Kaleyra: mGage Acquisition Analysis, Including Conversation With CEO Dario Calogero

Summary

• Kaleyra on Feb 19th announced the acquisition of mGage, an enterprise messaging provider majority owned by Blackstone for $215 million.
• The CEO of Kaleyra was kind enough to answer a few of my questions regarding the deal that were not entirely clear in the acquisition conference call.
• The direct connection to all 4 US telecom carriers is a prized asset held by only 3 other companies and the margin profile of Kaleyra is set to improve dramatically.
• The post-merger company will instantly be much closer to the 40/30/30 US, EU & APAC/ROW revenue goal of the company and will be rife with cross and upselling possibilities.
• I am keeping my S/EV ratio target of 5, however with the added sales of mGage purchased at a shocking 1.26 S/EV, this allows my fair value target to increase all the way to $46.

In this article, I would like to discuss Kaleyra's (NYSE:KLR) recently announced acquisition of enterprise messaging company mGage from majority holder, Blackstone Group (BX) and go over the implications for the company moving forward.

If you are not familiar with Kaleyra, the Italy-based multinational CPaaS company, I would recommend the following primer articles from myself here and from fellow Seeking Alpha contributor Matthew Zeets here before reading on.

The mGage Deal Specifics

On February 19, shareholders of Kaleyra such as myself awoke to news of the company acquiring multinational enterprise messaging company mGage in a truly transformative $215 million dollar deal.

mGage, is a best-of-breed mobile messaging solution allowing enterprise clients across a diverse range of end-markets to effectively engage with their customers through all mobile channels for a variety of use cases. mGage serves its customers through its cloud-based enterprise mobile messaging platform Communicate Pro, their API solution Connect, as well as Omnichannel mobile messaging offering such as SMS, MMS and RCS.

To fund the acquisition of mGage, the company will issue $200 million of aggregate principal amount senior unsecured convertible notes due in 2026, with certain institutional investors and $125 million of gross proceeds from the issuance of 10 million shares of Kaleyra common stock in a Private Investment in Public Equity (PIPE) transaction, with institutional investors priced at $12.50.

The consideration to mGage shareholders will consist of cash in the amount of $195 million and 1,600,000 shares of Kaleyra common stock. In doing the basic math of the transaction, mGage was purchased at a rather unbelievable price of 1.26 forward 2021 S/EV and an even more attractive 6.98 adjusted 2020 EBITDA figure. The deal is expected to close early in Q2.

Source: The trusted CPaaS - Kaleyra website

Those are the basics, now let us get to the fun stuff!

The Transformation

So, what changes with Kaleyra after the merger? In short, a whole heck of a lot! And in my view this deal appears to be nothing short of a grand slam.

Overnight, Kaleyra has transformed itself into a top 5 global CPaaS company stretching all over the globe. They are now the clear leader of the CPaaS industry in the important growth market of India and are now a legitimate player in the United States and the United Kingdom to go along with the company's home base in Europe.

In addition, the company is addressing one of my main concerns I have held by dramatically improving both the margin profile and the scale of the business.

Source: The trusted CPaaS - Kaleyra

I must admit that when I first viewed the above slide from Kaleyra, I had to fight back tears in my eyes. The combined company will not only double revenue and scale but is projected to increase gross margins by roughly 22%, EBITDA margins by 237% and total EBITDA by a whopping 462% to over $45 million in 2021.

Importantly, the company also is now almost dead on with its long-term revenue by geography goals with a projected balance of 33% of revenues generated in Europe, 31% North America, 18% APAC and a further 18% rest of world (primarily in the UK).

What changes this deal from great to amazing in my eyes is the vast cross-sell and synergies the combination offers.

Source: The trusted CPaaS - Kaleyra

The company is able to double-dip in the form of reduced costs through greater volume discounts and duplicate back office corporate cost elimination paired with what I see as the clearest cross-sell opportunity possible.

The two companies share zero customers and offer completely complementary products which means there should be no cannibalization of any kind in the cross-sell effort.

The company has guided for $7.8, $15.7 and $19.4 million in cost and revenue synergies in 2021-2023, respectively; however, this is in my opinion an extremely conservative projection as each customer the respective companies currently have is a 100% green space opportunity for the others services. Not only can Kaleyra cross-sell its products to mGage customers but they can now offer mGage products to Kaleyra's current customers.

In a perfect world with 100% cross-sell adoption, the potential of the combined company is likely in the neighborhood of $722 million in 2021. Now, obviously that is not at all feasible, but the guidance provided is only assuming a 2.1%, 4.3% and 5.4% cross-sell ratio.

In my opinion and my hope is that this cross-sell guidance is massively understated and was given to build in a margin of safety allowing the company to wow us quarter after quarter by consistently over delivering.

Last but certainly not least, Kaleyra will be inheriting mGage's tier 1 status with all US telecom providers, AT&T (T), Verizon (VZ) and T-Mobile (TMUS).

Source: The trusted CPaaS - Kaleyra

This is quite a big deal for multiple reasons, first is simply the quality of service that Kaleyra can now provide to its customers in North America. The CPaaS market is predicated on the quality of your service and specifically as you move up the chain of services from SMS to voice, video and chatbots the requirement of your customers becomes more and more stringent.

With the addition of tier 1 status, Kaleyra can now credibly cross-sell a suite of products to mGage's enterprise customers on equal footing with the biggest players in the market.

Second is cost. The direct connection to all major telecom carriers brings with it a certain reduction in costs associated with it. Third is simply the clout the company now will enjoy. They will be able to walk in to each sales meeting knowing that they are only one of 4 companies in the world with this direct connection to the carriers, instantly giving the company further leverage in crafting deals with the promise of a higher quality service that many competitors can provide.

Q&A with Kaleyra's CEO

After the announcement of the deal and the resulting conference call, I reached out to the CEO of Kaleyra to ask for clarification on some items that I felt were still unclear or not covered on the call. My questions focused specifically on the cross-sell opportunities, the anticipated US expansion along with mGage's API and integration with Kaleyra's flow builder.

Below, please see a portion of my conversation regarding the mGage purchase with CEO Dario Calogero who was gracious enough to give his permission for publication of this Q&A.

1) mGage seems to focus exclusively on messaging for enterprise clients, I am wondering frankly why they have not expanded into other areas such as video and voice as it seems to be a natural product leap and appears to provide much greater margins? The concern here for me would be if there is truly a cross-sell opportunity as logic would say that mGage would have already explored this avenue for organic expansion.

mGage is a GSO/BS asset. I assume that the Seller has concentrated the resources on one single channel (SMS mainly and its natural evolution RCS) because the Omnichannel play requires incremental investments that are typically consisting of hiring product and development engineers. Focus and short-term optimization, not long-term evolutionary strategy.

2) Do you see mGage’s existing customers migrating to your flow product or will you continue to operate mGage as an independent company using its existing API? It would seem Flow would provide a greater opportunity to showcase your other products if it would not cause too much disruption.

First thing, it's a little early to say. Second, I believe that mGage existing customers are happy with the product that they already have. Said that, as soon as possible we will be very keen to explore the cross-selling opportunities on both sides and also we will look in the product/platform on both sides to pursue economies of scope and synergies. The point is that the two companies have zero overlap on the customers and a very complementary offering, mGage more on Mobile Engagement and KLR more on transactional notifications. If you split the downstream communication processes of any Enterprise with their Customer (consumer) you will observe three macro processes: 1/ presales (generating the demand); 2/ sales (actually doing the transaction); 3/ post sales (Customer Relationship Management). While mGage is focusing more on the first one, KLR is mostly on the other two. In principle I would say significant cross-selling opportunities. Moreover a very nice geographical complementarity, and the Omnichannel capabilities of KLR Technology will be exploited on the mGage footprint.

3) The direct connection to the carriers would on the surface appear to be a further avenue for margin expansion and a fantastic pickup, is this something that will help margins or is this more of a service reliability and latency addition only? On the conference call it appeared that the direct connection was not highlighted as a contributor to a path towards greater margins in the states.

Both. In messaging discounts come with the scale. Together mGage and KLR will process over 50B SMS LTM which hopefully will lead to better sourcing costs, at least in some areas (GEOS). Also, in general 0-Hops interconnections, or Tier-1, bring higher QoS which is mandatory in the transactional space, i.e. SCA/OTP in Banking or in e.commerce.

4) Do you see this acquisition as an avenue to broaden out your reach in the USA beyond financial clients and diversify into travel, retail, etc. or should we think of this as an opportunistic purchase?

It's 100% strategic, not opportunistic at all. US domestic market is part of the equation, but accounts only for 41% of mGage revenues. Also LAC and India are important. Also EU is important, in the UK mGage is relevant.

From this conversation, I came away with a much greater understanding of just how much opportunity is present through revenue synergies and cross-selling along with putting a question to rest that I had regarding simply why mGage had not made the leap to upsell their current customers premium services like voice and video.

Also, after my Q&A and Mr. Calogero's response to my question regarding flow builder, I replayed the conference call and developed a much greater appreciation for mGage's API and the technology/expertise that can be integrated back into Kaleyra's operations, R&D and sales process.

I believe that the direct connection to the carriers was a key concern here for Kaleyra and not simply a cherry on top as he indicated that the quality of service that a direct connection provides is a major requirement in the sectors in which the company hopes to expand.

The only other question that I had, which I did not pose to him as it was well-covered in the call, is simply why did mGage sell for such a low price?

As the CEO indicated on the conference call, Blackstone is rolling over $20 million of the cash paid to them into the (PIPE) issuance in addition to the shares received, indicating that Blackstone sees the value of the transaction and is looking forward to becoming a long-term partner and stakeholder in the combined company into the future.

It was also stated on the call that current mGage management was overwhelmingly supportive of the deal with Kaleyra and made that fact well known during the sale and negotiation process. Reading between the lines here it looks clear that mGage management was dead set on merging with Kaleyra, as the alternative looked to be a sale to another private equity firm.

At the end of the day, if the only real question that the investing public has with an acquisition is that you underpaid for it, then you have got one heck of a deal!

Updates to Valuation

Due to the low 1.26 S/EV number that Kaleyra is paying for the acquisition of mGage, the valuation profile of the company looks once again incredibly appealing.

With $361 million expected combined sales in 2021 and a current enterprise value of only $524 million and after adding in the $215 purchase price for a combined EV of $739 this takes us down to a 2.04 S/EV ratio on 2021 expected revenues.

Sticking to my 5 times S/EV target I previously set, which is looking more and more conservative by the day with the improving margin profile and growth outlook of the combined company, this takes me to a fair value of $46 per share or over 245% above current levels.

Data by YCharts

Investors have enjoyed nearly 300% returns so far since my initial article highlighting the company and the valuation discrepancy with peers. However, with this purchase and the resulting S/EV valuation reset, investors are offered an even greater discount to peers Twilio (TWLO) 36 S/EV, RingCentral (RNG) 29 S/EV and Bandwidth (BAND) 12 S/EV.

With this acquisition, the company is even trading at a discount to the major telecom carriers themselves with AT&T, Verizon and T-Mobile at 2.28, 2.80 and 3.60 S/EV, respectively.

I would absolutely love to hear a solid argument that Kaleyra, a company currently growing revenue at a 22% rate, in a booming field with miniscule debt and a vast growth runway ahead of it, should be valued lower than AT&T.

Bottom Line

This is clearly a fantastic deal for Kaleyra, it simply checks all of the boxes. mGage and Kaleyra are much better together than they ever were apart and in my wildest dreams I could not have asked for a better purchase price or resulting valuation. This is the definition of a well-negotiated, accretive deal that benefits shareholders, customers and employees.

This deal also gives investors another chance to purchase the company at a ridiculously low value of 2.04 times 2021 forward S/EV compared to the pre-deal figure of 2.91. In essence, investors were just given a 30% off coupon for a company with markedly better prospects than they were before Feb 19.

Before this deal, I was slowly accumulating a greater position in the company which is already the largest position in my portfolio. After the deal, I am now back to buying this with both hands!

Let's be clear, the company does have risks. It is still a rather small company with deeper-pocketed competitors, the ever-present potential risk of technological disruption and is likely to be highly volatile going forward; however, in my view this acquisition was a de-risking event and I am far more confident in my position today than I ever was prior to February 19.

Thank you for reading and good luck!

Analyst’s Disclosure: I am/we are long KLR, TWLO, T, VZ. 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.

"I am not a licensed financial advisor. This is not a solicitation to buy or sell a specific security nor is it to be construed as investment advice, please contact your licensed financial and tax advisor for advice to your specific situation"