AKJ

SoundBite Communications: Cheap Valuation Means It's Time To Buy

I'll start by saying I agree with the author's summary - this is a good buy. This whole space is going to be radically changed by Voice Over IP which will bring down the cost of delivering calls to nearly 0. There are alot of "mom and pop" vendors in this space who will be rolled up or put out of business by a well capitalized competitor like SDBT. The cash flow situation is very strong as well - good ability here to land prepaid, long term contracts. Even the pay-as-you-go contracts lock in a very strong gross margin.

Having said all that, I think you need to reconsider some of your valuation comps. Salesforce and Nuance are not relevant. CSG Systems (CSGS) is a direct competitor, as is Blackboard (BBBB) and Premiere Technologies (PTEK). CSG bought Prairie Communications, another direct competitor. Blackboard bought the NTI Group. Yet another competitor, Varolii, has filed an S-1 to go public soon.

Also - the gross margin decline doesn't really tell a great story. And I'm not sure why growth is lowering gross margin - is the cost to deliver calls affected by hiring more salespeople or opening new offices? I could perhaps see having to discount prices to win away marketshare from a competitor, but haven't seen that rationale communicated by SDBT.

Also interesting to note -the biggest consumers of this service are debt collectors. Will a recession actually help SDBT as collectors have more debt to collect? There's also a growing use by government and education users for emergency notification. These are juicy contracts but have extremely long sales cycles. They should also be immune to a recession (assuming emergency notification doesn't get cut out of the budget).

This is a great business model if you can get the sales front-end to work. You typically land clients for long term, highly profitable contracts. At some point you can pull back on sales and marketing spend and really let a large part of these 60+% gross margins start showing up on the bottom line.

I think the biggest risk right now in owning SDBT is trading risk. This is a small cap stock with little to no analysts following. One would think after Blackboard bought the NTI group for 6 x LTM Revenue (yes - Revenue!) that more analysts would take notice of SoundBite. If you have an appetite to buy and hold then, as the author stated, I think the upside potential is very good as SoundBite's growth into midcap renenue size range combined with large profit margins and good growth prospects in a recession will make this one a winner.