Piece from a 'research house' I was sent today:
On Tuesday, 22 March 2022, members of our investing team jumped on a call with members of Dubber’s executive team, including Steve McGovern (CEO and Managing Director), James Slaney (Chief Operating Officer) and Peter Curigliano (CFO), as well as its Investor Relations member Terry Alberstein.
Overall, it was a positive call. We were able to get further valuable insights into the business – including a first-hand demonstration of its ‘Notes by Dubber’ product (which has been rebranded from its Notiv acquisition) and further insights into what makes it a unique offering.We were also able to gain some additional comfort around Dubber’s cost base and cash outflows which were our chief concern following the group’s latest quarterly and half-year earnings reports.With that in mind, below are some of our key takeaways, followed by a more in-depth discussion.
- Telecommunications providers are excited about Dubber’s solutions, in particular ‘Notes by Dubber’;We had a live demonstration of ‘Notes by Dubber’, and are excited by its potential;
- Dubber has no exposure to Russia or Ukraine;
- Management is confident that it is fully funded to carry out its strategy;
- Dubber has filled most of the roles it needs to fill;
- The $4 million pre-payment made for cloud infrastructure during 2Q2022 is consumption-based, so does not have an expiration date;
- Peter Curigliano (CFO) appears willing to play a more active role in future earnings calls, which we think is important in the changing market environment;
- Although the long-term incentives (LTI) structure isn’t ideal, we still think management have more than enough incentive to build the business for shareholders;
- Management will still consider acquisitions, although that has become a lower priority for the business;
- Management hopes to be adding up to 4 new ‘Foundation Partners’ annually in the not-too-distant future
Mobile World Congress & Europe - When Dubber reported its half-year earnings results in February, Steve McGovern and James Slaney were both in Spain attending the Mobile World Congress conference, along with other major telecommunications businesses.According to the team, telecommunications businesses that attended the conference maintained their excitement toward Dubber’s products, in particular its new ‘Notes by Dubber’.
We can understand the excitement around the product; James, who we see as playing a key role in shaping the company’s product and technology offering, ran us through a live demonstration of Notes.If you’ve ever tried to follow along with a Zoom (NASDAQ:ZM) transcript, you’ll know they can be quite inaccurate. Our impression of Notes by Dubber was that its live transcription was actually fairly accurate by comparison. According to James, the technology provides a live transcription, and then another transcription process takes place once the call has ended to improve the transcription again.This is one of the products that can not only help Dubber gain further traction among business and enterprise users, but among consumers as well.
As Steve noted, outside of their service quality, right now telcos really have two strings to pull when they try to sign (or re-sign) a customer: price and data. Being able to offer such features could give them a third string to pull.It’s one thing for a company to talk about its own book. We asked whether any other companies had highlighted elements of their work with Dubber in their own presentations at the conference, and it appears Dubber’s solutions were highlighted by three other major businesses. That gives us greater conviction that Dubber’s solutions are making a difference.
While we were talking about the team’s time in Europe, we also felt it necessary to ask them if they had any exposure to Russia or Ukraine. They said the business has zero exposure to those markets (that is, no telcos, no receivables, no developers located in those countries, nor any data stored in those countries).
Costs and Cash Flows - we continue to be impressed by Dubber’s product, and overall market offering. Indeed, it is helping the business to generate strong top-line growth with revenue up 149% and 99% respectively in the first and second quarters, compared to their prior corresponding periods. Its reported Annualised Recurring Revenue (ARR) is also growing at an impressive rate.While that growth is part of what attracted us – and others in the market – to Dubber’s shares, its high (and rising) cost base is equally what has led some in the market to turn their backs on Dubber’s shares more recently. In the December quarter alone, the company recorded $14.9 million of cash outflows ($20.5 million for the entire half) while operating expenses for the half were $34.3 million. That figure included $11.6 million in share-based payments.
Hence, part of our concern has been that Dubber’s currently strong balance sheet ($108.5 million in cash, minimal debt) may not have that much staying power. While Dubber’s cost base is absolutely still something we need to monitor, the call did give us some comfort.First, it should be noted that there has been a very significant shift in the market’s appetite for spending and cash outflows. Dubber’s CEO Steve McGovern rightly noted that, in July, the market was hungry for top-line growth, and by the time it came to report its earnings, all the market wanted to see was cost discipline. Throughout the half, Dubber’s attention had mostly been focused on the former (growing revenue and ARR), with costs including the renovations across three levels in one of its offices (to accommodate its growth in staff), a $4 million prepayment for cloud infrastructure (which we’re pleased to learn is a consumption-based agreement, and thus does not have a time limit), and a $1.05 million repayment to the Australian Tax Office (the ATO had allowed small businesses to delay such payments during Covid – Dubber expects to have the amount fully repaid in the next couple of months).While the office fitout and ATO repayments were necessary, the $4 million cloud infrastructure prepayment can likely be seen as good dealmaking.
Although it probably wasn’t exactly what the market wanted to see when it came to cash outflows for the period, that payment will not be an ongoing occurrence.Management also appeared very confident that the capital they have on hand right now is well and truly enough to get them to where they want the business to be. Actions speak louder than words, so we want to ensure that is demonstrated in future financial statements, but it came across that management understands the need to control operating costs and outflows.What’s more, we also suggested that Peter (CFO) play a more active role in future earnings calls (he hasn’t been a participant on the calls, to date), and it appears they will take that on board. Indeed, it was a common observation among our team throughout the latest earnings season that, in the new market environment, analysts want more answers and direction from company CFOs than they have received from many companies to date, so we see his participation as important.
Share-Based Compensation -Dubber’s share-based compensation has been very high recently, and included $11.6 million of payments during the latest half. First, it should be noted that this is a non-cash-based expense, as it represents shares gifted to staff. However, it does represent a legitimate operating expense as that compensation dilutes shareholder ownership.Part of the reason the cost was so high during the latest half is because those options were priced at approximately $4 per share (the then-current market price). It should also be recognised that many technology businesses offer similar equity-based arrangements in order to attract developers and other staff members. In such a competitive environment for developers, Dubber probably has been required to offer greater incentives to join the business. It’s rough, but it’s also reality in such a market.We can also look at management incentives. We’re not overly fond of the way management is incentivised, with their long-term incentives (LTIs) based around ARR growth and telecommunication network deployments. Specifically, management with LTIs will receive 50% of their LTIs if annualised recurring revenue (ARR) is at or above $80 million by 30 June 2023 and another 50% granted if the company has more than 200 network deployments (whether or not yet active) by that same date. Notably, a portion of the LTIs vest if ARR is above $40 million and deployments are above 170. Both of those requirements have now been achieved.At the current share price, those LTIs – in the form of “ZEPOs” – for James Slaney, Stephen McGovern and Executive Director Peter Pawlowitsh, are worth north of $9.2 million. ZEPO stands for ‘zero exercise price options’, which means they have an exercise price of $0.00. Whereas an option that has an exercise price of, say, $2.00, would only be worth exercising if the shares were trading above that price, a ZEPO doesn’t have that hurdle rate. One reason why a company may offer these is because it may allow them to offer less ZEPOs in contrast to options with a higher exercise price to be seen as fair compensation by the recipient.We’re all for incentivising managers, but in our opinion they would be far better aligned if they were incentivised on per-share metrics. For example, incentivised on a revenue-per-share basis.That said, it has also become clear to management that ARR growth is no longer enough to appease the market, and that growth in costs or cash outflows may punish them.
So, two factors give us some comfort here. First, if all the company achieves is ARR growth and network deployments, the LTIs for the executive team might vest, but they’ll be worth less if the market punishes the share price. And second, management already owns a considerable amount of shares: Steve McGovern has an interest in 9.84 million shares – worth $13.3 million at the current price – while Peter Pawlowitsch and James Slaney own 8.58 million and 3.62 million shares respectively. Overall, insiders own 39.4 million shares, or ~13% of the company.Hence, in our opinion, although the long-term incentive program isn’t as clean as we’d like it to be, the incentive to grow the business for shareholders is still greater than the incentive to potentially compromise the business’ health in order to hit $80 million of ARR and 200 deployments (i.e. to unlock the LTIs). The above isn’t intended to question management’s integrity. But incentives do matter, and it’s good to understand what motivates a person both professionally and individually. We also suggested that, in the future, they consider making incentives based on per-share metrics.
Potential Acquisitions - when Dubber initially raised $110 million back in July last year, the message to the market was that a significant portion of the proceeds would be used to fund future merger & acquisition (M&A) opportunities. Since then, the company has only completed one acquisition of an AI technology company, Notiv, for approximately $6.6 million. This left a substantial amount of the capital raised still on its balance sheet, which we expected to be put towards a significant acquisition at some point.However, management has highlighted that whilst valuation for public market companies have declined considerably, the valuation for private companies have not followed in synchrony. With that in mind, management intends to pursue potential acquisitions only if it makes commercial sense and may instead maintain a strong balance sheet to focus on growing ARR organically.
As an example, Steve noted that in this environment, the company would be less inclined to spend $40 million to acquire a business at 4 times revenue (i.e. one generating $10 million of revenue). Instead, it may look to deepen its relationship with a customer such as BT, which may result in a slight increase in costs but would ultimately allow it to save capital and build organically. Considering its significant cash burn and the rising difficulty in raising capital on the market, we are pleased to see management applying this discipline when it comes to capital allocation.
Foundation Partner Program- building on its Foundation Partner program is very much a priority for the business. Dubber has so far signed Cisco (NASDAQ:CSCO) as its inaugural foundation partner, where Dubber’s call recording service is embedded as a standard feature for every subscription on its network. Management has previously stated that foundation subscribers are yet to be included in the overall numbers given it has only signed one foundation partner to date and therefore it is sensitive to report its partner’s numbers.Over time, we anticipate the foundation partners will not only commit to greater volumes and revenue (typically staged in quarters), but also see an increase in upselling opportunities to higher average-revenue per user (ARPU) offerings, which should continue to drive future ARR growth.In addition, management may also soon be in a position to report on its foundation subscriber numbers.
When asked about its pipeline of service providers to be added as part of the Foundation Partner program, CEO Steve McGovern said they would like to see the addition of one per quarter at some point in the not-too-distant future. This suggests that the company is near to closing and announcing some prospective partnership deals. We were encouraged to hear this news given our expectation was skewed towards a more conservative response of around 1 or 2 partners per year given the time and effort to onboard service providers.
Bottom Line- overall, this was a really positive conversation, and our excitement for the potential of this business has not waned. Some of our concerns were eased during the 90-minute meeting, although we do want to see words put into action in regards to its cost base and cash outflows.