Ooma: Rising Operating Expenses Restricting Income Growth

Summary

• OOMA reported mixed Q4 FY23 results with moderate revenue growth but deteriorating net income margins.
• The management has provided moderate guidance for FY2024, with revenues and net loss expected to be in the range of $235.5-$238.5 and $0.9-$2.9 million, resp.
• OOMA is trading at twelve-month trailing P/E multiple of 23.17x compared to the industry standard of 14x.
• I assign a Hold rating for OOMA.

SDI Productions

Investment Thesis

Ooma, Inc. (NYSE:OOMA) is an American communication services provider headquartered in Sunnyvale, California. My thesis is primarily based on OOMA’s performance in the fourth quarter of FY2023. I will also be assessing its valuation at current price levels. I think OOMA is overvalued at current price levels, and I don’t see a significant upside in its stock price in the near future, which is why I am assigning it a hold rating.

Company Overview

OOMA provides a wide range of communication products and services to customers, majorly based in the United States and Canada. Its business is divided into two categories; Ooma Office and Ooma Telo. The Ooma Office caters to small and medium-sized businesses with cloud-based multiuser communications platforms. The office communication services include voice-over IP, HD video meetings, voice call transcription, and call center solutions. The Ooma Telo category provides communication solutions to households, including phone line services and security and monitoring solutions.

Q4 FY2023 Results

OOMA reported mixed fourth-quarter results with moderate growth in the revenues but deteriorating net income margins. I believe the subscription and services segment proved to be an outperformer for the company in the quarter, with 15% y-o-y revenue growth. However, the increased operational expenses have restricted income growth to a great extent, which I believe is the primary cause of concern for the company.

The fourth quarter FY23 revenues stood at $56.5 million, up 12% compared to $50.5 million in the same quarter last year. As per my analysis, the acquisition of OnSIP resulted in increased subscription and service growth for the company. Breaking down the revenues, we realize that the subscription and services contributed 93% of the revenues at $52.6 million, up 15% compared to $45.7 million in the same quarter last year. On the other hand, the product and other revenues accounted for 7% of the total revenues at $3.8 million, down 20% compared to $4.7 million in the corresponding quarter last year. I think this decline in product revenues is reflective of a complete shift in the focus of management toward the subscription business model. Now talking about the operational expenses, I want to highlight that the company is consistently spending a significant amount on sales and marketing, but the output of this expenditure is not up to the mark and not translating into the expected sales. The sales and marketing expenses for the quarter were reported at $18.1 million, up a significant 19% compared to $15.2 million in the same period last year. I don’t see the marketing cost going down anytime soon as the company wants to expand its customer base, and with rising inflation, it’s not going to be cheap. The research and development expenses for the quarter were $11.8 million, up 18% compared to $10 million in the same quarter last year. The increase in R&D is significant, but I think it is necessary to improve the user experience and to stay relevant and updated in the dynamic communications industry. The total operating expenses were reported at $36.5 million, up a considerable 18% compared to $31 million in the same quarter last year. OOMA reported a net loss of $417 thousand compared to $99 thousand in the same period the previous year, representing a net loss per share of $0.02 in Q4 FY23. Significantly higher operational expenses and a comparatively lower revenue growth rate resulted in the widening losses for the quarter.

Now let us have a look at OOMA’s balance sheet. As of 31st January 2023, the company reported cash and cash equivalent to $24 million. They currently have no long-term debt. One alarming thing that I would like to highlight is that the inventories have been reported at $26 million, up 90% compared to $13.8 million last year, but in the same period, the annual as well as quarterly revenue growth has been in the range of 12%-14%. The high inventory levels and its low turnover could result in serious expenses for the company in the upcoming quarters. Apart from this, the balance sheet looks healthy, and there is significant scope for the company to raise funds in the future without putting massive stress on the balance sheet.

Overall, the results reflect that the company must work on profitability and come up with strategic cost-cutting measures to restrict the losses from widening further, especially in this highly inflationary market. The OOMA management has provided moderate guidance for FY2024, with revenues expected to be in the range of $235.5-$238.5, reflecting an increase of 9.7% at the mid-point compared to FY23 revenues. The net loss is estimated to be in the range of $0.9-$2.9 million. I believe that even though the targets are moderate, OOMA could face multiple challenges in achieving these targets owing to increased operational costs.

Quant Rating and Valuation

Seeking Alpha

OOMA has a Quant rating of Hold by Seeking Alpha. This clearly indicates that the stock has limited upside potential. It has a D- grade for valuation, which I believe accurately represents the company’s overvaluation at current price levels. The company has a C grade for profitability, which is a clear reflection of its financial performance in the recent quarter. OOMA has an A- grade for growth, which is primarily due to the revenue growth experienced by the company in recent quarters, but I do not think this is the right representation for the current revenue growth rate, and the grade could go down to B in the coming months. OOMA is ranked 17th out of 26 companies in the industry and 125th out of 254 companies in the sector, which reflects that there are better investment opportunities in the communication space.

OOMA is trading at a share price of $12.5, a YTD decline of 9%. It has a market cap of $310 million. OOMA is a loss-making enterprise as per the GAAP accounting method; that’s the reason I will be using non-GAAP numbers for its valuation. It is currently trading at a twelve-month trailing P/E multiple of 23.17x compared to the industry standard of 14x. This clearly reflects the fact that it is significantly overvalued with respect to its earnings. I do not see any reason for OOMA to trade at such a premium valuation, and I would recommend investors not to invest in the stock at the current price levels.

Conclusion

OOMA did experience revenue growth in the fourth quarter of FY23; however, profitability is the main cause of concern for the company. The operating expenses are consistently rising on the backdrop of increased sales and marketing costs. The high inflationary environment is only going to make things tougher for the company in FY24. They are overvalued at current price levels with respect to their earnings, and I see no reason for them to trade at such a premium valuation. Considering all these factors, I would recommend investors not to invest in this stock at its current valuation, and hence I assign a hold rating for OOMA.

Analyst’s Disclosure: I/we have no stock, option or similar derivative position in any of the companies mentioned, and no plans to initiate any such positions within the next 72 hours. 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.