Ooma: Impressive Growth For This Remote-Working Enabler

Summary

• Ooma is a VoIP services provider whose stock price has seen some upside in the last week.
• An important question is whether this will be a sustained.
• There seems to be a hype around the potential of remote-working technologies and thus, it is also important to give investors a clear idea.
• Revenues are strong and the company is finally having a grip on those expenses.

Ooma operates a communications platform for small businesses and consumers on which it offers cloud-based telephony. The company uses VoIP technology.

The market finally seems to be rewarding Ooma for its extraordinary streak of earnings beats (16 since the IPO) and more importantly the earnings surprise (+300% surprise) in the last quarter (consensus: $0.01 v/s actual: $0.04). Thus, there has been an upside of 20% in the last week. There was a prior 24% upside on Nov 21st 2019 when the company reported its first positive earnings in Q3-2019.

Figure 1: Ooma Earnings Surprises

Source : SeekingAlpha

I analyze whether this upside in the stock price is sustainable taking into consideration the market, competitive position as well as possible risks so that investors can position themselves accordingly. At the same time, I paint a picture of the technologies which enable remote working and how can Ooma benefit, more as an indirect beneficiary.

VoIP and Key Drivers for the PBX Systems Market

VoIP or Voice over the Internet Protocol allows people to communicate on a one-to-one basis or to make multiple calls over the internet. Using the Ooma Telo, subscribers can even plug in their analog (older generation land-line) phones and make calls without paying on a per-call basis except for local taxes.

Figure 2 : Ooma

Source : Ooma Telo will make you love your landline again

Interestingly, when compared to the competition, only Ooma has this feature. Also, no need for technical expertise to get going as the device just needs to be hooked to an Internet modem.

There has been a low adoption of VoIP services, whose limiting factor were the quality of the Internet connection. With the quality of Internet having improved and companies like Ooma having optimized their technologies to work on existing lines, VoIP services such as cloud PBX have a huge potential.

Figure 3: Growth in Cloud PBX market and ability of Ooma to unify remote workers.

Source: Ooma Earnings Call presentation Q4-2019

Another limiting factor restraining growth of IP PBX systems among small and medium enterprises was the high costs of servers and voice processing equipment. At one time, some were even using free trial versions of PBX systems designed for enterprises. Now, with cloud based PBX systems, such as those being offered by Ooma, this cost limitation factor has been drastically reduced as SMEs no longer have to endure large upfront IT infrastructure costs.

Thus businesses are transitioning to cloud business phones, which make use of VoIP and Unified Communications as a Service (UCaaS) as they need to support remote team members using Ooma softphones installed on their laptops. Also, Ooma Android and IOS apps installed on their using their mobile phones enable employees to engage in business communications, as if on their office phones.

Remote support/working, which was previously seen previously more as productivity improvement is now seen more as a "live saving" factor with the likes of Amazon (AMZN), Microsoft (MSFT), Google (GOOG) on the US West coast have already recommended their employees to work from home, as precautionary measures against the Covid-19.

The coronavirus crisis and quarantines which favor remote activities and virtual meetings are giving a boost to remote-enabling technologies and tools. However, not all the companies offering these tools will benefit in the same way.

Distinguishing between the direct and indirect beneficiaries

There are companies offering video conferencing tools like Zoom Video Communications, Inc. (ZM). There are others like Slack (WORK) and Whatsapp from Facebook (FB) which also enable co-working. These are the direct beneficiaries as they enable rapid deployment of applications to mobile phones and laptops so that teams located in geographically disperse areas can start collaborating. Companies like Ooma are more the indirect beneficiaries but the benefits are not less important as working habits change drastically.

First, as co-workers use their phones much more than before, the small businesses they work for can basically use the Ooma Cloud phone calling features to reduce their bills in the United States and Canada. Same is the case for the residential market segment, where the 2% to 3% increase forecast for the current year (2020) made during the Q4-2019 earnings call, could easily double to 5%.

There are more benefits when considering Figure 3: "Unifying remote workers and multiple offices". In this respect, Ooma solutions such as Ooma Office and Ooma business offer features like virtual office (virtual receptionist), mobility (call forwarding, voicemail) and remote office (three way conference calls). These features become crucial to allow a company’s work force to work seamlessly to a certain degree in case of an event when employees are not able to meet physically and are limited by the one-to-one communication feature offered by the mobile phone. However, there is a setup and customization time for the PBX solution just like for any other PBX provider. This said, unlike competitors, the company has been able to achieve a breakthrough which has substantially improved its competitive position.

Competitive position

Ooma operates in a highly competitive environment and recently, they were able to beat their competitors at winning a very large multinational customer with 20,000 users. Two factors which enabled them to stand out are simplicity of use and customizing the solution (in this case Ooma Office) for their specific needs.

Normally, these large customers have in-house PBX solutions, which have been specifically and extensively customized for them and thus they do not want to give up those capabilities when choosing a hosted (cloud-based) PBX solution. The fact that Ooma has delivered in such a context and met customer requirements to provide capabilities requested by the customer on Ooma's hosted infrastructure is very significant. This success could constitute a trend whereby their highly-customized solution is adopted by more of these large corporations.

The management is upbeat about the company's competitive edge and makes use of the following strong phrases during the Q4-2019 earnings: "we have demonstrated the superiority of our business solution versus others at a very large multinational corporation, and scaled it to over 20,000 users with this customer", “we've achieved growth rates for both our business revenues and our residential revenues that we believe exceed others” and “we brought to market important new features for our residential customers, including our 4G backup internet solution, we've taken internal actions to enhance our ability to drive the growth of a booming business”.

In addition, the company is now working with channel partners to expand sales and I will later show how these has potential to improve growth significantly.

The superiority of Ooma compared to its competitors is further validated by its first position as a provider of VoIP services in for the business market segment. The company scores best in “overall satisfaction” and “likelihood to recommend”.

Figure 4: Ranking by Readers for Business Segment in PCMag Magazine

Source : Ooma Conference Slideshow – Jan 15, 2020

The company stands at the first position ahead of competitors like Ring Central (RNG), VONAGE (VG) and 8x8 (EGHT) and other important names like Cisco (CSCO) and Avaya (AVYA). I next check whether this first position is translating into higher growth figures in terms of revenues.

Ooma Financials (revenues and expenses)

The company has seen considerable yearly growth in revenues (17% increases in Q4-2019 compared to Q4-2018). However, one important question in the minds of investors is whether the company can maintain these two digits growth in sales figures.

Figure 5: Annual Revenues and Annual Expenses

Source: Annual Revenues from Ooma investor presentation and Annual Expenses from SeekingAlpha

I believe that it can and the reason being that it is aggressively working with Value Added Partners (VAR) or channel partners. Now, as I had explained in my investment thesis on Counterpath (CPAH), unlike a "distributor" who is just an agent who supplies software products to retailers, a "channel partner" partners with a product development company, to market and sell the developer’s product. It can also provide value beyond order fulfillment.

While developing solutions for channel partners who, in turn will then sell the product can be time and resource consuming in the beginning for Ooma, the results can be impressive in the longer term. Salesforce (CRM) is a successful company that has grown as a result of channel partnerships promoting sales.

As a matter of fact, for the current year 2020, the company gave guidance in the range of USD 167 million to USD 170, which is a 12% increase over the full year 2019. Now, with the company's history of earnings beats, this could be a conservative estimate and the increase should be more.

However, one problem is that expenses are also increasing (figure 5). The expense consists of two components, the Research and Development (R&D) and SG&A (Selling, General and Admin) with the latter accounting for a higher proportion. Now, the management is aware and actively working on controlling those expenses. It already has seen some success with reducing R&D which taken on a quarter to quarter basis has fallen as the company discontinued research activities on non-core products.

As for SG&A, sales and marketing expenses are increasing due to higher sales headcount and increasing marketing programs to grow Ooma Business. For G&A, there was a non-recurring (will not occur in the next quarter) expense of USD 400K relating to a litigation claim.

Figure 6: Income statement with cost of revenues, SG&A, R&D

Source: SeekingAlpha

Additionally, when talking expenses, an important positive is that the company has been able to harness its cost of revenues thus increasing its gross margins (since Gross margins = Total Revenue – Cost of Revenues) in the last quarter (Q4-2019) from 58% to 61% compared to the prior year quarter. The reason for this increase in gross margins is that the cost of revenues have increased only by 5% while there has been a 12% increase in revenues for Ooma business, one of the company's major product from which it derives 42% of total revenue.

Therefore, by harnessing the cost of revenues, the company has been able to optimize on the resources (labor, processes and IT infrastructure) which it uses to develop its product. Achieving such cost efficiencies in an improving growth environment means higher gross margins and should more than compensate for any increase in sales expenses in the short term.

After seeing this great growth story unraveling, I next turn to the risks.

The risks

There are two risks, which according to me need investor attention. First relating to the Sprint OMNI viewed in context of the T-Mobile (TMUS)/Sprint(S) merger and second, the possible quality degradation on the cloud phones (making use of VoIP technology) which Ooma sells.

First, with respect to Sprint, the latter has a partnership with Ooma and launched the OMNI back in Nov 2019. The Sprint OMNI basically utilizes Ooma’s VoIP technology based Ooma Office which they have branded as Sprint OMNI. This partnership with Sprint is important for Ooma as, while Sprint sales team markets and promotes the new brand, Ooma also benefits directly in terms of revenues and indirectly as its VoIP technology becomes more popular in the US.

In addition, Sprint is also Ooma’s partner for wireless connectivity and there are expectations that one of the company’s solutions in this area, namely the Ooma Connect will be branded as a Sprint connect solution under the Omni brand.

Figure 7: Sprint Omni

Source: Sprint Business

However, the issue here is that T-Mobile already offers VoIP services and Teltik (formerly Harbor Mobile), a T-Mobile business reseller provides cell phone plan choices bundled with their cloud phone service. Teltik runs on T-Mobile network.

However, Teltik is just a Mobile Virtual Network Operators (MVNO), that is, a smaller wireless carrier which depends on T-Mobile network, as one of the currently big four US wireless network providers. Also, T-Mobile, unlike AT&T which offers VoIP devices as an integral product offering, offers these more as a non-core product offering through VoIP service providers. Hence, I see limited threat to the Ooma/Sprint partnership.

Secondly, ever since VoIP emerged on the communication scene, there have been concerns whether it would be able to deliver a clear voice quality. The quality has improved as Internet connections have been upgraded throughout the world. Now, with remote working and multimedia games and movies, internet traffic could increase three or even five-fold as people stay at home but more connected than usual. However, the fact that Ooma's services are mostly available in the US where the big four already have stable connections means that the voice quality should not suffer.

Figure 8: Big Four Download performance in competitive geographies

Source : Speedtest

Secondly, in the event of network congestion, the carriers can always prioritize VoIP traffic as cloud phones are now also used to make 911 (emergency) calls.

Therefore, there are risks which could at times cause some downside in the stock price depending on the way the news are broadcasts are done but they are unlikely to hurt the stock price in a significant way.

Valuations

Given the double digit growth, the Price/Sales (TTM) of 1.85 is on the low side when compared to Ring Central's (another important VoIP services provider but which stands behind Ooma in terms of rankings) value of 21.44.

Also, while the stock price of Ooma has seen an upside of 11.9% in the last month, its other competitors have been mostly down (-8.33% for Vonage and -18.33% for 8x8) except for Ring Central whose price has appreciated by 5.1%. Moreover, when considering price variation during the last year, a downside in Ooma stock by -4.9% is observed while for Ring Central there has been an upside of 111.9%.

Figure 9: Comparing stock price of Ooma and competitors in the last 3 months.

Source : Trading View

Based on the low Price/Sales and just 30% upside in the stock price given its competitive edge taking into consideration that Ring Central has appreciated by more than 100%, the stock should easily rise above the USD 20 level. In fact, the market has already started to reward Ooma as seen in the stock variation for the last one month and this should continue. A further upside up to the USD 25 could come in the form of windfall gains resulting from precautionary measures against the covid-19.

Figure 10: Comparing Ooma with Ring Central

Source: Price/Sales from SeekingAlpha and variations from Trading view

Key takeaways

Ooma is a double digit growth company with the potential to maintain these growth figures through channel partnerships. It has also managed to control R&D costs while at the same time reduce cost of revenues which is an indication of optimized product development.

Compared to competitors, it is ranked in the number 1 position by PC Magazine. The debt level is also low (Debt to equity at 16) compared to Ring Central whose figures are more than three times higher.

There are risks for the partnership with Sprint considered in the wider T-Mobile/Sprint merger environment and VoIP quality of call service suffering due to network congestion in the event of drastic quarantine measures. However, none of these risks is viewed as insurmountable.

In fact, the opposite could happen as VoIP traffic is prioritized over multimedia and the conference /group calls features offered by Ooma’s solution could in fact gain market share.

The current upside should continue well above the USD 20 mark, using conservative estimates.

Analyst’s Disclosure: I am/we are long OOMA. 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.

This is an investment thesis and is intended for informational purposes only. Investors are kindly requested to do additional research before investing and most welcome to request any clarification through the comments.