Description

Altigen (ATGN) is an opportunity to own an underfollowed, high quality UCaaS software company poised to inflect revenues and grow its enterprise value as a new product begins contributing to revenues in the coming quarters. We believe this is a highly asymmetrical opportunity with limited downside (due to the cash-rich balance sheet and the high-margin, predictable recurring revenues), and a path to upside of 2x - 4x in the next 3 to 5 years. Given recent M&A transactions of similar sized UCaaS companies, we think the current stock price approximates the downside case for ATGN (4x EV/rev).

Investment Thesis

·         The company has been diligently working on a new Microsoft Teams Phone System solution—this could nearly triple the size of the business in the next 3 to 5 years

o   While the company has historically focused on SMBs, the new solution will represent a shift to a larger customer base driving higher ARPU, better retention, and ultimately accelerated cloud revenue growth

o   We believe that the revenues from this new product (assuming they capture 400-800 new mid-market enterprise customers over the next 5 years) could be an incremental $7-13M of sticky/recurring SaaS revenues (the business today generates $10M of recurring revenues, so this would be a significant inflection point for the business)

·         In the core PBX business, lower price point, functionality, and service has allowed it to compete favorably with larger players such as RingCentral

o   Recurring revenues (cloud + maintenance) have compounded at a 15%+ CAGR and represent ~90% of total revenue and churn approximates 5-7%

o   Favorable industry tailwinds due to current shift from hardware-based to cloud-based phone systems

o   ATGN has proven it can acquire significant customers/partners with its technology, as shown by its partnership with Fiserv (FISV) (merged with First Data); their FISV partnership has driven significant growth and we believe can continue to grow 20%+ per annum over the next few years

·         There is substantial downside protection as the existing recurring revenues alone can be run off for ~$1.40/share and comparable UCaaS companies of similar size have transacted at ~8x recurring revenues; recent purchase of NetSapiens by CXDO would value ATGN at $3.30 per share

Business Overview

ATGN is a provider of cloud-based IP-PBX, Call Center and Contact Center solutions. It primarily focuses its sales efforts on SMB businesses, and its UCaaS solutions are primarily delivered as a cloud service, hosted and managed by Altigen. Its customers are in virtually every industry, but have larger concentrations of customers in the financial services and healthcare industries.

The vast majority of communication platforms in existence today are legacy, on-premise seats such as Avaya, Mitel and Cisco, amongst others. ATGN primarily competes with the cloud-based UCaaS and Contact Center service providers such as RingCentral (RNG) and 8x8 (EGHT), who are taking share from the legacy, on-premise vendors.

Before 2016, ATGN was selling hardware (the physical phones) and a small maintenance fee. It has since stopped selling physical hardware, and has transitioned existing on-premise (maintenance-paying) customers onto the cloud platform. As shown below, the company has successfully transitioned to a cloud-first company today.

Today, ~65% of total revenues are cloud, and recurring revenues (cloud + maintenance) are ~90%. Cloud revenues have compounded at a ~54% CAGR and recurring revenues at a ~16% CAGR since 2015. The company has stayed highly profitable and cash-generative, as EBITDA margins have averaged 20%+ over the past 3 years, with high FCF conversion rates (the company has $50M+ of NOLs; it will not be paying cash taxes for a while). Retention rates approximate 93% to 95%, but have slipped recently due to COVID-related churn (due to high exposure to SMBs). Software revenues (licenses) and Service support program revenues (maintenance revenues) have declined over the past few years as Altigen has focused on maintenance conversions and selling its cloud-first solutions. 

The company primarily goes through the indirect channel for its PBX solutions with roughly ~100 partners/resellers. Fiserv represents ~30% of revenues, and they use Altigen’s PBX solutions as a white-label solution for their end-customers. This line of business for Altigen has been growing nicely in the past 4 years:

We spoke to customers who used Altigen’s PBX solution, and most indicated that Altigen was chosen due to its lower pricing and product functionality (the openness of the architecture, ability to integrate with existing software and Microsoft 365, etc.). They also liked Altigen’s customer service, which was quick and responsive. We spoke to partners who also confirmed these data points, and they liked the economics/margins they received from selling the Altigen solution. 

Altigen also sells a Microsoft Direct Routing solution, which represents ~10% of total cloud revenues. This solution is sold by the direct sales team and is growing in excess of 100%+ annually due to the massive growth in Microsoft Teams.  

Over the past ~1.5 years, ATGN has focused its R&D efforts on developing its feature-rich Microsoft Teams Phone System solution, which we believe will prove to be transformative for the company and will further accelerate cloud growth. The company accelerated this vision by acquiring the assets of Blue Panda in September 2020, where it acquired a multi-tenant cloud solution called CoreInteract. Altigen is essentially bringing in all of the features it offers on its cloud PBX and contact center solutions onto the Microsoft Teams platform, and instead of focusing on SMBs, it will focus on mid-market and medium enterprise customers. ASPs will be significantly higher due to moving upmarket, and the customer base will be far stickier compared to a typical SMB customer. We’ve done work around the demand for this kind of solution (by speaking to IT managers who procure and setup these solutions). These were our conclusions:  

·         There is a trend towards uniformly using Teams internally for collaboration; for external needs, Teams is often used alongside Zoom, Webex, etc.

·         There will be a consolidation to Teams for most O365 users for two primary reasons: better integration with productivity tools and cost

·         Enterprises are in fact interested in integrating their UCaaS platform onto to Teams to have one cohesive video+phone platform

·         There is still a need for the cloud-based PBX business: businesses still have front offices, warehouses, etc. that have hard phones that require a more flexible, cloud-PBX phone system 

Market Sizing

·         In terms of the cloud PBX opportunity, there is ample room for growth. Just to give perspective, there are over 500k total users within the Fiserv base, and ATGN has roughly ~5k of them (a ~1% penetration rate). Beyond this, there are over 300M legacy, on-premise seats from the Avaya, Mitel, and Cisco user bases, which are rapidly transitioning to the cloud, and ATGN has ~15k users thus far.

·         More interestingly is the opportunity within the Microsoft Teams ecosystem. The last cited number from Microsoft was 145M daily active users in April 2021, up from 75M a year ago (+93%). With the new Microsoft Teams Phone System and a ~$180 ARPU, ATGN has access to a $26B opportunity. In other words, acquiring a small slice of this market would yield huge growth for the company.

Valuation

ATGN currently trades for ~4x LTM revenues, which is well below comparable UCaaS peers such as RNG and EGHT.

In our base case, we have ATGN acquiring roughly 30k Teams users at a yearly ARPU of $180 by FY25. To put this in perspective, ATGN currently has ~20k users in its cloud PBX business today. The 30k Teams users would yield ~$5.5M of new cloud ARR in FY25. We have ATGN doing roughly ~17M of total revenues by FY25, which should conservatively be worth 7x (this is more in-line with the comparable UCaaS company multiples). This would yield an outcome of ~$5/share, or 150% upside from current prices.

In our upside case, we have ATGN acquiring roughly 70k Teams users at a yearly ARPU of $180 by FY25. The 70k Teams users would yield ~$13M of new cloud ARR in FY25. We have ATGN doing roughly ~24M of total revenues by FY25, which should conservatively be worth 9x. This would yield an outcome of ~$9/share, or 350% upside from current prices.

The current investments in S&M and R&D are predominantly for growth—the company can be run at 50%+ EBITDA margins if management wanted to solely run this for cash flows, retention, and minimal growth. Using a 10% discount rate (conservative for a steady recurring revenue stream in our view), we can discount the future cash flows and obtain ~$1.40/share of run-off value for our down-side case.

In addition, a competitor called Crexendo (CXDO) bought a UCaaS company called NetSapiens for ~8x recurring revenues (recurring revenues were ~$7M and growing 35%+). It would be hard to imagine ATGN being worth less than 4x recurring revenues in the event it is sold to a strategic buyer, which would impute a value of ~$2/share today.

Management/Board

The company is run by a CEO who is committed and aligned, and happens to be the largest shareholder (with ~15% ownership). His background included working in various executive sales roles at Interactive Intelligence (a contact center software company) for ~15 years, which was ultimately sold to Genesys (a Hellman & Friedman portfolio company) for over a $1B. We got a positive reference check on the CEO from his former boss at Interactive Intelligence. Since he became CEO of ATGN in August 2010, the stock has compounded at a low-teens rate, which is phenomenal given that ATGN was a tough hardware business from inception. Since converting the user base to the cloud starting in 2016, the stock has compounded ~50%.

Other board members own over 10% of the company, and also have considerable experience and backgrounds given the size of this company.

There is one other investment firm that owns ~10% of the company as well.

Risks

·         Competitive pressures on the core PBX business (pricing pressure, etc.)

·         The new Microsoft Teams Phone System solution is a dud

·         Poor capital allocation

·         Fiserv partnership falls apart

Conclusion

Given the downside protection from the balance sheet and a sticky recurring revenue model, ATGN is ultimately a call option on the Microsoft Teams Phone System solution working out successfully.

Catalyst

• Microsoft Teams Phone System Solution is successful
• Core business continues to grow
• Exposure to the investment community