Sangoma Technologies Star2Star Update – $STC.v

On Jan 31, 2021 Sangoma announced the acquisition of Star2Star. This is their 10th acquisition and largest to date. It definitely transforms the company. Remembering Sangoma’s humble beginnings is not easy given how much the business has grown. I wanted to do a post to help synthesize my thoughts at this time as Sangoma has grown in complexity and the business had already stretched my circle of competence.

The company held a conference call to review the transaction with investors and put a powerpoint in their website. They require a special shareholder meeting to get approval.

They also released fiscal 2021 Q2 last night and held a conference call today that added a little more detail.

All numbers are in $CAD

Star2Star backgroud

  • headquarted in Florida
  • 10,000 customers, largest client is about 5% of revenue
  • has around 260 employees
  • privately held
    • 58% owned by employees (including founder), 15% is NewSpring Capital, other 27%
    • NewSpring seems quite sophisticated at first glance, here is a link to the companies they have partnered with
  • ttm rev of $107mil
  • 80%+ subscription based
  • 80%+ gross margins
  • balance growth and profitability (similar to Sangoma) with adj ebitda at 19mil (about 18%)
  • over 99% retention rate
  • they are a pure play cloud provider where Sangoma is on-premise and cloud based
  • their software is developed in house and is cloud native – meaning it is designed to be used on the cloud
  • they have a multi channel approach
  • they have a large focus on Mid-market and Enterprise value segments (this is a opportunity for Sangoma)

Rationale

Service and Product Portfolio

As discussed on previous conference calls, the CEO mentioned that customers are looking for a fully integrated provider for their unified communications needs. This concept has been coined UCaaS – unified communications as a service. They want that “one-stop-shop”. He has alluded that the focus on the business and future acquisitions will be on building out the product portfolio and channel opportunities for Sangoma. The acquisition will allow Sangoma to be a single provider with more options for cloud based, on-premise, or a hybrid of both.

The combined company will offer the most complete solution on the market.

Customer Mix

As mentioned before Star2Star has a focus on mid-market and enterprise customers, where Sangoma has been focused on SMB. Sangoma can leverage their larger international exposure of over 125 countries to market the Star2Star products which are focused in the US. The international market is generally underserved relative to the US from a cloud based solutions standpoint.

It should be noted that though cloud gets lots of love, there are still many new customers that request on-premise solutions both domestically and internationally. Sangoma already has a robust on-premise unified communications solution and now has a much more comprehensive cloud based option (or hybrid) should new customers request it. As well, it should be easier for existing customers to migrate to the cloud from on-premise.

Go To Market Strategy

Sangoma had some opportunity in various channels. This slide from the presentation goes over the pro forma channel avenues.

Market Opportunity

The combined company will now be consider top tier in industry and increases Sangoma shareholders to the faster growing cloud communications space. The increased top line will give Sangoma additional scale to support their growth strategy.

This gives Sangoma a complete fully integrated suite to take to their existing international markets which are underserved by the cloud. It also gives them a large mid-market and enterprise customer base.

Transaction Details

  • total consideration of $560mil
    • 5.23x rev
    • about 30x ebitda
    • 6.5x recurring rev
  • $135 mil in cash on closing
  • 110 million shares of Sangoma – $426 mil or so
    • 22 million shares on closing
    • 88 million issued in 14 quarter instalments starting April 1, 2022
      • I think this is a great piece on aligning both teams that may be overlooked

Combined Entity Leadership and Integration

Given that Star2Star is already a well run profitable business the integration risk is lower than some of the previous acquisitions. There are no major cost synergies planned. The opportunity is in upside synergies of the combined company.

Bill Wignall remains as CEO of the combined entity. The board will consist of 5 directors with the founder of Star2Star Norm Worthington becoming chairperson. NewSpring Capital’s Marc Lederman (an existing large shareholder in Star2Star) will also get a spot on the board.

Initial integration will include the low hanging fruit like HR and legal. More nuanced integration initiatives (marketing, R&D, etc) will take place slower and more methodically.

Pro Forma Financials

It should be noted that Sangoma reports in IFRS and Star2Star reports in GAAP so this isn’t an exact science.

  • 221 mil shares total
  • 245 mil in rev
  • 70%+ recurring rev
  • 70%+ gross margins
  • Adj ebitda of 44mil or 18%
  • expecting debt to ebitda of 2.4x or 101mil, which is quite conservative given the high recurring revenue and profitability
  • NewSpring will own about 6% of the total outstanding shares
  • Norm Worthington will own almost 25%

Initial Thoughts

I will be honest, even after executing 9 acquisitions at Sangoma I still always take time to process the acquisitions once they are announced. As an investor who gravitates to quantitative valuations the purchases tend to seem expensive. Having said that, this seems reasonable to me. The Star2Star team has build a strong business in a market that is fast growing, adds value to stakeholders and is very sticky. If Sangoma was able to pick up Star2Star at less than 10x ebitda or less than 3x revenue I would actually worry about the sophistication of the Star2Star team or the quality of the customers. I doubt you can find something with such high recurring revenue, high gross margin, steady growth, founder led, and high profitability for much cheaper. As well, both teams are incentivized to execute and remain onboard for several years.

I feel that Sangoma is getting better and better at cultivating a shareholder base that aligns with the business strategy. I still remember the days when shareholders used to yell at mgmt on the conference calls for not buying back shares when they traded less than NCAV.

Valuation and Potential Re-Rating

I would be remiss if I didn’t mention valuation, after all I own a business not a ticker symbol.

As it stands, the shares are still halted, but will trade on the 8th. I actually expect shares to open down based on my previous experience. There might be some shareholder churn in the near term.

If the shares remain flat then Sangoma will trade at the following.

The powerpoint has a slide on the potential re-rating of the share price relative to peers in the cloud communications space.

I will let the reader decide whether these are appropriate peers. As highlighted they will/do trade at a discount to these peers. I did a little digging and gathered a little more information around profitability and growth rates of this peer group.

Sangoma has one of the lower growth rates (I used organic growth and tried to strip out acquisitions) but they haven’t resorted to nuking the income statement to grow aggressively at any cost. Having said that, I am not sure even if they spared no expense I’m not knowledgeable enough to know what their growth rate would had they spared no expense.

It should be noted that Sangoma is more profitable than most, but these types of businesses do not usually trade on traditional profitability metrics.

What has to happen to make money from here

  • I believe that in order for the shares to re-rate permanently Sangoma needs to list on a major US exchange. They have committed to making that a priority this year.
  • The acquisition also needs to happen as intended, with no major customer churn.
  • Given the valuation, I think the broader market needs to be stable in order to Sangoma to re-rate. A major sell-off would likely pull down Sangoma’s share price.

Risks

  • typical integration risk that comes with an acquisition
  • there could be some upset shareholders in the near term
  • valuation is not cheap here based on traditional metrics, so there is a chance that the business performs well but the share price does not
  • the new shareholders could sell their shares as soon as they start trading and drive down the share price in the near term

Sangoma released a material change doc today and I’ll dig into it this weekend.

That’s it from me. Anyone else own Sangoma or have any thoughts?

Thanks,

Dean

*the author is long STC.v at time of writing

1 Comment

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One response to “Sangoma Technologies Star2Star Update – $STC.v

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