BroadSoft (BSFT) posted an ugly quarter, plain and simple. There was nothing pretty about this one. They missed top-line, license, and EPS estimates, and then if that wasnt enough, promptly reduced guidance for the December quarter. Management blamed the miss on consumer headwinds being worse than expected and carriers pulling back buying. When the press release came out, I felt like someone kicked my in the stomach, not once but twice.
While my thesis on the stock rested on 2014 as the point where things would come together, it's important to measure your thesis with the sign posts along the way. Let's just say I was going 80 mph head on into this sign post. So let's review the thesis. For not properly navigating this quarter, I reference the famous words of the philosopher Mike Tyson: "Everyone has a plan until they get punched in the face." Well, I feel like I was on the wrong end of Mike Tyson's uppercuts, but let's take a step back after we get up off the canvas.
The quarter last night was simply ugly. The miss shows management's inability to avoid quarters where they fall flat on their face; as they did in the fourth quarter of 2012. Next year still looks to be a strong year but now the stock needs to overcome management's poor execution. Investors will be hard-pressed to believe management if they lay out aggressive targets for next year. Bottom line, the multiple will compress.
The one bright spot after I pick myself up off the canvas is that BSFT's poor performance reminds me of a few software stocks. One is BEA Systems who couldn't execute themselves, so Oracle (ORCL) came and took them out of their misery by acquiring them. Oracle has half of the puzzle to solving carrier's problems with Acme Packet (Tekelec is a head scratcher) and the other half of the puzzle just got a lot cheaper after yesterday. Larry Ellison's patience is paying off again.
Oracle is one of the savviest buyers on the planet. I wouldn't be surprised if they were not waiting for an event like yesterday to occur before beginning to pounce. Their playbook would be to approach management about a takeout with the plan of ultimately paying just north of their 52 week high -- roughly $40 per share. BroadSoft management likely rebuffs Oracle thinking they have a big year ahead of them and if they just execute (though that's not as easy as it sounds) they can get the stock there in 6 months.
What to do with the stock at $27?
At $27, the stock trades at 3.9 and 3.4x EV to 2013 and 2014 revenue, respectively. Software stocks tend to never see a 2x handle when they are still growing. Oracle paid 5.5x EV to forward year revenue for Acme Packet. Acme Packet had its share of poor earnings reports that actually made BSFT look like IBM in managing its quarterly earnings. At 5.5x forward year revenue, BSFT would trade at $42. That level also equates to a nice 10% premium to the stock's recent 52 week high, a level acquired companies tend to ask for when being sold.
The best way to evaluate what to do when there is a dislocation (i.e. being punched in the face) is to ask yourself what you would with the stock if you had no position. At $27, BSFT will trade at 18x consensus 2014 EPS and 3.4x EV to '13 revenue. While it will take time to rebuild investor confidence and be rewarded with a 20x multiple, I would be accumulating the stock around 3-3.5x '14 revenue -- i.e. $25-27 -- as that is about as cheap as growing software stocks tend to get. Again apologies for flooring the car, not seeing the sign post and running into it head on going 80 mph. In retrospect I should have pointed out the risks around Q3 quarter and for that I am sorry. I feel like one of Mike Tyson's opponents on the canvas. But I am not staying on the canvas, I am getting up and will learn from the experience to be ready for the right hook which tends to land around earnings time for BSFT.
BSFT is a buy down here when the dust settles. BroadSoft has $3.39 net cash per share and I expect them to announce a share buyback very soon. As for BroadSoft management: don't be surprised if you hear from Mr. Larry Ellison in the very near future......