RingCentral: Neutral Downgrade Amid Uncertainties (NYSE:RNG)

RingCentral (NYSE:RNG) is a cloud-based platform offering business communication solutions like phone systems, video conferencing, team messaging, and contact centers.

I have analyzed RNG on two occasions. My first buy recommendation resulted in a successful 50% gain. However, a second buy recommendation made during the pandemic proved only partially correct. The initial coverage price in 2020 was $273, and the stock would then reach an all-time high of $443 in 2021, gaining over 62%. Yet, it then saw a gradual decline since then. Today, it currently trades at $33, representing an 87.7% decline from the price at the latest coverage.

I downgraded RNG to neutral. My price target of $35.6 implies a merely 5% upside at the end of FY 2024. Risk-reward remains unattractive, in my opinion.

Financial Reviews

Fundamentals are mixed. Revenue growth had been relatively steady between 30-40%, yet gradually declined to 20% and then 10% in FY 2023. Though RNG has been able to demonstrate operating cash flow/OCF expansion over the past five years, the double-digit growth has taken a toll on GAAP profitability. Net loss margin continued to widen until 2023 when RNG finished the year with a net loss margin of -7.5%. Last year, the net loss margin reached -40%, which is a five-year low. Overall, these are signs of potentially high share-based compensations/SBCs.

The balance sheet outlook is not ideal, but improving. While the cash level remains steady above $220 million, RNG has a relatively high debt level with negative book value. Given the history of unprofitability, RNG has had outsized negative retained earnings (or accumulated losses). RNG’s accumulated losses stood at $1.7 billion as of FY 2023, surpassing paid-in capital of over $1.2 billion, resulting in the book value turning negative. Its FY 2023 book value was negative $502 million.

Catalyst

There are several potential catalysts that should help RNG reaccelerate revenue growth and also improve GAAP profitability in 2024.

The company’s recent product launches, including RingCX, RingSense for Sales, and RingCentral Events, should represent a strategic move into potentially lucrative new markets like sales intelligence, CCaaS, and virtual/hybrid events. These products significantly expand RNG’s TAM, offering substantial growth potential beyond its core UCaaS business. In Q4, RNG has seen signs of strong demand for the offerings, demonstrating promise of growth continuation:

Regarding customers, we now have over 100 paying RingCX accounts, up from about 50 when we launched in November. These accounts include two Fortune 1000 enterprises who each purchased over 1,000 seats. We also now have hundreds of paying RingSense for Sales customers after having just launched in the second half of 2023.

Source: Q4 earnings call.

In my opinion, these markets are experiencing significant growth, driven by trends like the increased adoption of cloud-based solutions and the growing demand for remote and hybrid work models. In parallel, RNG also anticipates reacceleration in core business growth due to improved customer retention as the macro environment stabilizes. These could positively impact upselling, further accelerating growth.

According to a report by Fortune Business Insights, the global CCaaS market is expected to reach $16.43 billion by 2030, while the virtual events market is projected to be even bigger, with $262 billion in market size in 2030, growing at a CAGR of 18.8% from 2023 to 2030. These trends suggest that RNG’s expansion into these markets could enable the company to capture substantial growth potential beyond its core UCaaS business.

Furthermore, RNG is taking steps to improve its financial health. The company is committed to reducing SBCs as a percentage of revenue throughout 2024 and beyond. SBC is expected to decrease from 20% of revenue in 2023 to 16% in 2024, further declining in 2025:

Third, and very importantly, SBC. As Vlad noted, the senior management team and the Board are laser-focused on reducing stock-based compensation and dilution. We expect to reduce net new grants in 2024 by over 50% from 2023 levels. This results in total stock-based compensation coming down by approximately 350 basis points in 2024. We expect further meaningful improvement in 2025 and beyond.

Source: Q4 earnings call.

Reducing the level of SBC should improve GAAP profitability. This, in turn, could enhance RingCentral’s attractiveness to investors. As I mentioned earlier, accumulated losses have resulted in a negative book value since 2022. In my opinion, with the current outlook, achieving a positive book value, where retained earnings are no longer in the negative, will require RNG to deliver consistent GAAP profitability for some time. While reducing SBC may seem like a small step, I believe it’s an important one on the path toward financial sustainability.

Risk

I believe RNG’s potential for growth is not without its challenges. While the multi-product strategy presents exciting opportunities, it also introduces execution risks, in my opinion. Expanding into new markets requires navigating the complexities of selling and integrating multiple products, which could lead to longer sales cycles, lower win rates, or increased customer churn.

Additionally, successfully managing a broader portfolio necessitates careful resource allocation, as diverting resources from core products to new ones could negatively impact existing customer satisfaction and retention. The CEO indeed acknowledged this risk factor in Q4 earnings call, though he believes there is an attractive risk-reward in the multi-product initiative:

I can tell you that it sounds simple, for sure, you have one product, what’s another one to add. It is actually a big deal, okay, to go from a single product where you have a sales force trained to sell one particular solution, where you have product people who are specialists in one particular area and only that particular area, where your technology base only needs to address one use case, support, et cetera. So, everything now needs to be done several times over, which is a heavy lift.

Source: Q4 earnings call.

Competition also remains a key concern for me. RNG faces intense competition in every market it operates in. Established players like Microsoft Teams, Cisco Webex, and Zoom dominate the UCaaS space, while CCaaS boasts strong competitors like Genesys and Five9. These players are also rapidly integrating AI into their offerings as they aim to gain more market share. In my opinion, the competitive landscape can limit RNG’s pricing power, market share gains, and profitability, in the worst-case scenario.

Valuation/Pricing

My target price for RNG is driven by the following assumptions for the bull vs. bear scenarios of the FY 2024 projection:

1. Bull scenario (50% probability) assumptions – RNG to achieve FY 2024 revenue of $2.4 billion, a 9% growth, at the high end of the company’s guidance. I assign RNG a forward P/S of 1.5x, a slight expansion from the current level, implying a share appreciation to $38.

2. Bear scenario (50% probability) assumptions – RNG to deliver FY 2024 revenue of $2.378 billion, an 8% growth, at the company’s high-end guidance. I expect P/S to contract slightly to 1.3x, implying a correction to $32.89.

Consolidating all the information above into my model, I arrived at an FY 2024 weighted target price of $35.6 per share, presenting a potential upside of merely 5% from the current level. I give the stock a neutral rating.

Conclusion

RNG offers valuable communication solutions, but its investment potential appears limited. While a previous recommendation achieved gains, another one during the pandemic fell short due to the stock’s significant decline. Despite reaching an all-time high of $443 in 2021, RNG now trades at $33, representing an 87.7% drop. The recent development in product strategy seems attractive, but the potential remains uncertain, in my view. I’m downgrading RNG to neutral. My price target of $35.6 suggests only minimal upside by year-end 2024.