The Nuance of Growth
Kyle is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
Recently BMW announced a partnership with Nuance Communications (NASDAQ: NUAN) to put voice recognition software in all BMW cars. Although unconfirmed it is widely suspected that Apple (NASDAQ: AAPL) uses Nuance Communication software for their SIRI. Given that Apple only started selling the iPhone 4S since late October, it is likely that Apple will sell many more Nuance-Embeded products. These companies are just a small part of a long, increasing list of companies that use Nuance Communications in their products and services.
The growth of voice recognition software is unbelievable, and as the saying goes: “A rising tide moves all ships higher.” So naturally one would expect Nuance Communications to be growing by leaps and bounds right along with the rest of the industry, which it indeed has. In the five year period from FY 2007 to FY 2011 Nuance grew its revenues by 119% from 602 million to 1.3 billion. Over this same period of time net income went from a loss of $14.9 million to a gain of $38.2 million, with last year being the first profitable year. Over the past two years the company has grown its operating cash flow by 38% from $258.7 million to $357 million. This extraordinary growth however does not tell the whole story.
Nuance Communications has been growing its revenue and cash flow largely through R&D, acquisitions, and dilution.
Research and Development
Voice recognition software is a competitive industry with many major players in the market. Microsoft (NASDAQ: MSFT), IBM (NYSE: IBM) and Google (NASDAQ: GOOG) all compete against Nuance, and all have deep pockets. These companies are all well positioned with cash positions of $58 billion, $12 billion, and $47 billion, respectively, and have little debt. Additionally these companies are by nature vertically integrated, with each one owning their own hardware. These companies are more likely to use their own software rather than Nuance's. Because of this Nuance is forced to continually expand its product offerings to compete with these other larger companies. As a result, the company spends a lot of money and time on Research and Development. Last year the company spent $179.4 million on R&D. This is 13.6% of their total revenues, and over 50% of their operating cash flow. In order for Nuance to compete against their competitors they will have to continue to keep up their R&D spending which will significantly cut into their profitability.
Acquisitions
Part of Nuance’s growth strategy involves buying out smaller competitors. Last year the company made two major acquisitions, along with many other smaller acquisitions. Over half the company’s assets ($2.4 billion) are in the form of goodwill. Although these acquisitions help the company gain economy of scale, thereby making them more competitive, they also dilute the value of the stock for shareholders.
Dilution
Although revenue has grown by 119% from $602 million to $1.3 billion over a period of 5 years, dilution has mostly offset this gain. During that same period of time the company has increased its weighted diluted shares outstanding from 176.4 million to 316 million. This 79% increase in share count leaves the company with a per share revenue growth of only 22.3% over a five year period.
Valuation
The company is currently trading at 19 times its operating cash flow, and 38.28 times its operating cash flow if you subtract out R&D. Given the company’s low per share growth, and its high valuation relative to operating cash flow the company looks significantly over valued.
Nuance Communications should continue to grow its revenue and earnings over the years as the trend toward voice command technology continues, but because of the dilutive structure of the company, as well as the large costs in R&D that are required for the company to remain competitive, shareholders may not benefit from the boom in voice recognition technology. Investors should look elsewhere to find a good value in stocks.
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kf9211 has no positions in the stocks mentioned above. The Motley Fool owns shares of Apple, Google, International Business Machines, Microsoft, and Nuance Communications. Motley Fool newsletter services recommend Apple, Google, Microsoft, and Nuance Communications. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.If you have questions about this post or the Fool’s blog network, click here for information.
