StarBlue Inc. (STC) Earnings Call Transcript & Summary

Thank you for standing by. This is conference operator. Welcome to today's investor conference call. [Operator Instructions] I would now like to turn the conference over to David Moore, Chief Financial Officer. Please go ahead, Mr. Moore.

Thank you, operator. Hello, everyone, and welcome to Sangoma's Investment Call. We're here today to share with you today's announcement about the acquisition of Star2Star. We are recording the call, and we'll make it available on our website shortly for anyone who is unable to join us live. I'm here today with Bill Wignall, Sangoma's President and Chief Executive Officer; and John Tobia, EVP, Corporate Development, to take you through this morning's exciting news release, which is available on SEDAR and on our website at www.sangoma.com. As a reminder, Sangoma reports under International Financial Reporting Standards, IFRS. And during the call, we may refer to a couple of terms such as operating income, EBITDA and adjusted cash flow that are not IFRS measures but which are defined in our MD&A or the press release. Also please note that unless otherwise stated, all reference to dollars are to the Canadian dollar. Before we start, I'd like to remind you that the statements made during the course of this call that are not purely historical are forward-looking statements regarding the company or management's intentions, hopes, beliefs, expectations and strategies for the future. Because such statements deal with future events, they are subject to various risks and uncertainties, and actual results might differ materially from those in these forward-looking statements. Important factors that could cause actual results to differ materially from those in forward-looking statements are discussed in our September 30, 2020, MD&A, our annual information form and in the company's annual audited financial statements, all of which are posted on sedar.com. With that, I'll hand the call over to Bill.

Thank you, David. Good morning, everyone, and thank you for joining us. As you know, we issued a press release this morning announcing the definitive agreement we've signed to acquire Star2Star Communications. We are super excited about this transaction because it establishes Sangoma as a preeminent cloud communications company, clearly positioning us in the upper echelon of our entire industry. We have a lot to cover today, and I've structured my prepared remarks in 4 sections. I'll start first by describing Star2Star and its attractive business. Then I'll walk you through the transaction details. Third, I will cover the strategic rationale behind the acquisition. And fourth, I'll share with you an early snapshot of the combined business. Finally, I'll offer a quick summary to wrap up my comments, following which we will open the call up for questions as we always do. Just before I begin, there are no doubt a number of folks from Star2Star listening into this call with interest and curiosity. I'd simply like to extend a warm welcome from the entire team here, along with their valued customers and partners. We look forward to having you as a part of the ever-growing Sangoma family as we merge our 2 great companies together. So let's get started with the first section, an overview of the company. Star2Star was founded in 2006 and is about 15 years old, has approximately 260 employees and is headquartered in Sarasota, Florida. The company is privately held with the majority owned by the founder, Norman Worthington and employees; about 15% by NewSpring Capital; and the remaining distributed across other shareholders. I'm going to take a few minutes to introduce you to their products, their customers and their go-to-market approach. Let's start with product. First of all, Star2Star is a pure-play cloud company. It offers its customers a complete portfolio of cloud communications services. Offerings include a comprehensive suite of voice, contact center, collaboration, integration, video meetings, Communications Platform-as-a-Service, or CPaaS, and desktop as a service solutions. These cloud services work on any device, from desk phones to soft phones running on your computer to soft phones running on your mobile device, all accessible from anywhere. And they are truly enterprise-grade tightly integrated across the whole suite fully owned, not purchased from third-party companies or soft switch vendors. Further, the Star2Star services are cloud-native, a term that may not be familiar to some of you. The cloud-native concept is one used to describe the idea that the software itself was developed with the intent of being run in the cloud from the beginning and was optimized to do so. This is a relatively recent concept in the longer history of tech companies generally and software firms more specifically, a term that's really only been around for the last 5 or maybe 10 years. It's used to distinguish the software development approach and the benefits from it versus what had been the more traditional route of enterprise software, which was designed to be used by a single customer or company likely deployed at their site and may eventually have been ported later by the software development company to the cloud to run there. And finally, these cloud services are delivered via high availability, multi-tenant platform, which Star2Star develop in-house as you just heard. That has enabled a very impressive 99.999% core network uptime, a term that our industry refers to as five 9s, basically the gold standard. As I hope you will now appreciate, one of the things we really like about Star2Star is that they share this view of a unified set of cloud services aligns exceptionally well with what you've heard me describe as our Communications-as-a-Service, or CaaS strategy. The basic idea being that cloud commutations is not just about voice anymore but is increasingly becoming about the integration of these various cloud services: Voice, collaboration, CPaaS, video meetings, et cetera. Customers want an integrated buying experience colloquially referred to as one-stop shopping rather than buying 5 different cloud services from 5 different vendors. This Communications-as-a-Service differentiates us in the market. And the combination of Sangoma with Star2Star enhance this ability. Let's now turn to customers. Star2Star's customer base is expansive, with nearly 10,000 business customers relying upon its cloud services but with very little concentration risk, given no single customer represents more than about 5% of revenue. Their customers are truly Tier 1 caliber with clients like Enterprise Rent-A-Car, Taco Bell, RE/MAX, New Balance, Domino's, Xerox, et cetera, to name just a few. At this stage, Star2Star operates in North America, so most all of their customers in the U.S., something that presents us jointly with an exciting opportunity together that I'll discuss a bit later. In terms of market segments, like most cloud players, Star2Star started many years ago, focused more on the SMB category originally. That's because the earliest adopters of cloud at the time when it was much newer and less common tended to be smaller companies. But over the years, Star2Star has moved much earlier into the mid-market and enterprise segments than Sangoma has done with our cloud services. These segments are the highest value markets in the cloud communications industry today. That's because they are the least penetrated still at 12% and 2%, respectively, versus the SMB segment, which is already over 30%, and they are growing the fastest according to industry analysts. And finally, on customers. Star2Star has performed incredibly well in industry studies on customer satisfaction. In fact, one particular such study, Gartner ranked Star2Star as having the highest customer satisfaction versus even the largest competitors by assessing scores on overall peer rating and willingness to recommend. It's thus not surprising that the company has low churn, high retention rates and long average customer life. Next, I'd like to touch on Star2Star's go-to-market strategy and unique channel approach. This is another aspect of Star2Star's business that we really grew to appreciate and to like as our discussions unfolded. The company has a uniquely differentiated go-to-market strategy, one, which leverages multiple types of channels and does not rely solely on agents and master agents, what so many of our competitors seem to do. Star2Star has invested heavily in building out this differentiated channel approach, employing more than 65 -- 650 active partners across these different types of channels from traditional resellers and interconnects, to agents and master agents, of course, to enterprise partners who do not come from the communications space at all but who love the idea of being able to sell communication service with their core technology offering to wholesale, and finally, white label partners, a well-diversified and unique approach. One of the ways in which the company has successfully built out the unique channel model is by being able to offer to that channel a truly robust partner back office system. Star2Star has developed, once again, in-house, what we see to be the industry's most comprehensive partner enablement system, which they call Polaris. Many people underestimate the significance of such back-office systems because those systems are not front end facing user products. But to the prospective channel partner, this is a key differentiator for Star2Star. Polaris includes everything from a learning management system to a marketing hub to support a partner doing marketing of Star2Star services to an advanced quoting capability, including the ability for the partner to see their potential commission when quoting various product configurations and pricing models to the end user; a case hub, enabling the partner to see all of their open tech support cases for their customer in one organized place right through to provisioning and configuration tools and a fully searchable knowledge base. And for the last part of my Star2Star overview, I'd like to offer a quick financial picture of their business. Star2Star has an excellent financial profile with revenue that's reached the level, which is highly material for Sangoma and done so with consistent profitability. This is another of the common touch points that we realized during discussions between our companies. Star2Star shares our view and financial discipline in which both companies focus on a balanced mix of good sustainable growth and on reasonable profit, not growth at all costs. On an unaudited basis and in accordance with U.S. GAAP, Star2Star generated approximately CAD 107 million of revenue for the trailing 12-month period that ended September 30 or approximately USD 79 million, given prevailing FX rates, and this high-quality, high-margin business with over 80% of Star2Star's revenue being recurring. This revenue composition provides the company with 80% plus gross margins. That revenue and gross margin, along with solid reasonable investment into customer acquisition and innovation R&D, also affords Star2Star with healthy EBITDA margins. The company produced over USD 14 million of adjusted EBITDA for that same 12-month period, equating to adjusted EBITDA of just over 15%. And now that I've given you an introduction to Star2Star, let's talk about the transaction. Shifting gears to the details of the transaction itself, I'll now discuss the key terms and the process from here. As you will likely have seen in the press release, Sangoma will pay to Star2Star shareholders USD 105 million in cash on closing. In addition, Star2Star shareholders will receive 110 million shares of Sangoma common stock with 22 million shares to be paid at closing and the remainder issued in installments, starting 1 year after closing and continuing for a period of 14 quarters. Including all common shares that will be issued pursuant to the installment release, Sangoma would have approximately 221 million common shares outstanding. Based upon the 30-day VWAP, average closing price of Sangoma's common shares, the share consideration would be valued at just over USD 300 million. And thus, when the cash consideration is then added in, this results in a total purchase price of just about USD 420 million on a debt-free and cash-free basis and subject to customary net working capital adjustments. In total, this works out to approximately CAD 540 million. Such a purchase price implies a fair and attractive revenue multiple of just over 5x, which is well below the industry average in the cloud communications sector despite few public peers being EBITDA positive. The cash portion of the consideration will be funded, first, from cash on our balance sheet, including the proceeds of the $80 million equity raise we completed this past summer; and second, through an extension of our existing credit facilities with our current lenders who are fully supportive of this exciting transaction. That will bring our gross debt outstanding to about $101 million at closing. On a pro forma basis, our debt to adjusted EBITDA would then be a very manageable 2.4x. Sangoma's Board of Directors, after consultation with its financial and legal advisers, has unanimously approved the agreement and the transaction. It is subject to shareholder approval at a special meeting, and your Board unanimously recommends that its shareholders vote in favor of this transaction. The recommendation is based on various factors that will be described in detail in the information circular. The circular is expected to be mailed to shareholders in latter February or possibly early March, with the closing of the acquisition anticipated in or around the end of March. Finally, as you may have seen in the press release, this acquisition is a reviewable transaction under TSX venture policies, thus necessitating a standard and temporary trading halt, which I'm sure you've noticed today. Now that you understand a bit about Star2Star and the acquisition itself, I'd like to focus for a few minutes on the strategic rationale for the transaction by reviewing the 7 key advantages that we see. First, the combination creates much needed scale so important in a growing, consolidating space. Those that have followed the communications industry know the transition to VoIP and to hosted is well established. However, the transition to converge cloud-native solutions is still in its infancy. The addition of Star2Star will mean that Sangoma would have more than $245 million in combined revenue on a trailing 12-month basis. There are virtually no truly large global competitors yet, with the biggest just reaching the $1 billion mark. There is a ripe opportunity for Sangoma, and this acquisition clearly establishes the combined company as a top-tier communications player. The second strategic rationale for the acquisition is that the combined business will have the most complete, fully integrated suite of cloud communication services and of products in the industry. Customers today are demanding the integrated buying experience I spoke of earlier or that one-stop shop for all their communications needs, not this 5 different services from 5 different vendors. Merging Sangoma and Star2Star will enable us to satisfy that unmet need with the broadest set of products and cloud-native services available. This transaction will ensure we can meet any customer's preference, be it for purely cloud solutions or for on-premise deployments or a hybrid combination, a set of choices that enables us to win customers who may not yet be quite ready to go all in on cloud. We can now do it from small businesses right up to the largest enterprise-type customers. The combined company's full spectrum portfolio will appeal to both new and existing channel partners. Star2Star also has a complementary strategy to Sangoma. We both agree that exciting growth is possible without sacrificing profitability. Star2Star did approximately $107 million in the trailing 12 months, as you've heard, of mostly recurring revenue. And thus, on a combined basis, the company would have revenue approaching $250 million, ranking us clearly in the upper echelon of our publicly-traded peers. And we'll be doing this with compelling gross margin and very healthy EBITDA profiles, unlike many competitors. We see a very real and significant opportunity to realize increasing shareholder value, not only through continued execution and results, but also through material multiple expansion. Fourth, as many of you know, we've had a very conscious strategy for many years now to transform Sangoma from our product business into one of the communication industry's leading SaaS companies. This strategy has been working well, such that in recent quarters, you've finally seen Sangoma get to over 50% of sales coming from our services revenue. Star2Star, on the other hand, exceeds 80% of sales in recurring revenue. This acquisition will mark the culmination of Sangoma's long-term evolution into a leading cloud service and SaaS company. The combined business will generate over 70% of its sales in recurring services revenue positioning Sangoma among its top-tier SaaS peers. The next strategic rationale for the acquisition is that the combined businesses have unique but complementary go-to-market approaches and channel models. We will be posting a PowerPoint presentation on our website by Monday regarding this acquisition. And for those of you who might choose to look at it, you will see an excellent slide describing these complementary channel types. There were certain types of channels where Sangoma is strong and Star2Star is not, and others where Star2Star is strong and Sangoma is not. And finally, some where both companies have strength. Combined, our company's channel model will be amongst the broadest in the industry with the most differentiated types of channels. And as I mentioned earlier, Star2Star has a strong foothold in the rapidly growing but underpenetrated mid-market and enterprise customers so that combined, we will be able to serve all customer segments. Altogether, the combination will increase mind share and loyalty and our partner relationships, from a service provider that treats them well, cares about them, has a reputation for fair dealing and offers the most comprehensive partner-enablement capability. Sixth, the acquisition provides the combined business with a significant opportunity to expand our cloud solutions to underpenetrated international regions. While the North American market is at 30% penetration plus, which is still quite a small fraction, the international markets are nowhere near that. Sangoma has global staff as well as customers and channels in over 125 countries. Targeting these international markets where cloud solutions are underpenetrated and significantly less competitive requires a cost-effective, scalable solution on a multi-tenant platform, which the combined company will now have. And last but not least, the transaction combines 2 exceptional management teams with deep sector expertise and a well-proven ability to grow the business while doing so profitably. The teams exhibit cultural alignment and are super-excited to get going with this great opportunity together. This chemistry will serve as a foundation or competitive advantage going forward. Okay. Now that I've covered the rationale for the acquisition, I'd like to provide you a quick snapshot of the merged company, touching on strategy, scale, leadership and integration. The combined organization has an extremely large total addressable market in front of us. We will absolutely continue on our dual-pronged growth strategy, one that most investors in STC have become familiar with over the past several years. First, we will seek attractive organic growth by investing in R&D and customer acquisition. And second, we will keep augmenting that organic growth with deliberate and disciplined M&A. Star2Star represents Sangoma's tenth acquisition in the past several years and is a truly transformational one on our path to becoming a leading cloud and SaaS communications company. To give you a sense of the scale for what the combined business would look like, I'll now share a few financial metrics. This is based on a pro forma view, and it utilizes the unaudited results for Star2Star during the 12-month period ended September 30. I realize that some of these measures came up earlier in my comments, but I felt it might be useful to collect them all up and paint a single snapshot of the combined business. Revenue would be $245 million, with over 70% of that being high-value recurring services revenue. Gross margin would be over 70% of sales. And adjusted EBITDA for the combined business would total $44 million or 18% of revenue. Please note that at this stage, we have simply combined Star2Star under U.S. GAAP with Sangoma under IFRS. So the final pro forma results may be slightly different. On the topic of going forward leadership, I will remain CEO of the combined company with Norm Worthington, Star2Star's Founder and CEO, assuming the role of Board Chairperson following the closing of this acquisition. Norm and I have spent a lot of time together over the past many months, and not only will Sangoma benefit immensely from his extensive experience, but he's a gentleman and just a really good guy, and I look very much forward to working with him as our new Chair. Star2Star is also entitled to nominate 1 additional director to our 5-person Board, which will come from NewSpring Capital. And that will likely be Mr. Lederman, who has represented NewSpring on the Star2Star Board for several years and thus knows the business well. With respect to integration, since Star2Star is a financially healthy, well-run company, we do not plan restructurings nor expect large cost synergies. To be sure, there will be some cost savings opportunities to be explored such as traffic consolidation, data centers, duplicate marketing spend, et cetera, but this will not be the initial focus of our integration efforts. And regarding the people part of our integration plans, we intend to handle this in 2 steps. What some folks call the staff functions, so think finance or HR or legal, are departments that we expect to integrate quite soon after closing. However, the line functions and here think sales or engineering or marketing or operations, we will not integrate right away. It's always harder to do those departments immediately at the best of times in an acquisition. But given everything going on out there in the world, it's pretty far from the best of times with the COVID pandemic. And thus, the entire diligence process was conducted remotely over our respective video meetings services. And as a result, we've never even had the chance to meet each other face-to-face yet like when normally would, usually on multiple occasions during such a process and often for days on. And thus, we're going to take our time and get to know each other for a couple of quarters before bringing those departments together such that we do so after having built up a better understanding. In that interim period for the first several months, it will be pretty much business as usual in the trenches for both companies as the integration discussions take place. With that, I'd like to offer a brief wrap up and then turn the call back to David for questions. Sangoma has come such a long way. From a little nano cap stock and a company that makes hardware cards that go into smarts in servers. The progress is both rewarding and remarkable. To truly transform Sangoma into a cloud communications company with a SaaS business model is something that many people did not believe we'd be able to pull off. This little tiny one product line hardware company that made products for ever-increasingly obsolete PSTN applications. But with a committed long-term strategy that we clearly spelled out: Solid execution, new products, organic growth and prudent acquisitions to augment that growth, it turns out it was not only possible, but amazing. And Star2Star allows us to round out that journey with the transaction that just makes so much sense between 2 like-minded companies that were excellent on their own and will be even greater together. The acquisition marks the culmination of our multiyear evolution, and Sangoma will now be positioned in the upper tier of the industry's leading companies, companies with multiples that average something like 12 to 15x sales. So look out, world. Here we come. Just before we open the call to questions, I'd like to, once again, welcome the entire Star2Star team to the Sangoma family. And I'd also like to thank our traditional Sangoma employees for all their ongoing hard work that helped us get here. And finally, to you, our valued shareholders, we appreciate so much your investment and your confidence in our vision and our leadership team. Without your support and the backing of our lenders, this transaction would not have been possible.