growth, I would be a little more comforted if operating expenses would come down on a relative basis.
I remain cautiously optimistic, even after a successful offering as the current sales pace values the business at little below 7 times annual revenues, combined with solid gross margins.