Nuance Communications: Sell-Off Might Intensify Pressure From Icahn

| About: Nuance Communications, (NUAN)

Investors in Nuance Communications (NUAN) have seen increasing losses recently, adding to an already very difficult 2013. Last week, the diversified conglomerate best known for its speech and translation technology released a disappointing set of fourth quarter results.

The transition into a SaaS-based revenue recognition cycle for its cloud offering has a huge impact as well, as investors are not pleased with the guidance for growth in the next year. Yet after shares have seen a 50% correction over the past two years, there are some potential catalysts which could unleash further potential.

After activist investor Carl Icahn initiated a stake in the company, there is potential for significant value creation going forward on the back of deal-related activity, a break-up of the company or a departure of key executives.

Fourth Quarter Results

Nuance generated revenues of $472.2 million, up 0.7% on the year before. Analysts were looking for revenues of $489.6 million.

The company reported net losses of $32.3 million, or $0.10 per share for the final quarter. This compares to earnings of $0.36 per share last year.

Non-GAAP earnings came in at $95.2 million, resulting in earnings of $0.30 per share, down from $0.51 per share reported last year. Analysts were looking for non-GAAP earnings of $0.29 per share.

Looking Into The Results

After reporting solid revenue growth, even into 2013, this growth almost came to a standstill in the final quarter of the year as revenues inched up by just 0.7% on an annual basis.

This slowdown is due to an 8.1% fall in product and licensing revenues which came in at $192.3 million. This was offset by a 5.9% increase in professional services and hosting revenues which came in at $208.4 million. Maintenance and support revenue growth was very solid, but the contribution to revenues was just $71.5 million.

While revenue growth was disappointing, it is resulting in lower margins due to the mix. Gross margins of product and licensing are 87.4%, and it is this business being under pressure. The professional services and hosting business which showed revenue growth only displays gross margins of 29.6%.

As a result, firm-wide gross margins fell to 57.9% of total revenues which is down, 5.5% on the year before. At the same time, operating expenses were on the rise, resulting in a double impact on operational earnings. As a result, income from operations fell from $46.6 million to just $3.7 million.

..And Ahead

For the first quarter of the fiscal 2014, Nuance Communications sees revenues of $477 to $487 million. Non-GAAP earnings are seen between $0.18 and $0.21 per share.

Analysts were looking for first quarter revenues of $486 million and earnings of $0.31 per share.

Full-year revenues are seen between $2.03 and $2.09 billion, as earnings are seen between $1.05 and $1.15 per share. While analysts were looking for similar revenues at $2.07 billion, they were modeling for non-GAAP earnings of $1.41 per share into the coming year.


Nuance ended the year with $846.8 million in cash, equivalents and marketable securities. Total debt stands at $2.35 billion, for a net debt position of $1.5 billion.

Nuance generated annual revenues of $1.86 billion for the year, up 12.3% on the year before. GAAP losses for the year came in at $115.2 million compared to earnings of $207.1 million in the year before.

Trading around $13.50 per share, the market values Nuance at $4.2 billion. This values equity in the firm at 2.3 times annual revenues.

Nuance Communications does not pay a dividend at the moment.

Some Historical Perspective

Long-term holders in Nuance have seen decent returns, although investors have taken quite some losses in 2012 and 2013. Shares have steadily risen from lows of $3 in 2004 to a peak of nearly $30 per share at the start of 2012.

Shares have fallen to lows of $20 at the end of 2012, and after witnessing losses of nearly 40% so far this year, shares trade at just $13.50 per share.

Between 2009 and 2013, Nuance increased its annual revenues by a cumulative 95% to $1.86 billion. The problem has been to turn these revenues into real profits, as the firm reported large losses, partially due to one-time expense this year.

Investment Thesis

Nuance is facing a difficult time as it tries to sell more software as a cloud computing product, rather than traditional software products being installed. As revenues are being recognized on a SaaS basis, rather than upfront, this transition has a huge impact on GAAP revenues during the transition period.

Therefore, Nuance is providing booking numbers as well, as they are a better reflection of the company's real current performance. Nuance rationalizes the move towards the new billing model as customers demand this SaaS basis, while it creates recurring revenues and improves the predictability of the business.

For 2014, bookings are seen between $2.15 and $2.25 billion, up 14.6% on the year before at the midpoint of the range. While bookings seem solid, analysts are not impressed with the focus on earnings. CEO Ricci remarked that the company tries to balance between near-term financial performance and long-term success.

Of course, Nuance is best known for the software that runs Siri on Apple's (AAPL) iPhone. While short-term pressure is already resulting from the shift to a subscription-based business model, Nuance has been deferring deals with phone makers as it tries to hold on to higher pricing as well. This will result in no meaningful organic growth in the mobile phone segment the next year, which is a setback as roughly a third of revenues are being generated by mobile and consumer businesses.

The big shift in the business model takes a toll on the margins, with operating earnings taking a big toll this quarter. Investors are not too pleased with the transition, given the very poor share price development over the past two years. These poor developments attracted interest from activist investor Carl Icahn, which has bought a big stake in the company, known for its voice and language technology.

Given that Icahn took a stake into Apple as well earlier this year, and given the strong business relationship between Apple and Nuance, some sort of consolidation might be a big push for shares.

Icahn holds a nearly 17% stake in Nuance, and his presence could be a driver behind a deal or tie-up. Nuance is supplying to Samsung's Galaxy line and Apple might be interested in Nuance given the technology offerings. The "limited" enterprise valuation at $6 billion in relation to Apple's cash balances and the relationship of Icahn could spur deal-related activity going forwards.

Even if some sort of a deal might not materialize, Icahn could push for a break-up of the conglomerate. Nuance is active in healthcare, its promising mobile business, the enterprise business and imaging. These businesses arguably have little to do with each other, creating a poor rationale behind such a conglomerate. A possible deal would be obviously applauded by shareholders which are very dissatisfied with CEO Ricci's acquisition strategy.

As such deal making activity, a break-up of any form, or a departure of Ricci, all spurred by Icahn could be a huge driver going forward.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.