Chit Chat Stocks - Fundamental Analysis: Bandwidth Inc. (BAND)

Episode Date: May 7, 2020

On this show we discuss Bandwidth incorporated. Find out why Brett gave it a rating of 5.3 and Ryan a rating of 6.0.  --- Support this podcast: https://anchor.fm/chit-chat-money/support Learn more about your ad choices. Visit megaphone.fm/adchoices Learn more about your ad choices. Visit megaphone.fm/adchoices

Welcome in. This is the Fundamental Analysis Show on Chit Chat Money. My name is Brett Schaefer and I'm here as always with Ryan Henderson today talking Bandwidth Incorporated. A little bit of a misleading name. They're not a cloud company or a... Well, they're cloud-based software, but they're not like a telecom company, which I don't know why they'd call themselves Bandwidth. But yeah, they're a CPaaS, something as a service. So Ryan, do you want to get into what they do and then the history of the stock and the company?

Yeah. When I heard bandwidth, I definitely did think of some telecom company. So they are not a telecom company. They are a cloud-based CPaaS or communications platform as a service company. So bandwidth solutions include a range of software APIs for voice and messaging functionality. Anyone that doesn't know what an API is, don't worry. That was probably me like an hour ago. So an API is, the term stands for, correct me if I'm wrong, application programming interface or something like that?

Yes, I believe so. But the name, it's really what it is. It just connects software together so you don't have to build, for example, messaging applications on your own. Right. And so there are entire companies built around selling APIs. and an API, if you think about it as someone who is not a developer like myself, I think of them as sort of the Legos or the building blocks of chunks of code that you embed into your own code base.

It's like a bridge, kind of, sort of seamlessly like that, and you pay on a usage basis. Bandwidth also owns and manages one of the nation's largest internet protocol voice networks. so i i'm picturing the voice network as like a range of voice commands uh no no no i don't i do not think that's what it is um but it's just the ability to get a phone number and call into things and then also they have some 911 services like that i don't think it's like anything connected to alexa although i could be wrong but that's just what from what i read so one example that i could think of and i was kind of trying to come up with some is zoom allowing you to dial in through your phone that is an example zoom is a customer for bandwidth and

that's an example of their API being used in actual real enterprise business and like I said it's a usage based revenue model so as customers use more of their api's bandwidth will make more money and it's so if the API is used over and over and over they're gonna charge on that so it sort of scales with the enterprise business itself it's not a fixed cost model or it's not sort of recurring revenue. It's not like a subscription or anything like that. Interesting note though, they are directly advertising themselves as a Twilio competitor and they do a lot of the same stuff. They even went as far as adding a pop-up ad on their solutions page that says, are you

migrating over from Twilio? It's easy to do so. So maybe there's a lot of customers coming over from Twilio. Yeah. And yeah, if you're confused on what bandwidth is, just think they're basically a copy of Twilio just with a couple different things and a little less so they don't do like the email stuff that Twilio does a little less of the functionality but they're a smaller they do some email stuff there is yeah I'm looking at the use cases right now and I guess I'll go through them okay yeah go ahead so all their use cases include bring your own carrier SMS to email sms marketing sms surveys two-factor authentication click to call ivr system not sure what that is text alerts and notifications and call tracking so yeah that's all of them yeah they got a lot

of what twilio has they're they're very very similar and they actually undercut them on the pricing uh by like either 30 uh to 60 which is pretty big deal if you're a big enterprise customer Yeah. And there was very little history about the business. David Morkin was the founder. He founded Bandwidth in 1999. I have a hard time believing it was a voice and messaging API platform at the time when he founded it, but he is still the acting CEO. In 2001, Henry Kessner came on as the co-founder. They relocated their headquarters to North Carolina in 2012, and they didn't IPO until November of 2017. There really wasn't a whole lot of news on the company, but as far as management goes, David Morkan, the CEO,

served as an active-duty Marine Corps, so interesting background, I guess, and he also received a bachelor's in political science from Oral Roberts and a JD, which I think is like the legal jurist doctor or something like that, from Notre Dame Law School. So he checks the boxes as far as a CEO goes, but I'm really not sure what was happening all between 1999 and now because there's no way. Slow buildup, slow.

I mean, I don't know. I think they transitioned. They say they have a legacy system, so they must have had an old business, and they say that's slowly declining. mining. And the CPAS is what's really the big majority of the revenue right now. I think it's 80% plus, and that's the one that's growing the fastest. Okay. Why don't you get into valuation?

Okay. Well, they have a market cap of 2.3 billion, ticker BAND, that's BAND, and a stock price of $102.45. EV to sales, 9.33. Margin adjusted price to sales of 73, which is very high. And again, that's a measurement for the growth stocks. We always do this price to sales divided by sales growth and gross margin. So as sales growth increases, this could potentially go down and it shows what their valuation could be on an earnings or cash flow basis if they had, you know, whatever margins they could have based on their gross margin. So if a company has like a 45% gross margin to 50%, kind of what bandwidth has, you know, you could think, all right, maybe they could have 20% operating margins at scale. And then someone

like Zoom Video, who has like 85% gross margins, could probably think they could have a lot higher, 40%. But I'll go move on. They have no dividend and shares outstanding are increasing, but by a small margin, good number there on the share dilution for a company at this stage in their life cycle. They're spending 13% of their sales on marketing expenses, which is a solid number, pretty average, nothing too concerning there. And they also have a strong working capital number of over $400 million. And that is funded mostly by a recent $268 million convertible senior note that is on their balance sheet. And that is the mainly what their long-term liabilities are. Okay. And they reported first quarter earnings on April 30th. So about a week ago as of this

recording. And their first quarter revenue was $68.5 million, up 29% year over year. They had gross margins of 47%. I believe that jumped from the year before from 46%. So going in the right direction, not a huge jump there. They had a quarterly net loss of 1.1 million the year before they had 2 million in net income. And a lot of that came from a tax benefit. I know 2018, they had a $7.6 million income tax benefit. They did not get that this year. Their number of active CPAS customers grew 34% year over year to a total of 1,808 customers. They achieved a dollar-based net retention rate of 126%. Good sign there, really strong number. While they were less profitable on a net margin basis, they were more profitable on an operating basis. Like I said,

that's that $7.6 million income tax benefit. Their operating loss was 2.9 million versus last year they had an operating loss of 5.8 million. So operating wise, they are closer to profitability. Stock-based compensation as a percentage of revenue was 3.8%. So not a ton of share dilution there or not a lot of compensation through stock.

We've seen that kind of dilute some existing shareholders on other companies before. So not a red flag there by any means. okay let's hit the second half of the show and that means digging trenches the moat rating i'm gonna go here and i'm gonna say zero um it's well maybe 0.5 but twilio definitely has if anything the moat in this industry and bandwidth is just trying to catch up yeah i guess they have pricing power to some extent i didn't think that they would but uh and maybe it's just because they're cutting off Twilio's, but that's also reducing their margins. And sorry, you mean Twilio has

pricing power, correct? No, I mean, well, yeah, Twilio has pricing power, but bandwidth is coming in and undercutting those prices. So if they're getting a lot of people to come over from Twilio, maybe at one point they will have pricing power. Maybe. And maybe those margins can't, that's probably why their margins are so much lower than Twilio's. If they get the customers to come over and they have, and they start to compete in term. I'm not sure how many customers Twilio has as far as enterprise businesses, but if they're competing on that, maybe they'll be able to expand those margins.

Yeah. So either way, it's not very, yeah, it's not high at all right now. They have larger competitors and large partners like Google and Microsoft that have a lot of control over bandwidth. Bandwidth cannot negotiate with those large tech companies. But next up we have further reading. What do you got? um so their internet protocol voice network i'm curious how valuable it is they didn't talk much about that in the earnings and i'm not sure how it translates to revenue or earnings altogether

so i was a little bit confused on that and then also do they have any crucial patents around their products because that's i mean if they're going to be able to establish a moat they're going to have to have patents around certain solutions i would think or else people anyone can really develop the apis and sell them yeah i mean you have the network uh and it definitely isn't easy to build these or else someone like zoom would have already or slack would have built them in house uh but yeah i don't there's not much of a barrier to entry um there is a small one but not a giant one it's like you're selling tiny little knickknacks uh but again twilio like they they have the same thing. So I don't think this there's the patents can be that important

because Twilio has the same exact products. Um, even if they both have patents, they serve the same purpose. Okay. Uh, what are you looking at for further reading? So I thought that Slack would not be a customer, but someone mentioned it on the conference call that they do use Slack or Slack uses bandwidth, excuse me. Uh, so do they work with them on messaging or is it just for voice integration, I put video down here, but I meant voice. Seems weird that companies of that size wouldn't be building these tools in-house because Slack says they're a workplace communication platform. Why are they outsourcing some of that technology? Does that mean bandwidth? Is it such a hard product to build that someone like Slack or Zoom can't do that? That's just some questions

i have because losing those customers would be a big hurt uh to bandwidth yeah and you're right that does surprise me that slack has to come to bandwidth to get that sort of building block to embed in their code and maybe it's i mean i doubt it's laziness i doubt it's like all right we'll just pay someone else to do it if they could generate it in-house i think that they would and i think zoom would do the same thing for dialing in through a phone yeah so maybe they do have some sort of moat um but that's again something we'd want to look in further all right future growth opportunities what do you have so mine's the sms marketing i as a consumer get these from a few different places like places that i shop consistently where so like if i'm getting

clothes from lululemon constantly or whatever the brand is i'll get these instead of like targeted ads through google adsense that kind of thing i'll just get the text messages for whenever there's an update to the clothing line and I can just look at it and see if there's something that I like, that kind of thing. I think this is a lot more effective. It's a much more direct way to connect to the customer and you don't have to get the annoying ads. The only way you're getting these ads is if you ask for them, is if you sign up for them. So I think that's an effective way and it kind of builds, getting a text message sort of builds like a more powerful relationship between a business and the customer yeah definitely i just think it's probably a smaller addressable

market uh for advertising i don't think a lot of people like getting advertisements through their sms messages yeah i mean i i enjoy it compared to clicking on a google adsense ad but well neither are i mean no one's clicking on google adsense ads on purpose uh but yeah i guess i mean whatever that's all they want something you can always if you really want something you can just look up the store go to it and obviously do that i'm i mean and maybe there's other people that don't do this but i am only shopping like i don't stumble across i'm like oh i'll shop now like i i go in with an intention of what i want to buy yeah and that's i guess we're just getting into marketing tactics here which is a little off uh topic but yeah that that makes sense um what do you i'll go for mine

though work from home you know they are built to help video conferencing and messaging solutions work well for any sort of situation, I guess you'd describe it. And they've gotten a big boost from the event pandemic. Again, Zoom, Slack, Microsoft Teams are getting a giant boost in usage, which is in turn why bandwidth is having that large dollar-based net expansion rate. It was 126%. This quarter, the year-ago quarter, was only 111%. And that is from existing customers.

So that's why they're getting the higher usage. but one has to ask is this the ultimate business environment from them for them and is this as good as it's going to get because if so that valuation is pretty steep yeah zoom or the pandemic has definitely given them a boost and i'm not sure if it is the whole accelerating the inevitable or it's one time kind of thing yeah definitely all right highlights on low lights what do you got? Yeah. So another point that I wanted to touch on, you said they have a strong dollar based net expansion rate. It says net retention rate. Is there any difference? Same thing. Definitely. Yeah. Same thing. I guess technically if they do some sort of how they

define it, whether it's like, you know, trailing 12 month, you know, customers that are already there, you know, who qualifies for that? Some people can probably define that differently, but basically it's your existing customers that have been there for 12 months. What type of revenue growth have you gotten from them this quarter all right um yeah so my highlights is that they have carved out a little niche in the a2p or application to person space specifically they are the only software platform with 911 capabilities i'm not sure how big of a total addressable market that is they talked about how you can send like text messages sms to 911. I'm just picturing someone like tied down and like has to like voice control message the

police. Like I can't imagine the addressable market super huge for that, but they're the only one that does it apparently. So I think A2P or application to person communication will play a larger role in our future than it does now. I guess maybe not with the, maybe the one-time bump from the pandemic is helping in and bandwidth has the apis to sort of be in line to help with that however it looks like twilio is the premium player and yeah you talked about it twilio is kind of dominating that and i'm not sure i'm not sure how much growth is ahead considering that there's a possibility for me in my mind that everyone that's done all this digital conferencing stuff is going to get sick of it and use it less in the future.

Yeah, and then that would hurt bandwidth a bit, but again, with their call-in feature, so we're using Zoom right now traditionally, and I guess the video is off, but whatever. We're not using bandwidth right now. But if you use the call-in feature to a conference call, that is what bandwidth, you know, that's their specialty. That's the thing they do the best.

Those might become just as popular because if people don't want to do zoom meetings face to face, they'd rather just call in and listen or something like that. Yeah. What, uh, what do you have for highlights and lowlights? Uh, highlights again, strong Dibner, uh, expansion, right. Is, uh, during the crisis and it shows that when remote communication and tools and platforms grow, bandwidth grows with it. It's weird saying bandwidth, cause that's like a term for the internet and stuff like that. But the company grows with it. They have a good balance sheet, and you can see how they can get to 20% operating margins at scale. No customers over 10%, which I did think was a big concern

with Microsoft, Google, Zoom, Slack, and other large companies as their customers, because you'd think maybe Microsoft is 10% or 20% of their revenue. That could easily go away overnight if Microsoft wanted to go in-house, which they probably will someday. Lowlights, though, not the premier option. Twilio is the premier option. They cost more and they have the larger revenue. They're way more well-known, but they could be a good acquisition target for Twilio at a cheaper price. They have a little less of a sales multiple, but who knows? We'll see what happens in the near future. And then they have, again, large competition that could easily eat them or go away and go in-house like Zoom. If they didn't want to pay that up their gross

margins maybe they spend a little bit on operating expenses for that also not sure the total addressable market is as big as maybe people think um it doesn't seem like i mean how many times are you using two-factor authentication and how much is that worth um unfortunately i'm using it a lot and it's kind of annoying but it i i can disagree with you here and you've said this before with B2B businesses is how big is the TAM. I would almost rather, you only need so much customer penetration. I shouldn't say that, but you only need so much entrance into the market with customers if you have enterprise businesses. And I kind of like that model more as opposed to having to reach tons of consumers. Yeah, but it just means they're taking a tiny slice of that

market i don't know it seems like i mean how much more people going to spend on this stuff is it is everything just going to be digital and we're all connecting to all these things all the time and it seems like the ceiling is just not that high i also don't know where they go from here in terms of product evolution like how do they evolve their solutions right now i i can't think of anything but um well anyway what's your rating for the stock Rating's not going to be high. Their margin adjusted price to sales, which is something I like to pay attention to a lot for growth stocks,

just as a basic indicator, is a lot higher than I would expect for a company with this track record. I would expect someone like Twilio as the premier option to have a higher one, you know, valuation. But the fact that bandwidth has a higher one or just as high, you could argue it doesn't really sit well with me. I don't want to own a business like this that is the second tier unless you're getting it at a super cheap price.

So it's going to be like 5-3. Really, I really do not like it. I think it's a commodity business. I think they could easily lose a lot of customers. And yeah, it seems like something risky, especially at a sales multiple of almost 10. Yeah, I'm going to go with a 6. It really surprises me that companies don't go in-house for this kind of stuff.

Like the big ones, Google, Microsoft. And is Amazon a Twilio customer? I don't know. I don't know. I don't think so. Amazon does a lot of this stuff in-house, but I don't know. It strikes me as something that could definitely be done in-house if pricing got too high.

So I don't think pricing power is there for either business, really. But bandwidth could be a good acquisition target easily for like Microsoft or AWS or something like that. sure yeah like i said i'll go with a flat six doesn't and the valuation wasn't super favorable the margin adjusted like they're having to undercut twilio's prices and they're getting a lot of customers that switch over from twilio that's not like a that's not always a sustainable business model like you're gonna have to sacrifice your own margins at a chance of having a maybe like equal product yeah i don't know uh yeah six yeah definitely not too thrilled uh looking at

this i mean but it's good to always go over a business uh and that's gonna do it for this episode thank you guys as always for listening email us suggestions chit chat money podcast at gmail.com and tweet at us any suggestions at chit chat money on twitter again we are not financial advisors anything we say on this show is not formal advice or recommendation Thank you for listening. We'll see you guys next time. Thank you. Smarter

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