Bandwidth: Take Advantage Of The Dip To Buy At A Discount To Peers

Summary

• Shares of Bandwidth have inexplicably fallen ~20% from all-time highs after the company reported fiscal fourth-quarter results.
• The company saw revenue growth in excess of 80%, a reflection of strong pandemic-driven internet usage and the contribution from Bandwidth's acquisition of Voxbone.
• The company's dollar-based net revenue retention rate also soared above 130% in the quarter, putting Bandwidth above most other SaaS peers.
• The stock's <8x forward revenue multiple sits at a meaningful discount to most other software companies.
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With the recent rout in tech stocks owing to concerns over valuations and rising interest rates, some companies have been unfairly punished despite sitting at reasonable valuations already. One stock I've loaded up more on during the recent correction is Bandwidth (NASDAQ:BAND), a CPaaS (communications platform as a service) provider that helps companies build text-and-voice capabilities into their applications and is a smaller, lesser-known rival to Twilio (TWLO).

This software stock has enjoyed a very strong 2020. One of the best aspects about Bandwidth is that, like Twilio, the company collects revenue from its customers based on usage: that is, per text or per minute of voice call. The fact that we've increased our usage of the internet and our mobile devices during the pandemic means that Bandwidth's revenue also proportionally rises: a circumstance made clear not only by Bandwidth's surging revenue growth, but also by its net revenue expansion rates, a closely-watched metric in the software sector.

Yet despite these strengths, and a very strong fourth-quarter print released at the tail end of February, Bandwidth still remains ~20% off highs. This creates a really good buying opportunity in a very strong, if underappreciated, stock:

Data by YCharts

To me, there are a number of tailwinds for Bandwidth that are driving the bullish thesis for this stock, and why I think a near-term recovery is appropriate for the company:

• Growth is stellar, and like Twilio, Bandwidth prices its services based on usage. Bandwidth's 80%+ revenue growth (though supplemented by an acquisition) is tremendous. Usage-based pricing is the key behind many stocks that saw exponential revenue and stock price growth in 2020, including Twilio and companies like Fastly. Bandwidth's pricing follows a similar model, with voice calls costing $0.01 per minute and SMS messages costing $0.004 per message, for example (corporate clients would get customized rate packages that are better than list price). The key point here is that, because we are now using our apps and phones for virtually everything now, the amount of API calls to Bandwidth's services will keep exploding, giving it plenty of room to expand within existing clients.
• Recent international push. To date, Bandwidth has been largely a U.S. company catering to U.S. clients. Its growth has largely been organic. Last October, however, Bandwidth spent €446 million to acquire British competitor Voxbone. Two months of Voxbone's revenue were included in Bandwidth's fourth-quarter results. The company brings an instant $85 million in 2020 revenue (roughly a quarter of Bandwidth's current scale) and jump-starts its European market coverage.
• Large TAM post-acquisition. After acquiring Voxbone and expanding its territory overseas, Bandwidth believes its TAM will hit $17.7 billion in 2024 (suggesting only ~2% penetration at Bandwidth's current scale) and that the market will grow at a 33% CAGR from 2019-2024.
• Strong history of profitability. Though Bandwidth has stepped on its sales and marketing gas pedal and made acquisitions to capitalize on its healthy growth in 2020, the company has previously been able to generate both positive cash flow and GAAP profits. It will be able to return to profitability at a much greater scale in the near future.

In spite of these strengths, Bandwidth still trades at a fairly modest valuation. At current share prices near $153, Bandwidth has a market cap of $3.73 billion, and after netting off the $112.2 million of cash and $282.2 million of debt on Bandwidth's latest balance sheet, its enterprise value is $3.90 billion. This represents a 7.6x EV/FY21 revenue multiple versus Wall Street's expectations for $463.3 million in revenue (+35% y/y). Bandwidth itself has guided to revenue in a $460.4-$464.4 million range:

Figure 1. Bandwidth FY21 guidanceSource: Bandwidth Q4 earnings release

Competitor Twilio, meanwhile, trades at north of 20x forward revenue - despite similar ~30-40% levels of organic revenue growth (Twilio has about a ten-point gross margin premium to Bandwidth, but that hardly explains the large disparity in the two valuations).

To me, Bandwidth has plenty of head room to recover and rally even beyond its prior highs, especially with so many growth tailwinds at its back. Use the near-term dip as an opportunity to load up on this stock.

Q4 download

Let's now cover Bandwidth's latest quarterly results in greater detail. The Q4 earnings summary is shown in the table below:

Figure 2. Bandwidth Q4 resultsSource: Bandwidth Q4 earnings release

Bandwidth's Q4 revenue grew 82% y/y to $113.0 million, blasting past Wall Street's expectations of $96.7 million (+56% y/y). Bandwidth's revenue growth also accelerated versus 40% y/y growth in Q3 - the primary driver being the closure of Bandwidth's acquisition of European peer Voxbone, which the company said was running at an ~$85 million annual revenue run rate in 2020 (for Q4 specifically, the two months of Voxbone results that were consolidated into Bandwidth's results contributed $17 million to the CPaaS revenue line). Still, however, it wasn't just acquisition optics driving Bandwidth above expectations in Q1: the company reported that ex-Voxbone, CPaaS revenue would have stood at 53% y/y growth - also accelerating over Q3's 43% y/y CPaaS revenue growth rate.

Customer metrics were also very positive in Q4. As previously mentioned, strong usage during the pandemic has led to incredible expansion within Bandwidth's install base. Dollar-based net retention rates stood at 133% in the quarter, 20 points better than 113% in the year-ago quarter and even improving two points sequentially from 131% in Q3. The company also added 833 net-new CPaaS customers in Q4 (including the contribution from Voxbone), ending FY20 with a customer base that is 65% larger than the prior year.

It's important to note that Bandwidth called out two very specific factors that drove higher revenue in Q4: political internet traffic related to the November elections, and the coronavirus. Per CFO David Morken's prepared remarks on the Q4 earnings call:

Excluding Voxbone, Bandwidth's standalone CPaaS fourth quarter year-over-year revenue growth was 53%. Our growth was driven by the broad-based fundamental strength in our business and amplified by two factors. First, political messaging contributed more than $8 million to fourth quarter CPaaS revenue.

Second, COVID related tailwinds, which continued to decline sequentially in the fourth quarter, contributed approximately $2 million to CPaaS revenue. Combined, political messaging and COVID-related usage added 19 points to our fourth quarter year-over-year growth rate."

Bandwidth's FY21 guidance, which calls for ~35% revenue growth despite the added contribution from a full year of Voxbone, does seemingly strip out the temporary impacts of political-related traffic and an easing of pandemic tailwinds. However, particularly on the pandemic tailwinds end, we do think much of this strength will carry over, as our increased reliance on apps is unlikely to fade as we normalize from the pandemic.

Greater scale has also helped Bandwidth nudge up its CPaaS margin profile. In Q4 alone, Bandwidth increased CPaaS gross margins by two points to 51% on a pro forma basis; likewise, full-year CPaaS margins edged up two points to 50%. Continuous improvements in gross margin in FY21 (especially as Bandwidth fully folds in the Voxbone acquisition and continues to grow organically ~50% pace exiting Q4) will be a key watch item for the current year.

Figure 3. Bandwidth gross margin trendsSource: Bandwidth Q4 earnings release

Bandwidth's pro forma EPS of $0.13 also smashed Wall Street's expectations of $0.04, as the company rounded out FY20 with $14.2 million in positive pro forma operating income despite a loss in the prior year:

Figure 4. Bandwidth profitability trendsSource: Bandwidth Q4 earnings release

Key takeaways

There's a lot to like about Bandwidth as it enters FY21 in a position of tremendous strength: strong organic growth, a promising acquisition that expands Bandwidth's access to the European markets, and a compelling valuation after the recent ~20% correction from highs. Buy the dip here.

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

Comments

[kalu0003]

Gerry_Che
I totally agree with you. All analysts who focus on price at the expense of the quality of the business are simply poor analysts. These type of analysts focus on the earnings reports. They simply copy and paste tables and figures from these earning reports with zero analysis of their own. Stocks are cheap for a reason. I always go for the best of the breeds and I am will to pay a higher price. The best of the breeds have a wide moat. My 2 cents.

[G_X_C]

You always focus on price, but the right way is to focus on quality. This is why your recommendations perform so bad.

[kalu0003]

Out_on_a_limb
No, I am not jealousy. I just feel pity for you Out_on_a_limb for your losses. Losing your hard earned money in this fashion is bad indeed. I hope next time you will do much better to avoid or reduce your losses. Thanks

[Out_on_a_limb]

@kalu0003, I feel sorry for you. All the opportunities you've lost! Even your brain. Do you think the Fed will let interest rates run very high? You've lost your mind.

[kalu0003]

Are there some folks who are bleeding heavily due to their heavy investment style in growth stocks? calm down. This is just the beginning. Hopefully you are learning a good lesson in stock investment. Rates are still too low and when they really start jumping off - you know the story. Thanks

[Out_on_a_limb]

@kalu0003, you are so happy to vent out your frustration. I pity you. If you think the future is old economy stocks, stay invested there. You'll still loose at the end. There is no immanent justice. Jealousy is a horrible thing.

[wan yixiar]

If we consider the FY2021 expected sales ($463.3M), with todays price around $131 this means a P/S = 6.2 which is extremely low compared to peers. Buy the dip!

[kiwicarrotcake]

Think we hit low 120's thats when I am going long

[Taek]

@kiwicarrotcake Looks like you're right..

[kiwicarrotcake]

@Taek Gonna trade with all the other incredibly pricey SaaS stocks. Holding up surprisingly well..would have thought low 120's today for sure.

[kiwicarrotcake]

@kiwicarrotcake Nvm there it is

[kiwicarrotcake]

As long as rates keep ripping and negative sentiment keeps building towards tech...uh-oh.

[Invetrts]

Trading below 200 MA, seems that the only way is down.

[kalu0003]

It seems investing in BAND is dead money based on the forecasted results. Thanks

[Chrisaoun]

weak forecasted organic growth, if we exclude expected contribution from Voxbone, organic revenue is forecasted to grow at only 11% next year. Probably conservative but still pretty weak

[rammbler65]

@Chrisaoun I calculate 22% forecasted organic growth since last year included 2 quarters of voxbone. This seems very conservative with recent beats and organic growth above 50%.

[Chrisaoun]

@rammbler65 only the 4th quarter has voxbone revenue, total amount is 17.5 mil. Acquisition closed beginning of 4th quarter

[rammbler65]

@Chrisaoun Thanks for the correction. Somehow, I read 2 months as 2 quarters. With this correction, I calculate about 14% organic growth, a little higher than your estimate. But either way, if the market believes this guidance, that would explain the drop. But their low guidance doesn't seem to make sense give recent organic growth of 63% in the 4th quarter (excluding voxbone) and customer growth.

[1counselor]

no comment whatsoever on the -.81 cents loss of earnings that exceeded expectations by a wide margin---come on man.

[Wantingtotravelagain]

This is nothing but momentum trading...you benefit on the way up and take the hits on the way down...chart says it all...on two occasions it bounced at 144ish...BAND is in this channel until otherwise noted on the upside or downside....take a breath as it isn't always about the fundamentals. Can't have it both ways...

[Out_on_a_limb]

@Wantingtotravelagain, you are looking at the chart merely in weeks. Not valid. The stock is building a base, as it jumped quickly from the prior level (in the 50's).

[Wantingtotravelagain]

@Out_on_a_limb are you feeling ok? Band has been in a wide range for 6 months (180s to 140s). I don't consider that weeks nor base building The swings have been wide and very much momentum driven as of the last six months. If the macros continue to breakdown so won't your base building idea. Hope you are correct but not your typical base building activity

[Out_on_a_limb]

@Wantingtotravelagain, no need to disparage. The plateau started in September, which is nothing . A base can build over several years. Stocks are for the long haul, otherwise you'll lose due to interim volatility. But to each one his own.

[kalu0003]

Gary Alexander,
what is the advantages of owning both TWLO and BAND? Can BAND dislodge TWLO? or Can TWLO dislodge BAND? Is BAND the best of the breed in this space? Is it rational to buy a second class investment simply because it is cheap? Thanks

[rammbler65]

I reached the same conclusion at higher prices. With the current outlook suggesting continued strong growth and a recent stellar earnings report, the drift lower at this multiple is extremely baffling. Every analyst I respect is extremely bullish but it keeps getting cheaper. Either the market is temporarily irrational or the we're all missing something here, hopefully the former.

[67bmer]

The chart is going from bad to ugly and I can’t find a reason either. If it can’t recover on days like today than when can it? I am more inclined to be a seller than a buyer. Not shot but if market repeats last week it might be a potential short.

[Aidy]

@Gary Alexander What are the chances of BAND being acquired and whom might be interested in doing so?

[waterman101]

Nice summary. Very compelling opportunity here, no clue why this is trading wildly cheap. I've been buying BAND over the last couple weeks as well as KLR today. The multiples being this low are nonsense in a 30%+ CAGR space. I mean, c'mon. C'mon.

[kalu0003]

All,
what is the advantages of owning both TWLO and BAND? Can BAND dislodge TWLO? or Can TWLO dislodge BAND? Thanks

[wan yixiar]

@kalu0003 It is the same advantage as if you buy Amazon and Walmart or Costo, or if you buy Micron and WDC or any other microchip manufacturer, i.e. there is no specific advantage only you need to believe in this market. It can be an idea to buy 50/50; actually, BAND is cheaper than TWLO and has the advantage of the infrastructure, TWLO is said to be more aggressive in sales...