Summary: The acquisition machine which fueled 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.
Revenue Growth Estimate - All Values in 000's
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.
Revenue Growth Estimate - All Values in 000's
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.
Revenue Growth Estimate - All Values in 000's
Revenue Growth Estimate - All Values in 000's
Ketul S (http://usequity.blogspot.com)
Disclosure: The author or his firm doesn’t hold a
position in any company discussed in this report.
