Woah. Sentiment swings hard in a short time. My last post on Sangoma was right after the announcement of Star2Star. Things were looking rosy. Everyone was in team #neversell and stocks only went up.
I’m going to journal my thoughts here. Hopefully it will help me digest the current set-up and maybe even encourage someone to reach out and share their opinion.
YTD and Fiscal Q3 2021
Here is a quick look of the YTD chart.
You can see where the Star2Star announcement was in late January. After the initial rise the stock went sideways for 3 months then has really been hit hard in the last month. It’s now down 23% this month alone and is well below the price before the S2S announcement.
A keen trader would have sold STC above $5 and waited for a better entry point. I did not.
The most recent quarter showed how sensitive Sangoma is to currency fluctuations. The fairly dramatic rise in the Canadian Dollar year over year had revenues down 2% in the reported CAD currency in fiscal Q3 2021. Revenues were up 5% in USD. Not stellar growth, but better than the surface numbers.
Of course, the forward numbers are more important as they will include the Star2Star business going forward.
As mentioned in the previous post, Sangoma trades at a discount to other communication platform companies . The presentation used during the S2S acquisition identified relevant peers to use for a comparison of multiples.
Here is the slide from the presentation.
The recent share price weakness isn’t isolated to Sangoma. The entire sector has been hit as investors have been less excited by technology and seem to be rotating into more inflation protected and lower multiple names.
Here is a look at the performance of the previously identified comparable group.
Using analysts forward estimates, here is what the multiples look like now. As you can see the smaller companies tend to trade at a discount. Data is from TIKR.com
Though Sangoma boasts among the highest margins on both gross profit and EBITDA, they do have a lower growth rate than some of the group. They have stated that they intentionally run a balance between growing as quickly as possible and reasonable profitability. With the acquisition of S2S, Sangoma does have a larger portion of revenue being recurring than most of their peers.
Narrowing down the peer group
Though entertaining as it is to compare Sangoma to a bunch of different companies (some of which are only loosely related), I think I can narrow down the peer group a bit.
In a recent press release, Sangoma announced that they were ranked among the top 5 UCaaS providers in North America. The top 5 consisted of RingCentral, Zoom, Microsoft, 8×8, and Sangoma. I don’t believe it’s fair to compare Sangoma to Zoom or Microsoft, but 8×8 and RingCentral seems appropriate.
If we use the multiples for EGHT and RNG and apply them to Sangoma, we get a ton of upside.
Though imperfect, I think using sales and gross profit are the best metric at the moment. It should be noted that both RNG and EGHT boast recurring revenue over 90% and are growing quicker organically. So that may justify the discount regardless of market cap and exchange listing.
However, Sangoma is comparable how much CFFO the business generates as % of revenue. Of course, I am eyeballing it as S2S is not included in Sangoma’s financials yet.
As well, Sangoma has more product sales than these two peers and spends less on SG&A as % of revenue. I mentioned earlier that Sangoma has utilized the strategy of slower (and profitable) growth.
I think it’s been beaten to death that Sangoma trades at a discount to it’s peer group. With the recent decline in share price, Sangoma now trades at what I view as reasonable valuations to build a position. Just under 3x EV/S and 17x EV/EBITDA. Of course, these are forward looking.
- As witnessed in March-May of 2021, inflation scares have a negative effect on companies like STC who derive most of their value in the terminal value of business.
- CAD rising
- Though a slow rise in CAD is likely to have a more muted effect, a sharp increase in the CAD will hurt the reported results in the near term.
- STC is not cheap on an absolute basis using more “traditional” metrics even after the pullback.
- Integration of S2S
- Though it hasn’t been an issue previously and I’m not expecting it to be an issue, Sangoma could take longer to integrate Star2Star than expected.
- Key Personnel
- Given how integral the CEO has been in the long term strategy for STC, I would view his (or any of the C-suite really) departure as negative.
At these prices, I believe Sangoma is cheap relative to it’s peers and reasonable absolute valuation. The team has been good at sourcing M&A opportunities and providing value to stakeholders. To build their platform from the ground up would be no easy task. In my digging I feel that Sangoma is one of the companies that has maintained a comparable offering for on-prem and cloud based solutions. Despite the allure of the cloud, many of the new customers are won using on-prem solutions and some businesses are not ready to migrate to the cloud. This provides a future sales funnel for their cloud solutions.
Anyone else follow STC.v?
*I am long $STC.v at time of writing.