Is Nuance Finally Ready to Rumble?

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Nuance Communications (NASDAQ: NUAN) is counting on the potential of technologies that allow for virtual assistants and electronic health records via voice recognition, and the company has promised a stronger future than the actual results.

After guiding yet again to weak results going forward, the stock actually rebounded after an initial selloff. After the previous quarterly disappointment, the stock plunged from $24 to $20. This time though, the stock rebounded and held solidly to the previous day's price. This is a good sign that investors finally see the switch to on-demand, cloud-based services as finally baked into the stock price.

The company faces a similar shift that other major software firms such as Intuit (NASDAQ: INTU) and Adobe Systems (NASDAQ: ADBE) have previously faced. Those stocks have seen better gains as the market became comfortable with the shift and embraced the more predictable future of recurring revenues versus licenses.

Market trends

As with most software sectors, customers are quickly moving to on-demand services instead of paying an upfront fee for a license. This provides the software vendors with recurring revenues, but the on-demand, transactional, and subscription models create elongated revenue models. Now, Nuance faces up front costs for sales and marketing that might involve revenue that it won’t book for years.

As the company has been going through fiscal 2013, it has incurred a quickening in the trend that constantly impacts 2013 numbers, but improves the outlook for 2014 as the backlog grows.

However, Nuance continues to see positive trends in the mobile sector, healthcare, and virtual assistant on-demand contracts.The growing adoption of cloud-based, connected services whether via a mobile phone or a car will eventually boost revenue. Also, the virtual assistants such as Florence for healthcare and Nina for enterprise customers promise significant growth as these services take advantage of an increasing scope and complexity of speech recognition and natural language understanding. Regardless, the key to any turnaround in this stock is to finally get through the shift to recurring revenue versus the development of new products. The company continues to suggest that the transition will be complete by the start of 2014.

With the revenue shift, it had to reduce its Q4 revenue guidance to a midpoint of $485 million versus expectations of $518 million. While clearly disappointing, the stock only dropped 1% on a day the stock market was down.

Quickly rebounding software stocks

After being crushed during 2011, Intuit has seen the benefits in a shift toward recurring revenue from the upfront license revenue. The stock plunged to $40 back during the transition period, but it is now back around $65. The stock trades at nearly 20 times current earnings even with analysts only expecting 13% annual earnings growth in the next five years. The company is taking advantage of the trend of users moving to monthly fees for using QuickBooks online instead of paying a one-time fee for the software and having to eventually update it. Users get a constantly updating software service and Intuit gets more stable, recurring revenue.

Likewise, Adobe was crushed back during 2011 as the stock crashed below $24. It has now doubled to near $48 as the transition to cloud-based, recurring revenue has taken hold with investors. The company though, is still struggling with revenue declines from this transition as fiscal 2013 numbers are expected to decline nearly 7%. This stock trades at a much higher 27 times forward earnings even though analysts only expect 11% annual growth in earnings for the next five years.

Bottom line

The examples of both Adobe and Intuit provide hope that Nuance has finally bottomed as the transition to on-demand recurring revenue has had the biggest impact already. Nuance actually projected a similar earnings number to that expected of Adobe. Investors clearly have more confidence that the issues at Adobe were related to the transition to the cloud and subscriptions, whereas most investors question whether Nuance isn’t losing market share.

With the stock finally trading decent on a day where the news was bad, investors can finally step into the Nuance stock with conviction that the worse has probably finally passed. 

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Mark Holder and Stone Fox Capital Advisors, LLC have a position in Nuance Communications.. The Motley Fool recommends Adobe Systems, Intuit, and Nuance Communications. The Motley Fool owns shares of Intuit 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. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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