Synchronoss, a new position.

Investment Analysis Clubs Saul’s Investing Discussions
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Synchronoss, a new position.

You never heard of Synchronoss (SNCR), and I never heard of it either until it was a MF recommendation some four weeks ago. It’s totally boring. As I write, it has only 7 posts, total, on its discussion board, and that includes the post setting up the board. So why am I interested? Why have I built up a 5% position? Let me tell you about it:

Synchronoss’ legacy business was pretty boring. It entailed providing a software-based activation platform for mobile phones and other mobile devices (which I believe involves synching with other devices). They get paid $1 to $30 for each activation, but it’s a one-time deal. This cuts problem rates from 30-35% (with manual activations), to 2% with SNCR’s software, and is thus very valuable to the phone companies. Verizon and ATT are their two biggest customers by far, but Synchronoss has signed up close to 100 other mobile carriers around the world. This business makes up 54% of its revenue now but it is only growing at 5% to 20% per year. Pretty boring, isn’t it.

So why did it get recommended as a rule breaker?

Well, starting in 2010 they launched a cloud platform for mobile carriers. This was a genius idea! The carriers love it! When a subscriber has all their stuff on the Verizon cloud, for instance, they are much less likely to jump to another carrier. And in the mobile carrier business, that is a big deal!

For Synchronoss, this is recurring income. They provide the software for carriers to offer cloud services to subscribers. They then earn an annual fee from the carriers ranging from $1 to $5 per user. That’s each year, and it builds up! They are currently signing up 400,000 to 500,000 new cloud subscribers EACH WEEK. Last year the activation segment was up only 5%, but the cloud segment was up 81%. It now makes up 47% of total revenue. You can see where this is going. And Gross Margin is 60% and rising (slowly). It should rise as the recurring revenue requires little or no expenditure, and it’s growing.

And the recommenders think this company has great prospects for the Internet of Things:

Synchronoss, through its cloud services, is ensuring that all of these users will be able to back up, synchronize, and engage their content seamlessly across all of their devices. There’s a lot more to this trend than just phones. A plethora of new items is entering the world of connectivity in the ever-expanding Internet of Things: smart watches, cars, and homes, to name a few. Synchronoss plays a key role in this trend, not only providing the activation software for many of these devices but also launching a cloud platform last year called Integrated Life, specifically targeting connected devices. As households continue to add more devices under one data plan, Integrated Life enables these users to save and seamlessly transfer content across all of them. (It’s already started): Synchronoss already powers the Timex GPS smart watch, it’s in AT&T’s Drive platform for connected cars, and it’s behind Time Warner Cable’s new home management system.

This is now looking a lot less boring, isn’t it? Here are the quarterly revenues:

2012: xx xx xx xx = 275 million
2013: 80 85 90 98 = 352 million
2014: 99 104 126 131 = 459 million

2013 revenues were up 28.0%, and 2014 revenues were up 30.4%. That’s not bad! Here are the quarterly earnings:

2012: xx xx xx xx = $1.10
2013: 28 31 34 41 = $1.34
2014: 39 41 46 53 = $1.79

2013 earnings were up 21% from 2012, and 2014 earnings were up 33.6% from 2013.

At Tuesdays close (when I’m writing this), Synchronoss’ share price was $51.85 so it’s PE was 29.0, and with a rate of growth of earnings of 33.6%, its 1YPEG was about 0.86 (under 1.00 is good, and the lower the better).

Hope you’ve found this interesting and not boring at all.

Saul

For FAQ’s and Knowledgebase
please go to Post #7062

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The carriers love it! When a subscriber has all their stuff on the Verizon cloud, for instance, they are much less likely to jump to another carrier.

I was just thinking that with all their subscribers using SNCR’s cloud, it’s not very likely that Verizon or ATT would drop their relationship with SNCR either…Probably possible, but not very likely.

Saul

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I’m curious what you trimmed and why in order to get this to a 5% position, if you do t mind sharing.

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I’m curious what you trimmed and why in order to get this to a 5% position, if you do t mind sharing.

Hi 2020, I’ll be giving my current positions, and changes from the month before, at the end of the month, which is just a little more than a week away.

Best

Saul

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Hi Saul,

Thanks for this update. I’ve been watching this stock, and took a starter position today.

I read through their annual report, and the major risk seems to be the senior note of 230M. At the time of the annual report they had cash greater than note, and additional securities. The note is closely tied to business and could be cashed if the new cloud platform fails. Not too risky, but I have been with a cloud data center company which used notes, which were called during dotcom bust. The company went bankrupt. I don’t foresee that with this company, but it will be important to watch their cash flow.

I also noticed their ratio of expenses to revenue has stayed consistent.

I like their potential for the new cloud business. They even mention the ability to store data for the Internet of things devices. I’ve been looking at ways to track water usage, having a well and property In California, and storing on a cloud connected to my phone would be great. Data can be capture from flow meters and transmitted to my phone, then too synchronous cloud.

Regards,
Iain

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I’ve been looking at ways to track water usage, having a well and property In California, and storing on a cloud connected to my phone would be great. Data can be capture from flow meters and transmitted to my phone, then to Synchronoss’ cloud.

Thanks Iain, that’s an interesting example.
Saul

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Hi Saul,
It’s quite possible that I’m missing something completely obvious, but I’m curious how you arrived at your EPS numbers listed above?

Maybe I’m looking in the wrong place but the 10-K for the TTM ending 12/31/14 lists basic EPS at .96.

I like your number a lot better.

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It’s quite possible that I’m missing something completely obvious, but I’m curious how you arrived at your EPS numbers listed above? Maybe I’m looking in the wrong place but the 10-K for the TTM ending 12/31/14 lists basic EPS at $0.96. I like your number a lot better.

Hi Tim, These are directly from the Fourth Quarter and Year End press release (the bolding is mine though, to help you spot it):

On a Non-GAAP basis: revenues for the full year 2014 were $458.6 million, an increase of 30% compared to $352.5 million in 2013. Gross profit was $280.2 million, representing a gross margin of 61%, and income from operations was $118.1 million, representing an operating margin of 26%. Net income was $76.8 million for the full year 2014, leading to diluted earnings per share of $1.79, an increase of 35% from $1.33 in the prior year.

For the quarter, on a non-GAAP basis, Synchronoss reported … Gross profit for the fourth quarter of 2014 was $79.9 million, representing a gross margin of 61%. Income from operations was $36.2 million in the fourth quarter of 2014, representing a year-over-year increase of 44% and an operating margin of 28%. Net income was $24.2 million in the fourth quarter of 2014, up from $16.4 million in the year ago period. Diluted earnings per share were $0.53 for the fourth quarter of 2014, compared to $0.41 for the fourth quarter of 2013.

Saul

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OK, thanks. I see that I’m looking at GAAP earnings instead of non-GAAP. That makes sense. I’ve read your FAQ about GAAP vs. Non-GAAP.

So, follow up question then, for Saul or anyone and apologies in advance as I’m going to further out myself as someone with super-limited experience at digging into the numbers.

So, then the 10-K represents the GAAP earnings and the place to go to find them? Is there a corresponding document that gets filed with the SEC that reports the non-GAAP earnings? An “official” place to find those non-GAAP numbers, or do I just look for press releases like this from a company’s investor relations site?

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Here’s another view, just .02…

For the last five years a good deal of their growth has come from issuing equity and from borrowing (before the Notes they used their line of credit).


Beginning Cash                                   89,924	
		
Net cash provided by operating activities	272,272
Proceeds from stock                             165,752
Proceeds from Debt                              216,914
Net Forex                                            33
                                                -------
Sources of Cash                                 654,971	
		
		
Purchase of Fixed Assets, Net                  -210,653   
Acquisitions                                   -249,197   
Other Investing                                 -49,078    
                                                -------		
Uses of Cash                                   -508,928	
		
Change in Cash                                  146,043	
		
Ending Cash                                     235,967

The acquisitions are hurting performance, at least in the short term. Free cash flow per share and cash return on capital have both declined. Once they use current cash they’ll need to borrow more or issue more equity in order to grow. Dilution has been running around 7% annualized the last five years.


                2010    2011    2012    2013     2014

FCF/Share	0.16	0.70	0.55	0.15	-0.10

Return                  8.6%    6.1%    1.5%    -0.7%

Hope this helps.

Ears

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When a subscriber has all their stuff on the Verizon cloud, for instance, they are much less likely to jump to another carrier. And in the mobile carrier business, that is a big deal!

Saul;

Great and helpful post as always. But got a couple of questions.

I am using iPhone and also have iPads. They are set up to automatically backup to Apple’s icloud and all iDevices are in synch automatically vie iClound. I would think iClound is a major component of Apple’s ecosystem and its ecosystem is what makes Apple so successful. I would think other major providers would have their own iCloud type of setup. If this is true, why would a mobile user want to backup his/her stuff to a third party’s cloud?

Additionally, for the cloud part of the business, what is the moat? What keeps other companies, such as AT&T from setting up its own cloud?

Regards.
-M

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“Additionally, for the cloud part of the business, what is the moat? What keeps other companies, such as AT&T from setting up its own cloud?”

I don’t know. But, thinking about AT&T, they have taken on tremendous debt for spectrum, DirectTV and Mexican cell phone companies. These are strategic investments. With Synchronos providing this service, T gets the benefit without the CAPEX. What did Synch invest… almost $500 million? Not sure in what, exactly. T will be on a mission to reduce debt the next 2 to 3 years.
KC

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It looks like their Revenue and Earnings are growing nicely but I think the cloud is going to be very competitive. Google already gives 15 gig for their cloud storage free. Also Microsoft gives 15 gig for their one drive and if you get 360 it is unlimited, also free. As stated above Apple has their own storage.

I am with Verizon and I declined their cloud storage because I already have Google and One drive for my storage. Just something to watch.

Andy

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So, then the 10-K represents the GAAP earnings and the place to go to find them? Is there a corresponding document that gets filed with the SEC that reports the non-GAAP earnings? An “official” place to find those non-GAAP numbers, or do I just look for press releases like this from a company’s investor relations site?

Hi again Tim, if you are just looking for historical adjusted earnings, you can almost always get the last four on the investor relations website, under press releases, in probably 5 to 10 minutes total. It’s not a big job, and you get what the company presented.
Saul

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I am using iPhone and also have iPads. They are set up to automatically backup to Apple’s icloud and all iDevices are in synch automatically vie iClound. I would think iClound is a major component of Apple’s ecosystem and its ecosystem is what makes Apple so successful. I would think other major providers would have their own iCloud type of setup. If this is true, why would a mobile user want to backup his/her stuff to a third party’s cloud? Additionally, for the cloud part of the business, what is the moat? What keeps other companies, such as AT&T from setting up its own cloud?

Hi M, I think anybody in the Apple system wouldn’t be a customer for the Synchronoss cloud. Apparently ATT and Verizon have enough to do without going out into an entirely different field and trying to set up their own cloud. They are phone carrier companies, after all. The rest of the moat is that once ATT and Verizon have set up with Synchronoss, they are not going to disassemble all that because someone else comes along. They have a long history with Synchronoss from activation, and apparently trust them with their cloud. And for them, $1-$5 per year is a trivial price to pay for keeping the customer attached.
Saul

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Hi ears, I’d be curious if you could do the same calculation for WAB, since they also do acquisitions and use debt. Maybe you could also show that they are destroying value too. I’m skeptical about that way of looking at things.

Best,

saul

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Saul:

Ears wrote in conclusion:

The acquisitions are hurting performance, at least in the short term. Free cash flow per share and cash return on capital have both declined. Once they use current cash they’ll need to borrow more or issue more equity in order to grow. Dilution has been running around 7% annualized the last five years.

I think we need to distinguish established businesses in steady state from new ones growing fast. What may apply to the first group (and I think it does) need not apply to the second.

Take the expression “dilution” which means watered down. I went to the 10-K and, indeed, the growth in the number of shares is between 7 and 8 percent but that does not necessarily mean dilution, not if the new shares represent a much larger company. Say you have a bottle of 80 proof Jack Daniels and you buy a second bottle. The whiskey is still 80 proof, it has not been diluted but doubled.

Economist Hyman Minsky classified debt into three types: 1) hedge, 2) speculative, and 3) Ponzi

The “hedge borrower” can make debt payments (covering interest and principal) from current cash flows from investments. For the “speculative borrower”, the cash flow from investments can service the debt, i.e., cover the interest due, but the borrower must regularly roll over, or re-borrow, the principal. The “Ponzi borrower” (named for Charles Ponzi, see also Ponzi scheme) borrows based on the belief that the appreciation of the value of the asset will be sufficient to refinance the debt but could not make sufficient payments on interest or principal with the cash flow from investments; only the appreciating asset value can keep the Ponzi borrower afloat.

http://en.wikipedia.org/wiki/Hyman_Minsky

I’ve highlighted “speculative borrower” because that’s what fast growing companies are. Growth needs capital but the future is less certain than for stalwarts that borrow, say, to replace a worn out blast furnace – there is no growth involved in that.

My point is that there is an element of speculation with companies like Synchronoss but using metrics better suited to stalwarts is not the best way to evaluate them. Much more important with fast growth companies is to fully understand the business model.

In the case of Synchronoss I would like to know if “cloud” is or not a commodity. If it is then Synchronoss is not worth a high P/E. But if Synchronoss can engineer lock-in to their cloud then Synchronoss deserves a higher P/E. What is interesting about this thread is that there are posters on both sides of the commodity issue. I prefer investments where posters are less divided, where one can be more certain that it is an “increasing returns” type operation.

Denny Schlesinger

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I’d be curious if you could do the same calculation for WAB, since they also do acquisitions and use debt.

Hi Saul,

Here is WAB’s cash flow over the last five years. They are funded almost entirely by cash from operations. They’ve used this cash to grow but also to give some back to shareholders in the form of dividends and stock buybacks.


Beginning Cash                                  188,659
	
Net cash provided by operating activities     1,370,238
Proceeds from Debt                              124,864
                                              ---------
Sources of Cash                               1,495,102
	
Purchase of Fixed Assets, Net                  -175,242
Acquisitions                                   -918,509
Stock buyback                                  -102,230
Dividends                                       -45,319
Earn-out settlement                              -4,429
Net Forex                                       -12,183
                                              ---------	
Uses of Cash                                 -1,257,912
	
Change in Cash                                  237,190
	
Ending Cash                                     425,849

Free cash flow per share has been steady and grew in the last year. Cash return on invested capital indicates that WAB is likely providing a return well above its cost of capital.


                2010    2011    2012    2013    2014

FCF/Share       1.62    2.18    2.08    2.06    4.38
					
Cash Return            15.2%   13.3%   11.0%   19.4%

As Denny pointed out, we can’t evaluate SNCR and WAB the same way. WAB’s business economics are proven whereas SNCR is in the early stages of development – we don’t how it will play out. We can say so far that SNCR is not able to self-fund its growth, but that may change as the story changes. So SCNR is much riskier, and the question is are we being compensated for that risk at today’s price. Also, even though WAB appears to be a good business (I haven’t really looked at it in detail), there is the same issue of what price we pay for the value we get, so if we are paying too high a price for WAB then it can be just as risky. With WAB, however, is it is much easier to come up with a range of outcomes than it is for SNCR.

Again, just .02.

I have no position in either company and have no strong feelings about either of them as investments, good or bad. I just thought you might be interested in this way of looking at them. I really appreciate you bringing up your ideas on this board. These are fun companies to look at.

Thanks,
Ears

P.S., I did all this in a hurry as we are remodeling, so the numbers above may have errors. Also, I calculate FCF taking into account Capital Leases.

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About the mobile data storage.

During the transfer from your old phone to you new phone, which sychronoss SW is managing, you have an option to store everything to a cloud, which will keep synchronizing, and provide you with a backup, and emergency recovery.

The cloud storage sale is happening as your buying your new phone, and is an easy add on sale.

I think the moat is that this is integrates with installation SW from Sncr, and is easy add on revenue for the carrier. No capital and labor cost for carrier, just pure profit.

E.g. - while buying new phone, agree to $10 a month charge for backup and emergency recovery. Hardly noticeable on bill each month, and with the value of safekeeping pictures, etc. carrier keeps $5, Sncr gets $5 each month from carrier.

Now, sychronoss SW isn’t just used during installation, but continuously on the phone.

With Sncr sw on the phone, more opportunities for add on sales are available.
I like that Sncr will now have steady subscription revenue in addition to the lumpy installation revenue.

http://www.synchronoss.com/products/personal-cloud/

Iain

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Additionally, for the cloud part of the business, what is the moat? What keeps other companies, such as AT&T from setting up its own cloud?

-M

Core and Context

From Living on the Fault Line by Geoffrey Moore of Gorilla Game fame:

"The problem facing the IT organizations, which is in microcosm the same problem facing the corporation as a whole, is that too much time is being spent on tasks that are context too little on tasks that are core.

“A task is core when its outcome directly affects the competitive advantage of the company to its targeted markets – everything else is context.”

To put it more graphically, for McDonald’s hamburgers are CORE while clean restrooms – indispensable as they are – they are context. So McDonald’s hires Fuller to clean the restrooms and to Fuller clean restrooms are CORE. No one ever said: “Let’s go to McDonald’s, they have such clean restrooms.” But if the restrooms were filthy trade at McDonald’s would drop quickly.

This has been the driver of horizontal value chains (New IBM, Intel, Microsoft) and away from vertical integration (Old IBM).

Denny Schlesinger

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