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Business Strategy and Outlook

RingCentral's continued emphasis on infiltrating large enterprises as an important focus. Over 90% of overall revenue has long been derived from recurring sources. I think the company can have high switching costs due to a strong, reliable income stream, great customer retention,RingCentral is a disruptor, and revolutionized the business telephone systems. Team communications, video conferences, and phone conversations can all be made using the same simple platform; RingCentral MVP, a unified cloud-based business phone system. RingCentral MVP works with more than 2,000 well-known enterprise software programmes and solutions and provides an open API. Ringcentral is engaging in the Ucaas market with around 25% market share. Reinvesting in the company and establishing strategic alliances are the main goals of RingCentral's capital allocation strategy. Given the quick growth in the UCaaS market together with an environment that is becoming more competitive, I see the choice to invest in company growth as reasonable. Choosing the ideal business partners for long-term success has been a task that management has excelled at, in my opinion. The migration of the more than 450 million on-premises legacy PBX seats to the cloud, in my opinion, presents a substantial market potential for UCaaS providers. Less than 5% of hosted PBX seats have gone to the cloud as of yet, despite the fact that this process is speeding up. Avaya, Alcatel-lucent Enterprise, Mitel, three of the top five legacy PBX suppliers, and system integrators are all significant partners of RingCentral. This represents a significant upside for RingCentral, even if it fails to expand market share against 8x8, Teams, Zoom and more. Maintaining a leadership position is extremely likely based on customer satisfaction and the level of investment into it’s own business. If I model a 26% growth rate over the next 10 years and a longer-term average growth rate of 9%, we get a FVE of $303, despite a 13.5% discount rate being applied. My grey sky scenario for RingCentral would be around $155, which models them losing market share and having a longer term average growth rate of closer to 5%. Blue sky scenario would be at $557, modeling market share growth all the way to 45% as well as consistent secular tailwinds. Strong user numbers from RingCentral, in my opinion, measure and demonstrate the high quality stickiness of its products. Net retention is improving, churn is declining, and average contract values, or ACVs, are rising according to multiyear patterns. Although small and medium business retention rates keep the overall net retention rate below the best-in-class retention witnessed among corporate customers, it is consistently higher than 99%. The net dollar retention rates of 150% for the most recent cohorts of premium clients are astounding and reflect an increase in seats sold, increased cross-selling of UCaaS and CCaaS solutions, and decreased churn. As RingCentral's enterprise focus skews its client makeup away from small and medium enterprises and toward large corporations, I anticipate that net retention will continue to trend upward. The fastest expanding market category as of 2021, enterprise clients represented nearly 41% of annual recurring revenue, up from 24% at the end of 2018. As a result of the larger number of touchpoints a particular software vendor has across the organization, as well as the fact that large enterprise clients not only offer a greater lifetime value for a proportionally smaller acquisition cost, but also tend to be stickier in nature, I see rising enterprise usage. Overall, management has defined a strategy and executed well.

Moat


Ringcentral has a narrow moat due to high switching costs associated with RingCentral MVP, the company’s core offering. Communications are mission-critical for any company and switching would be extremely painstaking and costly. This makes protecting RingCentral’s leadership status an easier feat as companies are less likely to switch providers. This moat is displayed with a 99% gross retention rate and a staggering 150%+ net dollar retention rate for it’s enterprise customers. Ringcentral has also been able to convert its biggest competitor, Microsoft, into a coopetition status, as an integration between Teams and MVP allows for customers to use both products simultaneously and seamlessly. Strong user numbers, a subscription business model, and net dollar retention rates above 100% all underpin RingCentral's moat. In the upcoming years, I anticipate enterprise penetration, which has been the business area with the quickest growth, to increase even more, which will further increase transaction size and retention. RingCentral's position as a market leader in the UCaaS sector should be further cemented as a result of decreased attrition and better seat penetration. Since corporate communications are crucial and the company's extensive software is high-touch in nature, I think RingCentral's unified communications platform benefits from strong customer switching costs. I anticipate that the widespread adoption of cloud-based communications and the growing significance of a unified platform strategy, which enables a single device-agnostic user experience, will be advantageous for RingCentral. In my judgement, over the next ten years, RingCentral will provide excess returns on capital, especially if margins increase as the business grows and experiences secular tailwinds. I think the last great frontier that hasn't been totally digitalized when it comes to the modern corporation is the communications sector. While workflows got more digital, cloud-based, and intelligent as businesses modernised, communication systems remained mostly as long-serving legacy systems with outdated capability. On-premises private branch exchange, or PBX, systems are a significant part of this legacy infrastructure since they enable businesses to host their own telephone network without providing each user with a separate plain old telephone system (POTS) connection. Legacy PBX systems have high hardware and upkeep expenses and offered constrained, rigid telephony capability. Only about 15 to 20 million of the 450 million legacy on-premises PBX seats have so far been migrated to the cloud. A increasingly mobile workforce necessitates the capacity to communicate across all communication channels, through any device, with a single user identity. COVID-19 has hastened the shift to work-from-anywhere. Moreover, a mobile workforce needs to be able to communicate using a single user identity across all communication channels and devices. In the PBX industry, and later in the UCaaS industry, RingCentral has been a pioneer, driving the wave of migrations from on-premises legacy communication systems to cloud-hosted solutions and being among the first to understand the need of combining numerous communication modes. After the pandemic, I anticipate the secular shift toward cloud-based communications technologies to continue and benefit companies like RingCentral.



Competition

RingCentral competes in a cut-up, fiercely competitive market where big companies like Cisco, Microsoft, Zoom, and others are active. For many years, RingCentral has been a pioneer in the UC arena, developing much of what is now "standard" in UCaaS and cloud PBX systems. With more than 250 million Teams users, a robust messaging and video offering, and a trailing cloud PBX system, Microsoft has the most comparable UC platform offering. With an integration into Microsoft Teams that enables users to seamlessly use services from both apps (for example, RingCentral's cloud phone system offered within Teams' call functionality and RingCentral meeting scheduling within Teams), RingCentral has recently been able to reposition Microsoft into a partner-like competitive position, fostering a “co-opetition” approach rather than pure competition. A 2021 analysis by Okta, which is not exclusive to UCaaS or communication apps, reveals that 81% of companies using Microsoft 365 also employ multiple best-of-breed software solutions, supporting the multi-sourcing mentality of clients for various point solutions. Over the past two years, Zoom has swiftly ascended in the UC rankings thanks to its best-in-class video solution and a developing Zoom Phone service with many millions of seats. I see that, following a number of investments in the product, RingCentral's standalone video solution has seen great market momentum in recent months. Given the size of this market opportunity, I expect several winners to emerge and view RingCentral as having a strong competitive positioning, thanks to its best-in-breed cloud phone solution and legacy partners, which will allow the company to maintain its leadership position in the space.


Risk and Uncertainty

Microsoft Teams has the potential to keep gaining market share, reducing the growth runway for RingCentral as it upsells into enterprises, where Teams is dominant. With $267 million in cash and cash equivalents and $1.4 billion in convertible notes as of December 2021, RingCentral continues to have a precarious financial position. The company recently redeemed all of its 2023 convertible notes and issued fresh debt totaling $1.65 billion. $1.0 million and $650 million of these new convertible notes are due in 2025 and 2026, respectively. Based on cash levels and anticipated free cash flow generation, I do not believe the company faces a major risk when it comes to supporting the repayment of the notes, even though conversion into ordinary shares appears to be a steep hill at $360 and $424. I also believe that, should the necessity arise, the company could probably refinance the debt. In order to reach new clients and boost seat penetration, a significant portion of RingCentral's go-to-market strategy depends on legacy PBX partners like Avaya and international service provider partners like AT&T. If such relationships end, it can negatively affect RingCentral's sales strategy and hinder growth. Despite efforts to increase enterprise usage, the majority of RingCentral's clients are still small- and medium-sized businesses at this time. Smaller companies have shorter contracts, are less stable, and are more prone to churn. RingCentral may encounter difficulties expanding seat penetration quickly if enterprise acceptance cannot be increased quickly enough.



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