Summary: The acquisition machine which fuelled growth at Nuance might be slowing down due to the high debt that Nuance has accumulated in the last two years. Nuance’s interest coverage ratio is close to 1 and hence it is highly unlikely that Nuance could or want to add more debt.
Organic growth across all business segments has been slowing while insiders, including CEO & CFO, have been selling shares in 2008. Overall, Nuance competes in diverse segments such as traditional IVR services, medical transcription services, mobile software and imaging services. It has acquired multiple non-core service businesses which has taken a toll on its core software product expertise and added a lot of unnecessary debt to its balance sheet.
Organic Growth & Competitive Landscape
Healthcare Unit: This unit has managed to grow by acquiring high growth companies and subsequently riding the acquiree growth curve for 4-5 quarters; however, once the growth phase of the acquiree slows down Nuance has to look for new targets. Moreover, in its quest for top-line growth Nuance has acquired medical transcription services companies with low net profit margins in the range of 1 -2%. Case-in-point, Focus Infomatics which accounts for 15-20% of the healthcare revenues; its publicly listed competitor, MedQuist (NASDAQ:MEDQ) has net margins in the 2% range and transcription companies compete on price to gain market share. MedQuist reported a revenue decline of 7% on a y-o-y basis in the quarter ending June 30. More than 70% of the healthcare revenues are from medical transcription services contracts. Although, the contracts for medical transcription are generally for a year or more, there is hardly any switching cost for a hospital to move to a different vendor at the end of the contract. Moreover, most of the large hospitals are serviced by two or more medical transcription companies and hence could easily switch between them to get better pricing. Owing to low barriers to entry and no sustainable competitive advantage, the medical transcription industry is highly fragmented with more than 100 medical transcription companies competing in a mature market. Technology transcription companies such as eScription and Dictaphone are also not unique. They compete in a mature market where industry participants compete on price to gain market share. Moreover, Nuance doesn’t integrate the companies that it acquires and lets them operate as subsidiaries, thereby only achieving revenue growth but not any significant cost or sales synergies. eScription continues to use its own speech-to-text technology while Focus has not been integrated with Dictaphone so far. Organic growth of this unit is likely to slide and slip to the single digit range in 2009. Even with a growth rate in 10% range the bottom-line contribution from this unit is likely to be negligible due to the low margins in this business.
Embedded mobile speech: Nuance’s embedded solutions are used for voice command in embedded devices and are clearly market leaders in the segment. However, voice command embedded solutions haven’t moved beyond the visionary phase of the technology adoption cycle and show no signs of crossing the chasm at its current rate of usage. Nuance’s speech solutions offer a new interface that users are not familiar with and it is not good enough for them to relinquish their existing key-pad interface. Speech based solutions are successful in medical transcription since users can totally let go of other interfaces and the back-end transcriptionists take care of correcting the mistakes. Moreover, given the profile of mobile devices that are expected to be released in the next few quarters, it is highly unlikely that we will see a full-fledged Dragon-like speech converter on any of them due to Dragon’s high resource requirements. Owing to such constraints and the end of the visionary growth curve part of the product cycle, it is highly unlikely that Nuance’s mobile speech solutions could continue growing at historical rates.
Enterprise network speech: IVR and other speech solutions from Enterprise network division compete in a mature market dominated by traditional telecom heavyweights such as Avaya, Nortel, Genesys etc. Moreover, Nuance is not considered to be a complete solution provider in this area and hence the growth in this segment will be limited. Telephony services market is notoriously known for low margins due to severe competition and low barriers to entry. Nuance acquired Viecore to add a professional services and integration unit to offer end-to-end services; this puts Nuance in direct competition with its speech solution customers such as Nortel’s, Genesys’ and Avaya’s enterprise solution divisions. Owing to such competitive position with its customers and a mature market, organic growth is likely to be in mid to high single digits in 2009.
Dragon product line: Dragon is a market leader in pc-based speech-to-text conversion and so far it had very little competition. However, with Microsoft offering a free speech-to-text converter in Windows Vista the generic speech to text conversion market is unlikely to generate any revenues for Dragon. Microsoft’s product is not as good as Dragon in quality but then it doesn’t need a special installation and is provided free as a part of the OS. Moreover, it is the first release and MS is known for improvements in subsequent releases. Specialty versions such as Dragon Medical will continue to generate revenues for Nuance but the growth in such a niche market is limited. In the last 5 months Dragon Medical has sold approximately 2000 licenses/month which is average revenue of $6 million/quarter. If MS improves the quality of its speech-to-text software, it might compete in the specialty areas too. There will be a short-term increase in sequential quarterly revenues due to the release of Dragon 10 in August but the growth we have seen with the past versions is unlikely to be repeated.
Ketul S
July Fourteenth Capital Group
http://usequity.blogspot.com
Disclosure: The author or his firm doesn’t hold a position in any company discussed in this report.
Organic growth across all business segments has been slowing while insiders, including CEO & CFO, have been selling shares in 2008. Overall, Nuance competes in diverse segments such as traditional IVR services, medical transcription services, mobile software and imaging services. It has acquired multiple non-core service businesses which has taken a toll on its core software product expertise and added a lot of unnecessary debt to its balance sheet.
Organic Growth & Competitive Landscape
Healthcare Unit: This unit has managed to grow by acquiring high growth companies and subsequently riding the acquiree growth curve for 4-5 quarters; however, once the growth phase of the acquiree slows down Nuance has to look for new targets. Moreover, in its quest for top-line growth Nuance has acquired medical transcription services companies with low net profit margins in the range of 1 -2%. Case-in-point, Focus Infomatics which accounts for 15-20% of the healthcare revenues; its publicly listed competitor, MedQuist (NASDAQ:MEDQ) has net margins in the 2% range and transcription companies compete on price to gain market share. MedQuist reported a revenue decline of 7% on a y-o-y basis in the quarter ending June 30. More than 70% of the healthcare revenues are from medical transcription services contracts. Although, the contracts for medical transcription are generally for a year or more, there is hardly any switching cost for a hospital to move to a different vendor at the end of the contract. Moreover, most of the large hospitals are serviced by two or more medical transcription companies and hence could easily switch between them to get better pricing. Owing to low barriers to entry and no sustainable competitive advantage, the medical transcription industry is highly fragmented with more than 100 medical transcription companies competing in a mature market. Technology transcription companies such as eScription and Dictaphone are also not unique. They compete in a mature market where industry participants compete on price to gain market share. Moreover, Nuance doesn’t integrate the companies that it acquires and lets them operate as subsidiaries, thereby only achieving revenue growth but not any significant cost or sales synergies. eScription continues to use its own speech-to-text technology while Focus has not been integrated with Dictaphone so far. Organic growth of this unit is likely to slide and slip to the single digit range in 2009. Even with a growth rate in 10% range the bottom-line contribution from this unit is likely to be negligible due to the low margins in this business.
Embedded mobile speech: Nuance’s embedded solutions are used for voice command in embedded devices and are clearly market leaders in the segment. However, voice command embedded solutions haven’t moved beyond the visionary phase of the technology adoption cycle and show no signs of crossing the chasm at its current rate of usage. Nuance’s speech solutions offer a new interface that users are not familiar with and it is not good enough for them to relinquish their existing key-pad interface. Speech based solutions are successful in medical transcription since users can totally let go of other interfaces and the back-end transcriptionists take care of correcting the mistakes. Moreover, given the profile of mobile devices that are expected to be released in the next few quarters, it is highly unlikely that we will see a full-fledged Dragon-like speech converter on any of them due to Dragon’s high resource requirements. Owing to such constraints and the end of the visionary growth curve part of the product cycle, it is highly unlikely that Nuance’s mobile speech solutions could continue growing at historical rates.
Enterprise network speech: IVR and other speech solutions from Enterprise network division compete in a mature market dominated by traditional telecom heavyweights such as Avaya, Nortel, Genesys etc. Moreover, Nuance is not considered to be a complete solution provider in this area and hence the growth in this segment will be limited. Telephony services market is notoriously known for low margins due to severe competition and low barriers to entry. Nuance acquired Viecore to add a professional services and integration unit to offer end-to-end services; this puts Nuance in direct competition with its speech solution customers such as Nortel’s, Genesys’ and Avaya’s enterprise solution divisions. Owing to such competitive position with its customers and a mature market, organic growth is likely to be in mid to high single digits in 2009.
Dragon product line: Dragon is a market leader in pc-based speech-to-text conversion and so far it had very little competition. However, with Microsoft offering a free speech-to-text converter in Windows Vista the generic speech to text conversion market is unlikely to generate any revenues for Dragon. Microsoft’s product is not as good as Dragon in quality but then it doesn’t need a special installation and is provided free as a part of the OS. Moreover, it is the first release and MS is known for improvements in subsequent releases. Specialty versions such as Dragon Medical will continue to generate revenues for Nuance but the growth in such a niche market is limited. In the last 5 months Dragon Medical has sold approximately 2000 licenses/month which is average revenue of $6 million/quarter. If MS improves the quality of its speech-to-text software, it might compete in the specialty areas too. There will be a short-term increase in sequential quarterly revenues due to the release of Dragon 10 in August but the growth we have seen with the past versions is unlikely to be repeated.
Ketul S
July Fourteenth Capital Group
http://usequity.blogspot.com
Disclosure: The author or his firm doesn’t hold a position in any company discussed in this report.
