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Sergio Heiber

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Nuance Is Doing OK And Getting More Interesting

Mar. 3, 2015 2:26 PM ET  |  About: Nuance Communications, Inc. (NUAN)

Disclosure: The author has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. (More...)

Summary

• A third activist fund has taken a position.
• Quarterly earnings again beat expectations.
• Chart double bottom signals a trend reversal.

  Nuance Communications (NASDAQ:NUAN) is recognized as the premier voice and recognition technology company in the world. This company grew by spending heavily to acquire its competition, a formula that has not worked out well with many publications labeling CEO Paul Ricci as the worst CEO. NUAN has been undergoing a transformation in its earnings model, now relying heavily on recurring revenue. I think there are reasons to be optimistic about NUAN's transformation and future prospects.

  Reviewing NUAN's net new bookings, cash flow, and recurring revenue stream provide an indication that and NUAN is on target with their game plan. Theories that NUAN will be acquired or do a spin off are becoming less frequent but activist interest is increasing, and that is a good sign.

  New net bookings fell 5.5% Y/Y in FQ1 to $303.8M. The company cited currency exchange issues as a partial cause but still forecast FY15 net new bookings growth of 4%-5%. Despite labeling the results "disappointing" CEO Paul Ricci stated in the recent earnings call, "we do expect for bookings growth to accelerate in the back-half of the year simply because of the timing of some of those deals. And of course, Nuance historically as always had a strong quarter in its fiscal fourth quarter relatively speaking in both bookings and revenues."

  Cash flow grew 22% over the prior year. Management has put the cash right back in to support the stock price with an ongoing share buyback program having spent $200 million out of the approved $500 million.

  Recurring revenue grew 4% year-over-year and now comprises 66% of our total revenue as the company continues to succeed in shifting their earnings model away from licensing deals to more predictable and stable recurring revenue. The company believes that it is at the point were declining licensing revenue will have a lesser impact on earnings growth from recurring revenue.

  Takeover or split up rumors have been abundant since Icahn became involved in 19. Goldman research concluded that there will be no buyout and lowered NUAN to a SELL rating. "We do not see NUAN as a potential acquisition candidate." But new rumors continue to pop up. A possible BAIDU takeover was the subject of this article. But NUAN may end up alright on its own.

  A technical evaluation indicates a turnaround in stock price. There seems to be a change in direction. The stock price had been in a downtrend, but a trend reversal is in progress after a double bottom formation in December. (chart)

  During the last quarter, another activist fund, Okumus took a 5% stake joining Icahn who owns 19% and ClearBridge at 7%. This is noteworthy, as hedge funds tend to be ahead of the crowd in finding value. Okumus is not as well known as Icahn but is not an industry lightweight. The Okumus Fund was recently in the lead in the HSBC hedge fund sweepstakes.

  On February 5th, the company reported EPS of $0.25 beating estimates by $0.03 and revenue of $489M ahead of estimates by $2.13M. On fundamental valuation, NUAN is cheap and that as evidenced by the increasing interest from hedge funds. The stock sells at a modest PE of 13 and a PEG of .63 despite analysts' projections of earnings growth for the next five years of 20%.

  Despite beating estimates, management was very cautious about forward guidance and it is still too early to call NUAN a turnaround story, but there are signs that a turnaround is taking shape and that a foundation for earnings growth has been laid out.