BROADSOFT: THE NEXT CLOUD DARLING
In investing, as in gamesmanship, the ultimate setup is when you have multiple opportunities to win -- the so called "win-win" scenario.
In today's investment world, large cap stocks are so thoroughly covered and over-analyzed that even if you can predict future events, it is often hard to decipher how the affected stocks will react -- a "lose-lose" scenario, if you will.
· A stock beating numbers but missing the all-important "whisper number" sees their stock trade down sharply.
· Investors crowding in for an event sell the news causing a stock to trade off sharply during or after the event (i.e. Apple iPhone announcements).
One small cap stock I have been following for quite some time qualifies. Few analysts cover it, its story is not well understood, and there are identifiable catalysts. The stock has a great risk/reward profile and there are many ways the "win-win" scenario can play out. I researched this stock with some assistance from the analysts at PoisedToTriple Research and they agree that this stock is a winner.
My History Covering BSFT
I first started writing about BSFT in early March 2013 with the stock in the 20s (following a disappointing Q1). I argued that BSFT offered a compelling level of risk / reward and called for $40 price target.
My thesis was to take advantage of the weak Q1 they reported and to own the stock for a big growth year in 2014. As we sit here in early October, the stock has rallied into the 30s from its bottom… and the big 2014 is still on the horizon.
One valuable lesson I have learned from my years at a hedge fund is approach every stock as if you had no position and no history with it. Stocks don't care where you bought them or how long you have owned them. So, while the stock has rallied sharply off the bottom I am examining BSFT with a fresh perspective.
Bottom line: the stock is a must own here and I will explain why in the paragraphs and articles to follow.
Historically, each telephone needed its own dedicated line, which connected directly to the telephone company (now commonly known as "carriers"). As time passed, companies found that they could connect all of their phone lines into a box that would provide a single connection out to the carrier. That box is called a PBX (private branch exchange).
Carriers were not happy that PBXs were invented. They would prefer to have more lines (because more lines = more revenue)! However, the march of technology can't be stopped, so the carriers have learned to accept it (while seeking ways to combat it). Cisco (CSCO) currently dominates the traditional PBX market, holding 27% market share. They are followed by Avaya, NEC and Siemens. Microsoft (MSFT) is also a major player in this market via its communications software platform consisting of Lync, SharePoint and Skype.
Over the last decade, PBX technology has come a long way. Companies have been steadily upgrading their PBXs to IP (Internet protocol), which is a fancy way of saying that phone calls and data could be aggregated.
This is where BroadSoft comes in. They enable the move to IP. Better yet, they sell their solution to the carriers, like Verizon (VZ), AT&T (T), and Comcast (CMCSA), which can host BSFT's technology in the cloud. The reason is simple. Why buy and maintain a box in-house when you can just use a reliable service from your carrier and pay as you go?
Welcome to the era of cloud communications.
In short, BroadSoft is the carriers' arms supplier in their fight against Cisco and Microsoft. They don't show up in traditional PBX market share stats because their solution is branded by the carriers. However, BSFT already accounts for about 5% of the market penetration in the cloud communications market (and growing fast).
As the neutral arms supplier to the major carriers, BSFT is a favored partner. Because of this, they could easily double their market share over the coming few years.
Ultimately, the overriding issue is "who owns the customer" -- the carrier or the software provider? When the carrier uses Microsoft or Cisco software, the business interacts with the software brands: Lync, SharePoint, WebEx, etc. every day so it's clear that Cisco and Microsoft have the business relationship not the carrier (i.e. Verizon or AT&T).
However, in the case of BroadSoft, the carrier owns the customer and BroadSoft is happy to serve its role as the neutral arms supplier. BroadSoft software is branded as Verizon or AT&T or Comcast -- whoever the customer may be.
So What Does it Mean for the Stock?
The one thing I have tried to incorporate into every large position I take is a firm grasp of risk/reward. While most investors get the reward part down firmly, they ignore the risk part at their own peril. Risk for BSFT is they poorly execute a quarter and the stock gets hit, then what do you do? The beauty of BSFT is that it remains such an enviable acquisition candidate that buyers such as Oracle are salivating waiting for BSFT stock to correct so they can pounce and make a bid.
If BSFT reports a light quarter and the stock sells off in one of the next 3 quarters, I would aggressively buy that weakness as M&A chatter will heat up immediately thereafter.
Oracle acquired Acme Packet in February, followed by Tekelec in March. Acme Packet and BroadSoft were such great partners and such perfect complements that having one without the other would have been like buying a computer without software to run it. There have been rumblings in the space that the synergies between Acme Packet and BSFT are also so evident that Oracle is just waiting for the optimal moment to move on BSFT.
As for Google, Google Apps has about 5 million users and 33-50% of the cloud office market. They need BroadSoft's Unified Communications package to bundle with their Google Apps software suite to compete against Microsoft Office 365. This is especially true because Microsoft raised the ante by integrating Skype with Lync. As a result, Google desperately needs BroadSoft's carrier/MSO relationships and carrier-level voice quality.
Google Voice has been widely panned as a low-end consumer service. BroadSoft's carrier quality voice solution seems a surefire bet to supplant Google Voice's current low quality offering. William Blair analyst Dmitry Netis estimates that there exists a $300 million opportunity for BroadSoft to monetize the existing Google ecosystem based on a $10 per user per month fee. I would not be surprised if this partnership takes off and leads to an acquisition by Google to stay competitive with Microsoft's Lync/SharePoint/Skype bundle.
Why $2 is the Magic Number...
That being said, if BSFT keeps going at its current pace ORCL and GOOG might miss their chance. As we get closer to 2014, BSFT's growth is accelerating. Acquisition is a nice backstop, but my 2014 EPS estimate calls for $2.00, 20% above Wall Street's estimates (which have been rising) and represents 40%+ growth over 2013.
Because of BSFT's enviable market positioning and strong product roadmap, I believe this level of earnings will attract the attention of professional investors. A PEG ratio of 1 would yield a P/E of 40 and therefore a valuation of $80. I'm modeling a more modest P/E of 25, leading to a 6-12 month price target of $50.
This represents a 40%+ increase from current levels. All aboard...