Description

Broadsoft

We believe that Broadsoft ("BSFT") is a timely short opportunity with significant downside potential.  I will keep this write-up brief as this is time-sensitive with a catalyst this week.  Broadsoft IPO'd in June of last year at $9.  Since November its stock has increased by approximately 550%. 

 Broadsoft was a venture backed deal founded in the late 90's and took years to gestate.  It is a provider of software that allows fixed-line, mobile and cable service providers to deliver voice and multimedia services over their Internet protocol-based, or IP-based, networks. This is the function of a softswitch.  Their software, BroadWorks, enables service providers to provide enterprises and consumers with a range of cloud-based, or hosted, IP multimedia communications, such as hosted IP private branch exchanges, or PBXs, video calling, unified communications, or UC, collaboration and converged mobile and fixed-line services. Broadsoft serves as the software element that delivers and coordinates voice, video and messaging communications through a service provider's IP-based network. Service providers use BroadWorks to capitalize on their investments in IP-based networks and help them migrate services from their legacy, circuit-based networks to their IP-based networks.

Competition

Broadsoft is not the only company in this space.  They compete with legacy Class 5 circuit switch providers such as Alcatel-Lucent, Avaya Inc., Ericsson, Nokia-Siemens Networks, Huawei Technologies Co. Ltd as well as softswitch startups Digium, Metaswitch Networks and GENBAND Inc. and legacy softswitch providers Sonus Networks and Cisco Systems. 

Sonus and Cisco have been trying to convince telcos to replace their Class 5 switches since the 1990s.  There is nothing more economical than a fully depreciated Class 5 telecom switch.  They last well beyond their depreciable lives and once fully depreciated, the contribution margin of a dollar of revenue run through the switch is 95%.  The PSTN network where these Class 5 switches route calls and traffic are fully depreciated assets that are not going away.  IP networks have greater capacity and are more efficient that the PSTN because IP traffic does not require a fixed circuit.  But they will never fully replace the PSTN.  All of this is to say that Broadsoft's market isn't that large nor will it materialize that rapidly as displacing Class 5 switches is hard to do given their favorable economics.  

Valuation

Broadsoft currently trades at a valuation that makes even Salesforce.com blush.  The stock currently trades at a hefty 11 times the high end of 2011 sales guidance.  Earnings are not taxed, yet the stock trades for about 120 times last year's $.42 EPS.  Last quarter was the last quarter where they still had NOL carryforwards and EPS was $.44.  Next quarter they will be fully taxed and earnings will drop to an estimate of $.09.  The stock is trading at about 75 times the high end of 2011 EPS guidance (for .66 per share) BSFT is priced today as though they've developed some panacea for the telecom industry.  Very little of their revenue is recurring, so forward growth assumptions assume massive adoption by telcos of a technology that has been around for almost 15 years. 

We believe the wireline market will not provide a growth rate sufficient to sustain their current 14x EV/rev multiple.  Though the feature function and lighter footprint (vs a traditional CLASS 5 switch) of Broadsoft is terrific and its software instance can live quite comfortably in the cloud (someone's hosting center) but the company is worth 4-5x EV/rev as the leader in a relatively small market segment (as measured by addressable universe of revenue).

Catalyst