Buy Vonage: Acquisition Of Nexmo To Strengthen Positon In CPaaS Segment

| About: Vonage Holdings (VG)

Summary

VG’s outstanding sales growth over the last two years has helped increase the stock price by over 100%.

Acquisition of Nexmo would strengthen VG’s position as a CPaaS provider in the market.

Citigroup analysts believe that VG’s free cash flow would likely yield at over 10% based on their 2017 estimate and they have increased price target to $8.

Based on current market price of $5.43, Citigroup’s price target offers a 47.33% upside potential to secondary investors.

Company Overview

New Jersey based Vonage Holdings Corp. (NYSE:VG) was established in 2001 and currently they are one of the world's oldest providers of internet telephony service or VOIP. Vonage Holdings Corp. was one of the first companies to offer monthly subscription based VOIP calling plans in the North American market and swiftly expanded in key markets around the world, such as the United Kingdom by 2005.

Besides personal and home telephony needs, Vonage Holdings Corp. is also enjoying a large market share in commercial telephony market, where they provide cloud-based unified communications as a service (UCaaS) solutions that offers businesses an integrated voice, text, video, data, and mobile communications platform.

As of June 18, Vonage Holdings Corp. had a market capitalization of $1.19 billion and the company employed over 1,750 people around the world in its key geographic markets.

Review of Recent Financials

Figure 1: Vonage Holdings Corp.'s Revenue and Price Correlation

Since Q4 2013, Vonage Holdings Corp. has managed to gradually increase its quarterly revenue from $211 million to $227 million in Q1 2016. The steady top line growth of the company has also helped push its stock price during the mentioned time period, from around $3.00 per share to $6.50 per share by the end of 2016, representing a 116.67% increase.

Click to enlargeTable 1: Quarterly Finances of Vonage Holdings Corp

Although there was considerable revenue growth, Vonage Holdings Corp.'s gross profit remained somewhat same over the last few years, which effectively reduced its gross profit margin.

Despite a stalled gross profit margin, during this time, Vonage Holdings Corp.'s management has managed to improve its net income from $4 million to $8 million by cutting net operating costs. Especially, there was a dramatic reduction in the SG&A expenses that had vital contribution to increasing overall shareholder value of the company, which the market handsomely rewarded by pushing its stock price up.

But, since the start of 2016, over the past six months, Vonage Holdings Corp.'s stock price has fallen dramatically from more than $6.5 per share to around $4.00, representing a 38.5% decline. While there were many factors, the sudden decline in revenue during Q1 2016 has been identified as the primary driver behind this bearish move.

However, Over the last month, since May 12, 2016, Vonage Holdings Corp.'s stock price has been gaining bullish momentum and climbed from $3.90 to $5.43, representing a 39.23% gain.

Citigroup Upgraded Rating for Vonage

On June 14, Citigroup Analyst Michael Rollins issued a note to investors informing that they have upgraded the rating for Vonage Holdings Corp. from Neutral to Buy and effectively increased the price target from $4.75 to $8.00, which almost doubled the price target compared to the stock's market price.

As we discussed earlier, the recent bearish move was driven by lower sales growth, which Citigroup confirmed in the note. However, they pointed out that guidance of lower rate of sales growth and the purchase of Nexmo by Vonage Holdings Corp. was the key reason behind the bearish pressure on the common stock price.

Back in May 5, Vonage Holdings Corp. announced to buy Communications Platform as a Service (CPaaS) company Nexmo for $230 million in cash and stock.

It is worth mentioning, IDC forecasts that CPaaS segment to have a $8 billion market by 2018.

According to the Citigroup analyst, acquisition of Nexmo will pay off in the end, and he seems to believe that the platform will offer an "efficient customer service tool for new Internet-centric companies and for existing companies as a future substitute for toll-free service."

Although FBN Securities upgraded Vonage Holdings Corp.'s stock from Sector Perform to Outperform back in February 2016, the latest upgrade by a major bank like Citigroup has added fuel to the bullish momentum.

Conclusion

Over the last few years, Vonage Holdings Corp. management has demonstrated extraordinary perseverance to improve sales growth and the market has been rewarding the company. We believe the acquisition of Nexmo will certainly help Vonage Holdings Corp. to continue pursue growth at a higher rate.

We are fairly impressed with Vonage Holdings Corp. management's ability to reduce expenses during a time of rapid sales growth and they would likely continue to generate an ample free cash flow in the coming quarters.

Based on current market price of $5.43 per share, Citigroup's price target of $8 for Vonage Holdings Corp. offers a 47.33% upside potential to secondary investors and we believe this price target is realistic and would be achieved within the next two to four quarters.

Disclosure: I/we 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. I have no business relationship with any company whose stock is mentioned in this article.