RingCentral Stock: A Compelling Buying Opportunity (NYSE:RNG)

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Investment Thesis

RingCentral (NYSE:RNG) has performed exceptionally well since going public, up over 1,000% from 2013 to 2020. The company saw a further boost in share price thanks to the pandemic, as the demand for communication software skyrocketed. However, as the pandemic waned and lockdown eased, investors started to worry about the company’s future prospects. This and the broad market sell-off caused RingCentral to plummet, with shares now down almost 90% from the all-time high last year.

I believe the massive sell-off is overdone and offers a good buying opportunity for long-term investors. While the world is moving on from the pandemic, hybrid work is here to stay. The opportunity in the communication software space remains huge. This is shown in the company’s latest financials, with revenue up over 28% despite facing a slowing economy. The current valuation is also near its historical low and a lot of pessimism is already priced-in in my opinion. Therefore, I rate RingCentral as a buy.

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RNG data by YCharts

Why RingCentral?

RingCentral is a cloud communication software company operating in the UCaaS (united communication as a service) space. It provides enterprises with solutions for voice, message, video, and contact centers. Its integrated solution allows customers to seamlessly combine messaging, video conferencing, and phone calls into one unified platform. The company’s current customers include SoFi (SOFI), Renault (OTCPK:RNLSY), and more.

Unlike the pure video conferencing space, UCaaS has a better product breadth and wider user cases, which results in more durable market growth. According to Fortune Business Insights, the global UCaaS market is forecasted to grow from The global unified communication as a service market is expected to grow from $28.96 billion in 2021 to $69.93 billion in 2028, representing a CAGR (compounded annual growth rate) of 13.4% for the period. The growth is largely driven by the broader adoption of hybrid work and distance learning. The trend is not likely to stop any time soon as hybrid work and learning are more cost-efficient for businesses.

Currently, RingCentral is the leading company in the UCaaS space alongside Microsoft (MSFT), as shown in the magic quadrant below by Gartner. It is even ahead of other giants like Cisco (CSCO) and Zoom (ZM). Unlike Zoom and Microsoft which focuses heavily on video, RingCentral focuses a lot on voice, message, and contact centers. While these segments are relatively niche, it differentiates them from other competitors and gives them a competitive advantage. The increasing popularity of Microsoft Teams is also providing tailwinds for RingCentral. As a lot of Teams’ customers currently do not have voice services, they are now turning to RingCentral for other add-on solutions, such as voice and contact centers.

Mo Katibeh, COO, on Teams’ tailwinds

Microsoft Teams, which continues to be a growth driver for RingCentral. Second quarter was the single largest quarter of growth yet. Now, the vast majority of Teams customers are on E1 or E3 licenses, which do not include any sort of phone or telephony service, a key part of any business identity. This creates an immediate opportunity to complete the cloud communication suite by adding a well-integrated UCaaS solution like RingCentral. And as to the minority of Teams customers who have an E5 license, first, they still require an incremental calling plan to make calls outside of their company.

RingCentral

RingCentral

Strong Financials

Despite the pessimism surrounding the company, RingCentral posted another set of strong results, beating analysts’ estimates and raising guidance once again. For Q3, the company reported revenue of $487 million, up 28% YoY (year river year) from $379 million. Subscription revenue increased 32% YoY from $351 million to $463 million. It also ended the quarter with an ARR (annualized recurring revenue) of $2 billion, up 38% YoY. The growth is attributed to the strong demand for its contact center solution and increased spending from existing customers.

Vlad Shmunis, on second-quarter results:

“Our second quarter key metrics exceeded the high end of our guidance range and demonstrated our consistent execution. We continue to see the benefits of scale, with solid top line contributions complemented by increasing bottom line profitability. The market opportunity in front of us is large, and customers continue to gravitate to RingCentral because of our industry leading UCaaS and integrated CCaaS solution, proven reliability and broad geographic reach.”

While the top line continues to be strong, what impressed me the most is the improvement in the bottom line. Non-GAAP operating income was $55 million, up 41% from $39 million. Non-GAAP operating margin was at a record high of 11.3%, up 110 basis points from the prior year. Margins continue to expand as shown in the chart below. Non-GAAP free cash flow increased significantly by over 104% from $14.4 million to $29.4 million, or 6% of revenue. Non-GAAP EPS was $0.45 compared to $0.32, up 40.6% YoY. The improvement in profitability is largely due to the economies of scale and better cost control.

The company also raised its guidance for FY22. Non-GAAP EPS is now expected to be $1.91-$1.95, up from the prior range of $1.83-$1.87. While the revenue growth rate is forecasted to be around 27.5%, indicating strong ongoing demand. The management team also reaffirmed its long-term target non-GAAP operating margin of over 20%, as profitability continues to improve.

RingCentral

RingCentral

Compelling Valuation

After the huge drop in share price, RingCentral is now trading at a very compelling valuation. The current EV/sales ratio of around 3.2 is near its all-time low back in 2015, as shown in the first chart below. However, the company has grown substantially since then, with annual revenue up over 600% from 2015 to 2022. The second chart below shows that the company’s fwd P/E ratio and price/FCF ratio are 23.2x and 18x, respectively. This is very cheap when considering the strong growth rate the company is posting. Zoom and Microsoft are also currently trading at similar valuations, yet their revenue growth is much lower. I believe the current multiples have priced in a lot of pessimism and offer a good risk and reward for investors.

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RNG EV to Revenues data by YCharts
Seeking Alpha

Seeking Alpha

Risks

The current pricing model and potential competition are two underlying risks investors should keep an eye on. While RingCentral operates with a SaaS (subscription as a service) model, it is priced based on the number of users. The per-set-based pricing structure may pose significant risks to the company if we were to see a huge increase in layoffs. The unemployment rate is currently still near historical lows, but we are now seeing an increasing number of companies announcing layoffs. RingCentral may also be under pressure if other companies like Microsoft or Cisco decide to enter the space. They have a much larger cash pile and ecosystem, allowing them to invest and scale very rapidly. The chances are quite low as the space is relatively niche, but it is still something worth noting.

Conclusion

In conclusion, I believe the current price appears to be attractive for RingCentral. The UCaaS market is forecasted to grow at a decent rate thanks to the broader adoption of hybrid work and learning, which will provide tailwinds for the company. Its leading market position and successful differentiation from competitors give it strong pricing power. It is also poised to benefit from the increasing popularity of Teams as those customers are forced to find external voice solutions. Despite facing a weakening economy, RingCentral continues to report superb top-line growth while improving profitability. After the significant drop, the current valuation is also very compressed, which offers a huge potential upside. Therefore, I rate RingCentral as a buy.

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