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  • RingCentral - Compelling SaaS Solution Disrupting A Very Large Market 0 comments
    Mar 25, 2014 11:08 AM | about stocks: RNG

    RingCentral (NYSE:RNG)

    Company Description

    RNG is a SaaS based provider of enterprise grade communications solutions for SMB's and enterprises. For a monthly subscription fee starting at ~$25 / month, RNG's flagship RingCentral Office product offers a comprehensive set of communication solutions including:

    • VoIP phone service including fax, voicemail and multiple extensions
    • Call management features such as auto-receptionist, call forwarding and answering rules
    • Audio, HD video and web conferencing features
    • Mobility solutions such as business SMS, softphone and mobile communication management
    • Integration with other key business applications such as Outlook, Salesforce and Box

    RNG's solutions replace on premise private branch exchange (PBX) communication systems with a cloud based off premise solution that results in lower TCO and requires less up-front investment. Traditionally many of the services that RNG offers were only available to large enterprises that could afford significant upfront PBX investments, however RNG's SaaS solution provides SMB's access to these same features at an affordable monthly fee.

    RNG markets and sells their services directly through an internal sales force, VARs and distribution agreements with AT&T and TELUS. While SMB's remain the core customers for RNG, RNG continues to try to move up market and address larger organizations. As of February RNG has over 300,000 customers with a total of over 1mm users, and its single largest deployment consists of almost 1,000 users.

    Investment Thesis / Position

    At $20 RNG represents a potentially compelling risk reward opportunity. RNG operates a disruptive business model in a very large addressable market, offering a more cost effective solution with increased functionality. RNG operates in the voice communication industry, an industry that is potentially open for significant disruption given the increasingly disturbed nature of workforces, BYOD trends and unified communication trends. Combined with the high ROI of SaaS based telephony solutions and its higher value proposition, cloud based communication solutions have the potential to displace traditional PBX solutions and create greenfield opportunities out of SMB's that had previously never considered PBX solutions. RNG stands out as the largest and fastest growing cloud PBX solution on the market, offering a compelling mobile centric solution that works well for both SMB's and enterprises.

    While RNG offers a compelling solution, the market is fragmented and highly competitive. Key competitors include Shoretel, Mitel and 8x8, however the market appears large enough ($15bn in North America, $36 - 41bn globally ex. US) and growing quickly enough to support multiple successful companies. As the market continues to evolve, RNG has efficiently and effectively scaled its business into the largest and fastest growing cloud based PBX solution in the industry while maintaining 99% retention rates.

    RNG currently trades at ~7x 2014 revenues, a slight discount to other SaaS companies. Based on historic operating efficiency metrics, its investment in to its sales force and the compelling solution it offers to a very large market, near term and long term revenue estimates appear reasonable and likely conservative. For example, the midpoint of RNG's 2014 guidance is $205mm, representing just 13% growth off annualized Q4 2013 revenues, which grew 37% YoY. The combination of RNG's compelling and disruptive solution, the large market it addresses and conservative revenue estimates from the street make RNG a potentially compelling investment opportunity.

    Investment Strengths

    RNG's solution is a cloud based, disruptive approach to a large addressable market

    • RNG offers a solution with increased functionality at a lower TCO and initial investment. The solution is deployed with out of the box functionality and is set up in minutes.
      • Traditional PBX's were designed 30 years ago to serve the needs of brick and mortar businesses and function within a single building. As work forces become more distributed and mobile, a more robust solution is required.
    • According to Infonetics, from 2008 - 2012, there were 61mm PBX lines sold in North America. Assuming a base selling price of ~$20 per user per month, the potential replacement market is approximately $15bn in North America.
      • This estimate may significantly understate the potential market opportunity. Greenfield opportunities have been created out of businesses considering a business communication system for the first time as traditional PBX solutions were impractical due to functionality limitations, cost and other factors.
        • William and Blair estimates that the addressable market for U.S. businesses with 5 - 499 employees to be ~$10bn.
      • BofA estimates the global PBX replacement market as $36-41bn, and RNG considers the Europe opportunity to be as big as the U.S.
    • The hosted IP telephony market is fragmented. According to Frost and Sullivan, the market had ~$1bn in revenues as of 2012, is growing 34% per year and includes 80 key competitors with the top 3 holding a 23% market share.
    • RNG's go to market strategy includes an internal sales force (which works in conjunction with SEM and SEO efforts), VARs and distribution relationships with AT&T and TELUS (TELUS relationship was signed in Q4 2013 and RNG expects to start seeing revenues by late 2014). These relationships help add credibility to RNG's solutions and lend validation to the scale of the platform as they try to move up market.
      • RNG is in the 2nd year of a 5 year agreement with AT&T. The relationship currently represents <10% of revenues, but is one of the fastest growing channels. AT&T leverages RNG's solution to more effectively address the needs to SMB's.
      • The indirect sales channel, which includes VARs and carriers, represents ~20% of revenues and is growing quickly.
      • RNG is the only cloud service provider with multiple carrier relationships.

    RNG offers a solution that has increased functionality at a lower upfront cost and TCO.

    • RNG initial cost is 39% that of traditional PBX, cumulative cost 53% that of traditional PBX over 10 yrs
    • Features included with a RNG subscription but are additional costs with a traditional PBX solution include fax, toll free numbers, customer support, audio and video conferencing and mobile functionality.
    • RNG's enterprise edition is priced at $45 / user / month and includes a full suite of communication services, while leading standalone meeting products by themselves cost ~$50 / user / month.
    • A similar Webex or GoToMeeting video conferencing solution by itself costs $49 / user / month ($39 with an annual subscription).
    • RNG's solutions have more functionality and flexibility than traditional PBX solutions.

    RNG revenues are sticky and recurring, with monthly dollar retention rates of 99%

    • 99% retention rate illustrates product stickiness (dollar retention rate includes up-sells).
    • Attractive unit economics, with 8x revenue payback for every S&M dollar spent and 5x contribution payback.
    • While RNG's Office subscribers often enter into annual or multi-year contracts, many customers do not have long-term contracts and may terminate service at any time without penalty.
    • RNG clients tend to be SMB's, which may have more churn than enterprises. Business mortality is one of the biggest sources of churn for RNG.
    • Key Customers: DME Automotive (300 employees, 2 offices), TRUSTe (100 employees, 4 offices), Motion Recruitment (900+ employees, 22 locations), Amerivset Realty (200 associates), Naked Wines (60 users, located in UK and CA), TruGreen (500 users, 65 offices), John Varvatos (100 users), FinFit (250 employees, 67 locations)

    The complexity of RNG's infrastructure, sophistication of the solution and reliability of service create significant barriers to entry.

    • BofA research analyst estimates it takes 10+ years to internally develop a cloud PBX system due to the complexities of switching / routing, call termination and real-time service assurance. RNG's platform was developed over 10+ years.
    • According to Infonetics, of 81 PBX vendors being tracked, just 14 have internally developed technology PBXs. The vast majority of vendors are using a PBX switch offered by BroadSoft. This hosted PBX switch business model inherently carries higher costs to the provider and a lock-in with the features and roadmap of one vendor. It is also much more difficult to build in product differentiation. This leaves a handful of internally developed PBXs in the market, especially those designed for the cloud, with very valuable intellectual property and a differentiated business model. One of those few vendors is RingCentral. (BofA)
    • RNG has built an international, highly scalable and flexible infrastructure designed to provide enterprise class service while being affordable / accessible to SMB's.
    • Data centers are designed to host with redundant, fault-tolerant subsystems and compartmentalized security zones.
    • North America: 3rd party data center in San Jose, CA and Vienna, VA
    • Europe and UK: 3rd party data center in Amsterdam and Zurich
    • Service GM target of 75%+ in the next 3 years or so, 80% over time

    Growth drivers include increased prevalence of BYOD, video conferencing, trends in unified communication and international opportunities.

    • RingCentral Office, RNG's flagship enterprise grade offering, is available in Standard, Premium and editions. Office is RNG's most important growth driver, representing 94% of net new recurring subscriptions.
    • Office annualized monthly recurring revenues (MRR) were $112mm and grew 67% in Q4 2013 vs $173mm and 39% for all of RNG. Office solutions have higher ARPU, retention rates (>100% net) and margins.
    • In Q4 2013 RNG added a multi-point HD video conferencing solution to its Office product, expanding the TAM and helping to drive ARPU.
    • According to an April 2013 Gartner report, by 2017 half of employers will require their employees to supply their own devices for work purposes (BYOD), creating additional challenges for businesses using legacy communications solutions.
      • RNG offers a mobile centric solution that allows employees to manage and access the full functionality of their communications systems from anywhere in the world.
    • As of December 2013, 99% of revenues come from US and Canada, however RNG sees significant international growth potential in Europe.
      • RNG entered the UK market in October 2013.
    • Potential for additional distribution relationships, both domestic and abroad.

    Investment Considerations

    RNG operates in a highly competitive market with deep pocketed competitors and incumbents.

    • Traditional PBX providers like Shoretel (NASDAQ:SHOR) and Mitel (NASDAQ:MITL) have started to offer their own hosted / cloud PBX offerings. SHOR has focused on larger deployments (average of 44 seats per deployment) while RNG has found success in SMB's (5-10 seats), however as RNG moves further up market (targeting business with 1,000+ users) it will start competing more directly with SHOR.
    • SHOR's offering, through its acquisition of M5, is a bit of a hybrid approach that often requires a dedicated T1 line that can cost $500 - $1,200 / month.
    • MITL is a relatively new competitor, significantly increasing its cloud presence through its purchase of Aastra ($362mm, cash and stock).
    • RNG's most direct competitor is 8x8 (NASDAQ:EGHT), who also focuses on the SMB space but like RNG is trying to move up market and compete with SHOR. While RNG is larger by revenue, EGHT remains RNG's most relevant competitor in the SMB space and shares similar enterprise aspirations. RNG is the largest and fastest growing company in this market.
    • As RNG moves further up market, sales cycles will extend. SMB sales cycles today are <1 month, enterprise sales cycles can last 3 - 9 months.

    Company

    Cloud Subs.

    Users

    Monthly ARPU

    Avg. Seats

    Monthly Churn

    Run Rate Rev ($mm)

    RNG

    >300k

    >1mm

    Low / Mid $20's

    5-10

    1% (0% office)

    $173.2 ($112.3 office)

    EGHT

    36.8k

    463k

    $22

    12.6

    1.5%

    $120.8

    SHOR

    3k

    136k

    $45

    44

    0.3%

    $125.6

    MITL

    NA

    NA

    NA

    NA

    NA

    ~$100

    Distribution relationship with AT&T and TELUS

    • While RNG has distribution agreements with telecom providers such as AT&T and TELUS, RNG also competes with them on some traditional telecom services.
      • AT&T currently does business in 22 states, and RNG provides a geography / footprint independent solution to SMB's. RNG's solution allows AT&T to efficiently serve SMB's seamlessly across all 50 states and even allows AT&T to enter some new markets.
      • The AT&T and TELUS relationships are driven out the carriers' mobility group.
    • Verizon has opted to provide its own VoIP offering for SMB's by leveraging Broadsoft's solution.
      • Over time there is a risk that AT&T and / or TELUS could adopt this model and end its relationship with RNG, though traditionally AT&T has had difficulty effectively serving the needs of SMB's.
      • AT&T related revenues represent <10% of total RNG revenues.

    Reliability of VoIP solutions

    • Because enterprises are less willing to tolerate latency in voice transmission, voice data can be more difficult and complex to transmit than data associated with other SaaS applications (i.e. email, CRM, etc). Strict quality of services (QoS) protocols are required to ensure that voice data packets receive transmission priority over other data packets, and RNG has developed sophisticated proprietary technology to help ensure high quality and highly scalable VoIP transmission.
    • With RNG's own proprietary solutions as well as continued technological and service improvements associated with broadband delivery, RNG has the potential to deliver a more reliable service than even a traditional PBX solution.
    • While RNG has worked to make VoIP as clear and reliable as possible, as long as packets are traveling across the open internet there will be some concerns regarding signal interference and bandwidth.

    Disclosure: I am long RNG.

    Stocks: RNG
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