Via SeekingAlpha.com

As the global pandemic continues to rage across the US, sifting through what stocks to invest in relies on imagining what a post-COVID-19 world would look like. In the new normal of social distancing, communications stocks are forecasted to do well as they enable people to continue to work and interact. As companies move to quickly enhance their communications capabilities to deal with a post-COVID-19 world, a company I believe that is poised to do well is Vonage (VG).

Social Distancing could change the way we shop forever

There are multiple scenarios on what a post-COVID-19 world would look like where the economy restarts but social distancing guidelines remain in place for the foreseeable future. What this means is that there will be less crowded events (no concerts, only closed-door events, etc.), companies promoting work from home and malls, shops and restaurants having limited space and seating. In this type of world of limited social interaction, the importance for companies to have a robust communications platform is more needed.

I’ve discussed the CPaaS market before in my article on Twilio (TWLO). Pre-COVID-19 the CPaaS market was expected to grow rapidly reaching $11 billion by 2022. Post-COVID-19, I expect this growth rate to only further accelerate and the reason is that the current shopping experience was not built for a post-COVID-19 world.

CPaaS market growth

Shopping post-COVID-19 may involve a lot of long lines

Just like Twilio, Vonage through its acquisition of Nexmo allows businesses to integrate various communication features like SMS and voice into its clients’ apps without having any in-house hardware, or having to deal with telecom carriers. The CPaaS industry, in which Twilio and Vonage are among the market leaders, has the potential to improve the customer experience within a social distancing world. Imagine instead of lining up for hours to enter a store due to the in-store limit of how many people can be within the store, you can queue up and track your place in the line via an app that is constantly communicating with you. You can queue up to enter a store or schedule a visit online. You can have a more collaborative workplace as the means of communication becomes more integrated, etc. These are just a handful of obvious examples, Gartner has identified dozens more in its CPaaS report as shown in the table below. These use cases were already being discussed and imagined in a pre-pandemic world however this crisis may have accelerated companies’ need for such services.

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Possible use cases identified by Gartner

Vonage vs. Twilio

The current leader in the CPaaS industry is Twilio on which you can find my thoughts here. Pre-COVID-19, I felt that the valuations of the company were too expensive and initiated a position in Vonage. Both companies’ stock prices have fallen a substantial degree yet I believe that Vonage remains the cheaper option between the two. In terms of features, Vonage/Nexmo has similar capabilities as Twilio albeit a bit lagging behind and not as advanced in particular with regard to its API.

Attribute comparison of the different CPaaS companies

However, currently, Twilio has a market cap of $11.2 billion as opposed to Vonage’s market cap of $1.7 billion. Twilio has a 2019 revenue of $1.13 billion and a negative operating income of $354 million; this indicates that a lot of its current valuation is based on the promise of the CPaaS industry.

By comparison, in 2019, Vonage’s business segment revenue was $804 million, recording a continued impressive growth rate of 32%. The company’s legacy consumer business suffered an 11% decline ending 2019 with revenue of $385 vs. $441 a year prior. However, the fact that the legacy consumer business is making any money at all is a good thing as it provides the necessary cash flow to fund this future business. Vonage had a 2019 operating income of $7 million, down from its 2018 operating income of $62 million. Nothing exactly to write home about but it’s better than Twilio’s negative operating income. Both companies have negative EPS. Twilio and Vonage have similar results when it comes to business capabilities and financials, yet have a wide disparity with how they are valued by the market.

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Vonage investor relations

Vonage also has an advantage over Twilio in that apart from its CPaaS business, it also operates other communication business platforms. This allows it to deliver a broader range of communications solutions to its clients, giving it an edge over Twilio which is largely focused on CPaaS. Vonage has begun winning larger clients, recently signing up Teladoc (TDOC) and Peloton (PTON) for video APIs. Vonage also has strong unified communication and contact center offering further stacking the odds in the company’s favor.

Bundling these capabilities with CPaaS could give Vonage an edge

Risk and Challenges facing Vonage

The main risk Vonage faces is its relatively large debt position of about $500 million and a low cash position of about $24 million. The company mainly used debt to fund its acquisitions. Taking out the portion of goodwill, Vonage has total assets of $764 million giving it a long-term debt to asset ratio of 65% and overall debt to equity ratio of 1.4. Having a fair amount of debt is normal; however, going into a potential recession puts the company in a weaker position relative to its competitors. In contrast, Twilio has cash reserves of $1.8 billion against a long-term debt of $458 million.

Another particular risk to my thesis is if Twilio ends up dominating the CPaaS market essentially crowding out other competitors. I don’t believe this is the case though, as I don’t particularly view the CPaaS market as a “winner-take-all market” due to the presence of a number of competitors, evidenced by Twilio’s own market share of 32%. A “winner-take-all” market would have strong network effects, which is something the CPaaS industry doesn’t seem to have. Rather, I view the different players to have unique and compelling offerings and as mentioned, Vonage’s advantage is its wide array of product offerings that the company can bundle together in different ways.

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Conclusion

As mentioned before, Twilio is the current market leader in the CPaaS industry and the recent market drop could make it an attractive potential investment. That being said, I believe that there is a greater upside in Vonage as the cheaper alternative, as the industry itself is poised to face tailwinds.

Given the competitive position of the company as well as the tailwinds facing the CPaaS industry as a whole, the potential for Vonage to get re-rated by the market is a strong possibility. Vonage growing to even ¼ of Twilio’s market cap (from $1.9 billion to $2.8 billion) by catching up to it service-wise or by winning over clients with its broader range of features would already yield a hefty upside of 47%. There is room for both companies to thrive in a post-COVID-19 world, especially if the CPaaS market grows faster than forecast.

Disclosure: I am/we are long VG. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.