Glowpoint: Solid Execution On Growth Strategy Is Showing Impressive Results

| About: Glowpoint Inc (GLOW)
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Management is two years into the implementation of a successful growth strategy comprised of investment in a cloud-based video collaboration services platform and shift away from legacy services.

Despite a modest revenue decrease partly due to this shift, gross margins and EBITDA reached the highest level in >5 years; EBITDA growth should accelerate further as revenue actually increases.

As the platform becomes increasingly automated, gross and EBITDA margins should increase to ~60% and 20%+ from 45% and 17% currently.

A refinancing provided by its largest shareholder removed a near-term debt maturity; the exchange of preferred shares eliminated a $10.2 million liquidation preference and annual dividends of $600,000.

Glowpoint is the only publicly-traded pure play in the video collaboration market; steady investments by strategic buyers in the past year support the investment thesis.

Company overview

Glowpoint (NYSEMKT:GLOW) provides video collaboration, network and support services that allow customers to use videoconferencing as an efficient and effective method of communication.

New management almost two years into growth strategy yet market is oblivious

Since Peter Holst came on board as CEO in January 2013 (shortly after GLOW acquired his company Affinity VideoNet in October 2012) and David Clark as CFO two months later, GLOW has built a cloud-based and automated video collaboration services platform from the ground up, reduced costs and successfully managed the shift away from legacy non-core professional services (video communication solutions for live-to-air or live-to-tape production).

Although the latter was partly responsible for the 4% revenue decrease in 3Q14 to $8 million, gross margins expanded 469 bps to 45% due to increasing efficiencies, operating income improved to $556,000 from $(105,000) and EBITDA increased 11% to $1.4 million for a margin of 17.1%. Not only were each of these metrics the highest in >5 years but this margin expansion was despite an intensely competitive environment.

If the recent improvement in bottom line profitability continues as expected (from a net loss of $551,000 to net income of $198,000), there may be a partial reversal of the full valuation allowance against the $37.2 million of NOLs that do not begin to expire until 2017.

However, there is still room for meaningful improvement as management said at the Craig-Hallum conference (audio only; free registration) in September 2014 that the goal in the next three years is to increase gross margins to 60% and EBITDA margins to 20%+ by replacing manual redundant tasks (high touch) that have been performed by people for the past 15 years with zero-touch automation.

Improvement in financing removes three key risks

The threat of a near-term debt maturity has been removed (principal payments of $3.6 million and $3 million would have been required in 2014 and 2015, respectively) after a refinancing in 4Q13 provided by its largest shareholder Main Street Capital (which owns 43%) extended a majority of maturities to 2018. In 2H13, all of the outstanding Series B-1 preferred shares were exchanged into common shares, which eliminated a $10.2 million liquidation preference and annual dividends of $600,000.

GLOW has been able to fund capex (which is lower after the shift to the cloud) with internally generated cash flow (FCF of $354,000 in the LTM) compared to several years ago when GLOW consumed cash. Usage-based pricing (including monthly subscriptions) reduces working capital requirements and the shift towards relying exclusively on channel partners rather than a direct sales force (which should be complete within the next two years) reduces sales and marketing expenses.

Think outside the boardroom: The future of video collaboration

By the end of this year, 87% of enterprises plan to add video communications to their unified communications (UC) deployments. However, these enterprises are not simply building more video conference rooms (typically located in a boardroom) but rather extending this functionality beyond desktops to their increasingly virtualized employees who use tablets and mobile devices, in which the market is growing ~10x the rate of traditional UC. For example, the global UC market is growing at a 15.7% CAGR while the market for video-enabled mobile devices used by businesses is growing at a 162% CAGR.

GLOW should benefit from three trends. The first is the trend of a growing number of employees working from home or out of the office, which by definition increases the demand for collaboration services given the physical separation. Second, the trend towards replacing often unnecessary physical meetings with video conferences has already reached the tipping point as the financial savings from the elimination of travel costs provide a rapid ROI while employee productivity is maximized. The third is the shift from in-house, hardware-based solutions to outsourced, cloud-based solutions. The interoperable Glowpoint Cloud platform seamlessly consolidates audio, web and videoconferencing services across different hardware/software platforms (Polycom, Cisco, Microsoft, Avaya) and networks.

The superior service and support (here is a specific example) provides a competitive advantage given the effective "zero tolerance" policy for failures or interruptions, which ultimately results in high customer retention and increased use of the platform. For example, GLOW provides concierge services, in which a conference producer personally launches the meeting, greets participants, adjust settings and remains on the call.

The fact that GLOW already has >1,000 customers in 96 countries including Disney, ESPN and McKinsey is evident of its competitive position. Even companies with in-house IT departments utilize GLOW's services specifically because of its expertise.

Management said on the 3Q14 conference call that it has already generated $1 million of revenue from a very small group of customers this year from the new platform, which should be more widely deployed next year.

There are two near term catalysts. The first is continual new product launches including a hybrid video service (combines high and low touch services) in 4Q14, Reservationless video service (allows users to collaborate via video on demand) in 4Q14 and IT Service Management platform (a multi-tenant, web-based platform that allows customers to manage and measure incidents, problems, changes and service levels) in 1Q15. The second is the recent addition of three global channel partners, which could yield results in mid-2015 as they are currently on the beta side of the platform.


Although the refinancing removed the near-term maturity risk, there is still $11.3 million of debt (due largely to the Affinity VideoNet acquisition), which requires annual interest payments of ~$1.3 million.

GLOW is dependent on its network providers accommodating (at a reasonable fee) the expected increase in video traffic. Any system failure or interruption would most likely result in customers switching to a competitor or simply dropping video conferencing altogether in favor of traditional teleconferencing.

GLOW faces direct competition from the >300 companies offering similar services as well as indirect competition from telecoms and larger competitors (or their subsidiaries) that offer web collaboration services (Citrix or Webex, which is owned by Cisco). Although the level of competition is expected to increase, the number of competitors is expected to decrease due to the ongoing industry consolidation as larger companies acquire smaller ones with unique offerings. However, this is not a zero sum market opportunity as the $10 billion total addressable market for conferencing and collaboration services is large enough to accommodate many competitors, which can grow by stealing market share from traditional audio or web collaboration service providers rather than just each other. GLOW should remain competitive as a result of the continual product upgrades/expansion, patents in key areas of routing/service delivery and strong reputation.

In the YTD period, two major wholesale partners accounted for ~21% of revenue. Management expects a small number of customers to account for a majority of revenue going forward.

Valuation and price target

A traditional peer comp is difficult as many of its direct competitors are private while the seemingly unfavorable comparison to its closest publicly-traded peer is less meaningful (and primarily provided for context) for two reasons. First, not only is GLOW the largest publicly-traded pure play in the video collaboration market but many of its peers are not cash flow positive or have a much lower revenue/EBITDA run rate. Second, the fact that EBITDA reached the highest level in >5 years despite lower revenue implies significant (and underappreciated) earnings power as revenue growth accelerates in the next several years.

Although terms or revenue/EBITDA data of the following acquisitions (or investments) within the past year were not disclosed, these strategic buyers almost certainly paid higher multiples than GLOW currently receives. Blue Jeans Network raised $50 million in September 2013 (and only had $10-15 million of revenue), Fidelity acquired Vidtel in October 2013, Snapchat acquired AddLive in May 2014, Cisco acquired Assemblage in June 2014, Vidyo raised $20 million in July 2014 and Blackboard acquired Requestec in September 2014.

The price target of $1.95 is derived by applying a 10x multiple to EBITDA of $8.1 million (20% EBITDA margin on revenue of $40.4 million; 25% above the LTM level), which GLOW should be able to generate in the next 2-3 years. The stop loss should be placed below the recent low at ~$1.10.

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