Viewed as one of the market’s favorite plays on the novel coronavirus, cloud communications platform RingCentral (NYSE:RNG) has seen its stock soar over the past few weeks. From its mid-March lows, RNG stock is up a whopping 60%. The S&P 500, by comparison, is up just 23% over from its March lows.
Should you hop in on this epic rally in RingCentral?
Maybe. But I think there will be a better entry point over the next few months than where the stock trades today.
Broadly speaking, RingCentral is a really strong cloud communications company that is a leader in the secular growth Unified Communications as a Service (UCaaS) space. But, RNG stock reflects this reality. That is, shares are pretty expensive here.
So, before buying into the big rally in RNG stock, consider these observations first:
- RingCentral is an important and big player in a vital space. RingCentral is regarded as one of the leaders in the UCaaS market, which projects to grow at a double-digit pace for the next five to ten years.
- Demand for RingCentral’s services will increase over the next few months. Thanks to the coronavirus pandemic and innovative new product launches, RingCentral is well positioned to turn rising demand for UCaaS services into rising revenues in Q2 and Q3.
- The UCaaS market is highly competitive, and RingCentral may be losing momentum to competitors. Although RingCentral is a leader in the UCaaS market, there are several other, highly formidable players in the market. Evidence suggests some of those other players are stealing market share.
- Relative to the company’s long-term growth potential, RingCentral stock is richly valued. Even in an “everything goes right over the next decade” scenario, it’s still tough to justify today’s $220 price tag on RNG stock.
Big and Important
Unified Communications is essentially the idea of integrating enterprise communication services, such as messaging, voice, and video, into one platform and ecosystem. Unified Communications as a Service (UCaaS) is simply taking the unified communications concept, and making it a cloud-hosted service (as opposed to an on-premise solution).
The UCaaS market is projected to grow by leaps and bounds over the next several years, as companies increasingly pivot towards cloud-hosted services and rely on tools that enable remote work, employee mobility and workflow flexibility. Most market research firms project the UCaaS market to grow by somewhere between 10% and 15% per year over the next five to ten years.
In that market, RingCentral is recognized as one of the market’s leaders, given the company’s robust cloud communication platform, which ties together message, call and video; the open platform nature which allows for easy integrations and strong brand equity. Consequently, RingCentral has reported 30%-plus revenue growth in each of the past three years.
Big growth will continue. RingCentral will leverage its leadership position and continued tailwinds in the UCaaS market to report 15%-plus revenue growth for a lot longer. Given a favorable margin profile, this robust revenue growth will lead into equally robust profit growth.
Over the next two quarters, demand for RingCentral’s UCaaS solutions will rise as companies accelerate their pivot to the cloud and increasingly digitize and virtualize their workflows, processes and data.
This is especially true given RingCentral’s newest product expansion. In response to the coronavirus pandemic, RingCentral rolled out a new video meeting product in early April. This new video product adds to what was already one of the most robust UCaaS ecosystems in the market.
It was also launched at a time when the best-in-breed video conferencing company — Zoom (NASDAQ:ZM) — is coming under a wave of scrutiny for its privacy and safety practices. Many organizations, like NASA and SpaceX, have dropped Zoom. Many countries, like Germany, Taiwan and Switzerland, have banned Zoom.
In other words, RingCentral could not have launched a new video product at a more perfect time. Demand is rising, and the competition is stumbling.
Over the next two quarters, then, investors should expect RingCentral to see a material boost in revenues.
The UCaaS market is exceptionally competitive.
Of course, there is Zoom is the video conferencing world. Adobe (NASDAQ:ADBE) also operates in that world. Meanwhile, LogMeIn (NASDAQ:LOGM) has a formidable UCaaS offering. So do tech giants Microsoft (NASDAQ:MSFT) and Alphabet (NASDAQ:GOOG, NASDAQ:GOOGL).
Net net, the industry is full of very formidable competitors.
Yes, RingCentral has separated itself from the pack. But, evidence suggests that Microsoft Teams and Zoom are gaining traction on RingCentral, especially amid the coronavirus pandemic. Even if RingCentral does ultimately trump those competitive threats, doing so will not be cheap. It will cost significant product development, market research and sales and marketing dollars.
This will remain true for the foreseeable future. The UCaaS market will remain crowded. Competitive risks will forever stick around. RingCentral will have to consistently spend big to thwart those competitive risks.
Valuation Is Rich
All things considered, RingCentral is expensive.
The company will net somewhere around $1 in earnings per share this year. RNG stock trades hands at $220. Thus, the stock is trading at 220-times forward earnings.
Some of that premium valuation is warranted by robust growth prospects. Not all of it.
My long-term model on RingCentral makes some aggressive assumptions. Nearly 20% revenue growth per year over the next 10 years. Several hundred basis points of gross margin expansion. Significantly positive operating leverage. Over 30% operating profit growth per year. A rise in earnings per share from $1 in 2020 to $15 by 2030.
Still, those assumptions make a $220 price tag for RNG stock seem stretched.
Throw a 35-times forward multiple on $15 in 2030 profits. You arrive at a 2029 price target for RNG stock of $525. Discount that back by 10% per year. You arrive at a 2020 price target of roughly $220.
And that’s assuming shares fetch a rich 35-times forward multiple in 2030. In actuality, they will likely fetch something far lower than that.
Bottom Line on RNG Stock
RingCentral is a great company. Current tailwinds are also enormous. Given those facts, I understand why its tempting to want to chase this rally in RNG stock.
But, don’t let “fear of missing out” drive you to pay any price for this stock. The valuation today is rich. It doesn’t price in any hiccups. Inevitably, over the next few quarters amid significant macroeconomic turbulence, RingCentral will have a hiccup. When it does, the stock will drop. That will be the time to buy RNG stock — not now.
Luke Lango is a Markets Analyst for InvestorPlace. He has been professionally analyzing stocks for several years, previously working at various hedge funds and currently running his own investment fund in San Diego. A Caltech graduate, Luke has consistently been recognized as one of the world’s top stock pickers by various other analysts and platforms, and has developed a reputation for leveraging his technology background to identify growth stocks that deliver outstanding returns. Luke is also the founder of Fantastic, a social discovery company backed by an LA-based internet venture firm. As of this writing, he was long ADBE and MSFT.