SoundBite Communications: Cheap Valuation Means It's Time To Buy

A more thorough and detailed analysis of SoundBite Communication’s (SDBT) last quarterly and full-year 2007 report and reevaluation of the company’s financials and fundamentals, have only reinforced my original investment thesis.

SoundBite is the dominant player in its niche (Automated Voice Messaging/Customer Contact Solutions), growing faster than its overall market and taking market share away from competitors.

In addition, its dirt cheap valuation relative to its fundamentals leaves me scratching my head as to how Wall Street can be so wrong about this company, and compels me to re-recommend SoundBite as an immediate BUY.

If you haven’t already done so, you need to add shares of SoundBite to your portfolio. Here’s why:

I’ll break down this report into 5 parts:

• Latest Financials: SoundBite’s latest financials, earnings
• Margin Trends: Onward and upward
• Latest Valuation: Dirt cheap, it’s time to pounce
• Rounding Out The Business: The latest news out of SoundBite
• Bottom Line: Add to, or start your SoundBite position immediately

Let’s get right into it.

Another Great Quarter/Year

Earnings Beat Estimates, Company Raises Guidance

Let’s take a look at the growth trends and overall financial performance within SoundBite’s business over the last 3 years, with 2008 estimates where applicable.

Note that diluted shares increased exponentially because of SoundBite’s IPO, so I didn’t bother including the previous years’ diluted share data before 2007.

The interesting thing to note when looking at these trends is that SoundBite’s top line grew about 36% this year (2007) and is projected to grow 35.4% next year (2008). This is great news, as it shows that the company is actually growing sales at a faster clip on an absolute basis and keeping the % growth in line from year to year. This is what we call accelerating sales growth.

Don’t forget as well that analysts have raised these projections every single quarter as SoundBite blows by their estimates. It wasn’t too long ago that the growth rates for both 2007 and 2008 were below 34%!

Either way, I think that analyst estimates are lower than they should be, so you know where that leaves us.

For 2007 SoundBite finally showed a positive EPS, and continued to be cash flow positive to the tune of about $3.28 million dollars. You can see the cash flow trends for the last 3 years, which shows a huge cash flow improvement over the previous years. Finally, free cash flow is also improving rapidly.

Ultimately this is the bottom line. How much cash are they actually keeping once everything is all paid for?

As they accelerate their top line, improve their margins, and drop more income to their cash flow figure, their free cash flow will turn positive well within the next year or so, and this is when things really start ramping up and Wall Street will really take notice.

Either way you slice it, SoundBite is leveraging its top line into further improvements to its bottom line numbers. This year is a turning point in terms of accelerating its top line, and becoming both cash flow and free cash flow positive going forward.

Here are the highlights from the company's latest earnings announcement (4Q/2007) on February 27th, 2008:

Looking at SoundBite’s prior year comparison, it’s not quite as impressive as the overall 3-year table above.

However, you have to remember that SoundBite’s revenues and growth are lumpy from quarter to quarter, so this type of stuff happens often. That’s why we need to take the view of SoundBite’s business from year to year, not from quarter to quarter.

Even so, you can still see the increasing leverage of SoundBite’s business model as it continues to expand margins, profitability, and drop more and more cash on the bottom line.

Finally, share count increased significantly due to the IPO.

Margin Trends

Onward and Upward

Looking at a company’s margins is critical to understanding its past performance and future prospects. Usually, businesses start out with smaller margins which expand over time as the business becomes more efficient and scales up.

Let’s look at SoundBite’s 3-year margin trends and see how they stack up.

We can see that SoundBite is really starting to leverage more and more of its top line revenues into bottom line operating and net margins.

From here on out, SoundBite will begin to establish the capabilities of its business and its ability to scale, and thus begin to leverage more of its top line into bottom line growth. Although quarter-to-quarter margins are lumpy for SoundBite, you can see that the yearly trends speak favorably for the business as we head into 2008.

Finally, according to their latest guidance, SoundBite is targeting a long-term gross margin in the range of 62-65%, so it appears it will stabilize its cost of sales going forward at the level it is at now, and then slowly leverage its operating and net margins as time goes on and it scales upwards.

Now, let’s zero-in on SoundBite’s margins for the last 6 quarters.

SoundBite’s margins can be lumpy from quarter to quarter based on its revenue and client mix, as well as expenses.

Traditionally, the 4th quarter is its best on the revenue and margin side and you can see that’s the case here.

The reason for the steep drop in margins in Q1/2007 was because of its rapidly expanding business, the ramp-up of new technology, and the hiring of new staff to handle its increasing volume of customers.

Look for all of these margins to improve, but not in a straight line, as we go forward. The longer term trend is for stable gross margins within the previously specified range of 62-65%, with steadily improving net and operating margins going forward now that SoundBite has a more stable client base and has sufficiently ramped up its sales force and support staff.

As a percentage of revenue, operating expenses for staff and infrastructure are going to decrease, and we can see that already playing out both in the year over year figures above, as well as the last 6 quarter trends.

The way I see it, it’s fine for a company to take a temporary hit on margins, free cash flows, etc., to grow their business when the need and the opportunity arise.

I think these metrics will be less and less lumpy going forward as SoundBite scales its business model and expands its client base in order to be less reliant on the timing and seasonality of the collections industry, which typically sees its usage of SoundBite’s systems peak in the 4th quarter of each year.

Valuation

Dirt Cheap and We All Know It

I have chosen the following metrics for valuation purposes for SoundBite:

• Discounted Cash Flow [DCF]
• Price-to-Sales Ratio (P/S)
• Enterprise Value to EBITDA (EV/EBITDA)
• Price-to-Earnings Ratio (P/E)
• Price-to-Earnings/Growth Ratio [PEG]

Discounted Cash Flow [DCF]:

Using a modified DCF analysis, here’s what I get under 3 different scenarios:

• Best Case Scenario: SoundBite’s shares are valued at anywhere from $15.81 - $18.33 per share ($17.07 median).
• Middle Scenario: SoundBite’s shares are valued at anywhere from $9.63 - $10.84 per share ($10.23 median).
• Worst-Case Scenario: SoundBite’s shares are valued at anywhere from $5.30 - $5.86 per share ($5.58 median).

Using the DCF metric, SoundBite’s share value is trading way below its intrinsic value of about $11.33 per share, and should be at least double where it stands today.

Upside potential of 126%:

Valuation Table:

Since SoundBite has no direct public company that it competes with, I made certain assumptions and chose certain companies that I thought matched up well with what SoundBite does, and where I think it should be valued.

I’ve consolidated the other valuation metrics into the following table, along with those of SoundBite’s competitors or comparable companies:

Some quick valuation metrics:

• Using P/S: Fast growing companies always deserve a higher multiple than slower growing companies, but even if we assume SoundBite’s growth is slightly slower than its peers (which is true for top line growth, but not profit growth), SoundBite is still trading at a huge discount to where it should be by at least 100%.

If we look at profitability going forward, then SoundBite is trading at an even larger discount to its peers by about 200%.

This doesn’t even include the overall industry multiples, which put SoundBite at a steep discount to the overall industry that is growing much slower than SoundBite.

Upside potential of 100-200%:

• Using EV/EBITDA: On the same token as the P/S ratio above, if we take into account SoundBite’s Enterprise Value (EV = Market Cap + Total Debt – Total Cash & Short Term Investments) divided by EBITDA (Earnings Before Interest, Taxes, Depreciation, and Amortization), we see that the company is trading at a very steep discount to its peers.

When taken together, the EV/EBITDA ratio is a great way to measure companies across an industry, excluding one-time profitability items, different tax rates or one-time tax effects, and their total debt. It’s a sort of “equalizer” when it comes to valuing companies.

That being said, SoundBite’s EV/EBITDA ratio is an amazingly low 10.93.

In fact, SoundBite is so well capitalized that it has about $2.30 per share in cash in its coffers! That represents almost 50% of the total share price, and is a valuation more on par with a company that is suffering through some bad times, not one that is thriving and accelerating revenues and profits like SoundBite.

Companies that churn out cash, and have a fat cash hoard on their balance sheet usually always receive premiums over companies that are leveraged and have a lot of debt.

Likewise, companies that leverage their sales and profit as SoundBite does with growing and expanding revenues, profit margins, and bottom line profit excluding the aforementioned items, always trade at a premium, NOT below fair value.

Upside potential of 100-400%:

• Using FORWARD P/E: Analysts are pegging SoundBite’s earnings to be about $.14 per share in 2008 and $.31 per share in 2009, which I feel are both conservative numbers.

That being said, in the table above, I used the projected 2008 numbers for comparison’s sake. If we use the 2009 projected numbers, SoundBite’s P/E ratio drops to 16.13.

But remember, when a company is just starting to earn a profit as SoundBite is, using trailing or even forward P/E ratios is tricky because there is no established track record, and the forward projections can be skewed immensely by revisions either up or down.

Using this metric, SoundBite looks a little overvalued compared to its peers and industry, but again, a fast growing company (the average growth in the industry is about 20%) deserves to be valued higher, and remember that SoundBite just became profitable, so a basic P/E ratio is almost useless until a few years down the line.

Now, be careful when analyzing the growth trends of the companies listed above. Most of these companies' growth rates will be slowing in the coming year(s) while SoundBite’s is remaining steady and even accelerating, therefore it deserves to be at LEAST valued on par with its peers.

In fact this is indeed the case, as we can see that analysts project SoundBite to increase earnings per share [EPS] by at least 35% over the next 5 years, while the other companies and the industry as a whole, with the exception of Salesforce.com (CRM), are all expected to grow much more slowly.

Using the projected 2009 figures makes SoundBite’s shares look much more reasonable and “cheap,” but again, that far out there is way more risk of the company missing earnings (which will hammer the stock price) or some other business event happening (not to mention a slow-down in the business itself), that would bring these estimates into question.

Bottom Line: Traditional P/E ratio metrics, while useful for more mature businesses, are not as beneficial to us in measuring SoundBite’s true scale and eventual profitability at this time, but even so, provide us with another piece of info that shows the shares aren’t being respected and getting the premium valuation that they deserve because of their added and accelerating growth.

• Using Price to Earnings Growth [PEG]: A good measuring stick to use for risk/reward ramifications is to look for a forward PEG with some downside protection, so anything around 1 or less is usually considered less risky (although there already is plenty of risk involved when looking that far out ahead, which is why you want a lower PEG multiple and not a higher one).

In 2008, analysts expect SoundBite’s earnings to grow to $.14 per share, over about $.03 in 2007. Assuming SoundBite earns $.14 this year and grows to $.31 next year, this would yield a growth rate of over 121%.

If we just use 2008’s forward numbers, we get the PEG ratio of about 1, which looks like a great bargain, and doesn’t even include the ramping up of sales in 2009 and beyond. You can see this discrepancy reflected in the forward 5-Year earnings estimate provided by analysts, of which SoundBite’s is 35%. Analysts and other investors are using their “best guesses” to estimate FUTURE earnings potential, and thus are assigning this rough estimate to the next 5 years of growth on a compound annual rate.

Like I said, anything around 1 (sometimes for really fast growing companies, ahem, like this one, you might pay up to 1.5 PEG), and certainly anything UNDER 1 is a steal.

This gives us more information to look at to better understand valuation and when to pull the trigger on a trade to minimize downside risk and maximize upside potential, otherwise known as the RISK/REWARD, something I look at very carefully and take very seriously here at PeakStocks.com.

But even with this multiple, SoundBite still looks way undervalued if we just take 2008 numbers, let alone the incredible growth forecast for 2009.

Bottom Line: Using the PEG multiple valuation metric, while flawed, gives us a better indication of SoundBite’s potential, and its valuation. I believe that using this metric, SoundBite is undervalued by at least 100% or more, which could prove conservative if they beat estimates again, and raise future guidance.

Upside potential of 15-25% (using a 2008 PEG of 1) to 50+% (using a 2008 PEG of 1.5).

Upside potential of 117-261% (using a 2009 PEG of 1) to 326+% (using a 2009 PEG of 1.5).

Rounding Out The Business

Here are some other quick reasons why it’s prudent to add to your SoundBite position or start one immediately:

• SoundBite continues to dominate its market niche and is gaining traction and market share.
• Valuation sits at a supreme risk/reward level.
• For the 1st quarter of 2008, SoundBite is projecting sales of $10.7-11 million vs. analysts estimates of $10.45 million.
• For the full year of 2008, SoundBite expects revenue to range between $53.3 million and $55.3 million, up from $39.5 million in the previous year, vs. $52.3 that analysts were projecting.
• URS Litigation Update: As explained in my original research report, SoundBite is suing Universal Recovery Systems, URS, for tortuous interference, and unfair and deceptive practices for interfering with its IPO, and bringing false patent claims against SoundBite.

Since that time, depositions have been taken and documents filed, and recently, URS sought to dismiss the lawsuit. SoundBite expects to vigorously oppose the motion and believes the court will rule in its favor. If the suit is not dismissed, a trial has been set for May of 2008.

Given the facts and circumstances presented thus far, SoundBite believes that pursuing legal action against URS will prove to be a “good investment” for them.

Acquisition of Mobile Collect

It’s time to add text messaging to the list of ways that SoundBite can contact customers on their client’s behalf.

SoundBite acquired Mobile Collect in an all-cash transaction for $500,000 plus additional contingent consideration of up to $2 million based upon a certain percent of text messaging revenue. Just like SoundBite, Mobile Collect is a Software as a Service [SaaS] provider of customer contact solutions, but dealing strictly with SMS or text messaging.

The most important part of this acquisition is the fact that Mobile Collect is a pioneer in Free-to-End User [FTEU] text messaging.

In fact, as of Tuesday’s press release (4-8-08), SoundBite is currently the only provider to implement FTEU text messaging on all four major wireless carrier networks, reaching 81% of U.S. wireless subscribers.

As a result, organizations that utilize SoundBite’s hosted, multi-channel communications platform are now able to deliver these messages to their customers using AT&T (T), Sprint (S), T-Mobile (DT) and Verizon Wireless (VZ) networks. SoundBite’s text and automated voice messaging solutions support inbound, outbound and interactive customer communications.

So why is FTEU important?

It's because text messages aren’t free, and most of us are charged per text message, anywhere from $.01-$.05 or more, unless we subscribe to various plans that can bring this cost lower for more frenetic text messagers.

This is also potentially a huge market, as more than 240 billion text messages were delivered in the U.S. during the 12-month period ending July 2006. More and more people would rather receive a text message than a phone call, and companies are only to happy to oblige to keep their costs low and get a higher response rate to a less “intrusive” form of communication.

On top of that, this solution allows SoundBite to now deploy multiple customer contact solutions. A campaign can be set up to first send you a text message letting you know your phone bill is overdue, then SoundBite’s system can follow that up with an email, followed by a voice mail, finally followed by a phone call where you actually speak with an agent.

The Bottom Line

If You Haven’t Already, It’s Time To Get In

Look, there are no guarantees in life, let alone investing.

However, if you eliminate the unknown from the equation, do your thorough analysis and research into an incredible company and stock, and virtually eliminate your downside risk, you increase your chances to beat the market, no, strike that, CRUSH the market. I’ve done all the leg work for you, all you have to do is press the “buy” button and sit back and watch the SoundBite story play out.

You’ve got a niche business, a growing market, a stock that sits at about $5.00 per share as of this writing with a company that has about $2.30 per share in cash on the balance sheet, and is undervalued by virtually any metric you use, and finally, a company growing earnings and sales at extraordinary rates.

Needless to say, SoundBite grossly qualifies for my Double Thesis.

I don’t know when, but it’s only a matter of time.

Comments

[AKJ]

I'll start by saying I agree with the author's summary - this is a good buy. This whole space is going to be radically changed by Voice Over IP which will bring down the cost of delivering calls to nearly 0. There are alot of "mom and pop" vendors in this space who will be rolled up or put out of business by a well capitalized competitor like SDBT. The cash flow situation is very strong as well - good ability here to land prepaid, long term contracts. Even the pay-as-you-go contracts lock in a very strong gross margin.

Having said all that, I think you need to reconsider some of your valuation comps. Salesforce and Nuance are not relevant. CSG Systems (CSGS) is a direct competitor, as is Blackboard (BBBB) and Premiere Technologies (PTEK). CSG bought Prairie Communications, another direct competitor. Blackboard bought the NTI Group. Yet another competitor, Varolii, has filed an S-1 to go public soon.

Also - the gross margin decline doesn't really tell a great story. And I'm not sure why growth is lowering gross margin - is the cost to deliver calls affected by hiring more salespeople or opening new offices? I could perhaps see having to discount prices to win away marketshare from a competitor, but haven't seen that rationale communicated by SDBT.

Also interesting to note -the biggest consumers of this service are debt collectors. Will a recession actually help SDBT as collectors have more debt to collect? There's also a growing use by government and education users for emergency notification. These are juicy contracts but have extremely long sales cycles. They should also be immune to a recession (assuming emergency notification doesn't get cut out of the budget).

This is a great business model if you can get the sales front-end to work. You typically land clients for long term, highly profitable contracts. At some point you can pull back on sales and marketing spend and really let a large part of these 60+% gross margins start showing up on the bottom line.

I think the biggest risk right now in owning SDBT is trading risk. This is a small cap stock with little to no analysts following. One would think after Blackboard bought the NTI group for 6 x LTM Revenue (yes - Revenue!) that more analysts would take notice of SoundBite. If you have an appetite to buy and hold then, as the author stated, I think the upside potential is very good as SoundBite's growth into midcap renenue size range combined with large profit margins and good growth prospects in a recession will make this one a winner.

[PeakStocks.com]

Hey AKJ,

Thanks for the feedback and thoughts. I always really appreciate honest and well-thought out counterarguments to my points.

When people disagree with me, even if very slightly, they often have no reasoning or basis that makes sense, so I thank you for your well-researched and knowledgeable response and additions to my thoughts.

A few comments to your points:

1 - The valuation comps were chosen because a) there are NO direct competitors that do what SoundBite does that are public, and b) the companies you mention plus others that I outline in my research report on my website, only have a portion of their revenue derived from AVM solutions, not all of their revenue like SDBT does, c) Varolli withdrew their IPO plans to go public, and if they ever do, I will add them to the comps. list.

So that being said, I thought it prudent to align the company with others in the "customer contact" space like Livepersn, Nuance (which SDBT actually gets some of their technology from), and then CRM to show that because SDBT's revenues are derives all as SaaS, their multiple should more reflect the companies in that space and NOT the companies in Telecommunications spaces, and the like.

2 - The Gross margin decline was expected as a result of higher cost of sales of building out their network, lowering prices to remain cost-competitive and like you mentioned, to hire and train more staff.

The long term Gross margin is likely to remain between 62-65% per SDBT's guidance, and I can live with that, especially with the other margins improving over time.

3 - So far debt collectors account for a large part of SDBT's revenue, and as I stated on my website in my research report, this actually bodes well for SDBT now and in the future as the economy recovers and people start paying their debt.

you are also right as to the long term status of contracts. Although SDBT does not have any long term contracts, once the system proves worthwhile to a client, they are less likely to ever switch to a competitor and are more likely to keep coming back to SDBT for all of their customer contact needs that had nothing to do with their original reason for using SDBT.

4 - Analysts coverage: There are actually 4 analysts covering this stock now, including the 4 that brought SDBT public. They all have strong buys or buy on the stock with price targets pegging SDBT at at least double from where it sits today.

This is a great play for patient investors, and as I mentioned, you'll get at least a double from here on out, and it could happen very quickly with some news announcements, different analyst coverage, etc.

The whole point is to be in the stock NOW not after these events take place.

Thanks again,
Chris

You can read my full research report on SDBT for free here:

peakstocks.com/researc...

[SDBT=nothingspecial]

Soundbite is half the technology tcnbroadcasting.com is! They are launching a new product soon that will be untouchable by varolii, livevox, and GC1.