RingCentral: Navigating Growth Challenges (NYSE:RNG)

Investment Thesis

RingCentral, Inc. (NYSE:RNG) growth rates are slowing down. And to compound matters, its balance sheet is meaningfully overleveraged.

Furthermore, given its slowing pace of growth, this means that investors are increasingly valuing the business on its current valuation, rather than as a growth story.

More specifically, investors are looking at its enterprise value, and wondering whether paying 20x forward free cash flows is all that enticing? I’m not convinced it is.

Why RingCentral? Why Now?

RingCentral is a cloud communications and collaboration platform. It has two main operations, Unified Communications as a Service (”UCaaS”) and Contact Center as a Service (”CCaaS”)

UCaaS provides a comprehensive suite of communication tools, including voice, video, and collaboration features, designed for general business communication and collaboration needs.

Think of this business unit in this manner: RingCentral’s UCaaS aims to provide comprehensive communication and collaboration tools for businesses. Essentially, RingCentral aims to streamline internal communication and enable collaboration among team members.

CCaaS, on the other hand, is tailored specifically for contact center environments and includes features such as inbound and outbound call routing, IVR (Interactive Voice Response), queue management, and call recording.

Think of CCaaS as providing customer service and support operations.

CCaaS enables businesses to efficiently manage and handle customer inquiries, support requests, and other customer interactions through various communication channels, such as voice, email, chat, and social media.

In the past month, the stock has rallied as investors became excited as a hedge fund took a large position in the company and the idea of a potential merger with 8×8, Inc. (EGHT) surfaced. Here I’ve not put any emphasis on this outcome, as it’s difficult to quantify right now.

Now, we’ll turn our focus to discussing RingCentral’s financials.

Revenue Growth Rates Are Slowing Down

RingCentral is being forced to tackle its overleveraged balance sheet, more on this soon.

For now, the key takeaway is that RingCentral’s revenue growth rates are slowing down. The business may find some way to reaccelerate its growth rates, but it appears that for now, it’s unlikely to grow significantly faster than 15% CAGR.

The Bear Thesis: Leveraged Balance Sheet

Last month, RingCentral announced that it had repurchased approximately $460 million worth of its convertible notes.

Given that its balance sheet only held about $275 million worth of cash as of Q1 2023, you may wonder how did RingCentral get hold of the remainder of that cash? Here’s a quote from the earnings call that explains this,

[…] you may remember, last quarter, we announced a $400 million Term Loan A. That’s a delayed draw facility, which we have available to us through November of 2023 and we will be opportunistic in terms of when and if we decide to draw on that, depending on market conditions.

Accordingly, it appears that RingCentral has in the past couple of years been actively repurchasing its stock at higher prices rather than being more proactive in buying back its convertible debt.

As of today, there are looming doubts as to whether or not RingCentral will succeed in paying back its approximately $539 million worth of convertibles that mature in 2 years. And on top of that, there’s still more than $520 million that is due for conversion the year after.

In an effort to appease investors, management stated on the call,

We shared last quarter that we would double free cash flow generation from a normalized level of $140 million in 2022 to at least $280 million by 2024 by fiscal year end.

Needless to say, even if RingCentral got its free cash flow to $280 million in 2024, this would still not be enough to pay down more than $1 billion worth of convertibles, plus whatever sum is outstanding from its revolver.

Meaning that, one way or another, the business is meaningfully overleveraged. And with slowing growth rates, too.

The Bottom Line

RingCentral, Inc. is facing challenges as its growth rates slow down and its balance sheet becomes overleveraged.

Investors are increasingly valuing the company based on its current valuation rather than as a growth opportunity.

While the stock has recently rallied due to a hedge fund’s position and potential merger rumors, it’s difficult to quantify the outcome.

However, RingCentral’s financials show that its revenue growth rates are slowing down.

The company’s overleveraged balance sheet raises concerns, as it may struggle to pay off its convertible debt of over $1 billion in the next few years.

Despite management’s efforts to generate more cash flow, it may not be enough to address the debt, making RingCentral’s situation concerning with both its overleveraged position and slowing growth rates.