customer growth. Per the company’s 10-K, a client’s first order is usually for a small number of services and low dollar amount; so the firm depends heavily on new customer sales and up-selling. This dependency ensures high marketing spend is required to keep the revenue growing. LivePerson’s business model is not working.
Cost issues aside, the market’s expectations baked into LivePerson’s stock price imply that the firm will grow much faster than the firm’s expectations while also taking nearly all market share, as we’ll show below.
LivePerson Is Already Priced For More Growth Than Management Expects
Despite more than halving from its all-time highs in 2012, LPSN is up 21% over the past year, which outpaces the 16% gain of the S&P. At current prices, LPSN is significantly overvalued. To justify its current price of $7/share, LPSN must achieve NOPAT margins of 4% (compared to -4% in 2016) and grow revenue by 10% compounded annually for the next 12 years. In this scenario, LivePerson would be generating nearly $700 million in revenue 12 years from now. For reference, Technavio estimates the entire live chat software market will be worth $819 million by 2020. This scenario also seems unlikely given that LPSN’s revenue fell 7% in 2016 and is expected to fall 8% in 2017. Furthermore, competitive pressures noted above make it unlikely to spur revenue growth while also improving profitably in a commoditized market.
Even if we assume LivePerson can achieve a 4% NOPAT margin and grow revenue by 8% compounded annually for the next decade, the stock is worth only $5/share today – a 29% downside. Each of these scenarios also assumes LivePerson is able to grow revenue and NOPAT/free cash flow without spending on working capital or fixed assets. This assumption is unlikely but allows us to create very optimistic scenarios that demonstrate how high expectations in the current valuation are. For reference, LPSN’s invested capital has grown on average $14 million (6% of 2016 revenue) per year over the last five years.
Is LPSN Worth Acquiring?
The largest risk to our bear thesis is what we call “stupid money risk”, which means an acquirer comes in and pays for LPSN at the current, or higher, share price despite the stock being overvalued. Prior Danger Zone pick and competitor Interactive Intelligence was acquired by Genesys in mid 2016. Many are betting that LivePerson could be the next M&A target, but a review of recent acquisitions makes a similar white-knight acquisition of LivePerson less likely.
Many competitors have already acquired smaller services that compete with LivePerson. In 2016, Nuance Communications acquired TouchCommerce and Nice Systems acquired inContact. Less recent, Oracle acquired RightNow Technologies in 2011 and has integrated it into its public cloud offering.
The key point from each of the acquisitions, including Interactive Intelligence, is that the acquired firm offered more than just chat-based customer support. The acquired firms integrate online support with call support, analytics, and more. These omni-channel offerings provide more value for an acquiring firm.
Furthermore, the willingness to overpay for an add-on chat based provider is diminished since the acquisition would provide marginal benefits over existing services. We see an acquisition as possible only if an acquiring firm is willing to ignore prudent stewardship of capital and destroy substantial shareholder value. We show below how expensive LPSN remains even after assuming an acquirer can achieve significant synergies.
To begin, LivePerson has liabilities of which investors may not be aware that make it more expensive than the accounting numbers suggest.
- $25 million in off-balance-sheet operating leases (6% of market cap)
- $17 million in outstanding employee stock options (4% of market cap)
After adjusting for these liabilities we can model multiple purchase price scenarios. Even in the most optimistic of scenarios, LPSN is not worth the current share price.
Figures 5 and 6 show what we think Cisco (CSCO) should pay for LivePerson to ensure it does not destroy shareholder value. Cisco could immediately integrate LivePerson into its call center software and bolster its customer support offering to increase competitiveness within the market. However, there are limits on how much CSCO would pay for LPSN to earn a proper return, given the NOPAT of free cash flows being acquired.
Each implied price is based on a ‘goal ROIC’ assuming different levels of revenue growth. In each scenario, the estimated revenue growth rate in year one and two equals 5%, which is the consensus estimate of revenue growth in 2018. For the subsequent years, we use 5% in scenario one because it represents a continuation of next year’s expectations. We use 10% in scenario two because it assumes a merger with CSCO could create revenue growth through increased client base and usage.
We conservatively assume that Cisco can grow LivePerson’s revenue and NOPAT without spending on working capital or fixed assets. We also assume LivePerson immediately achieves a 4% NOPAT margin, which is below large tech firms from Figure 3 with other business lines but above cloud platforms eGain and 8×8. For reference, LPSN’s NOPAT margin is -4%, so this assumption implies immediate improvement and allows the creation of a truly best case scenario.
Figure 5: Implied Acquisition Prices For CSCO To Achieve 6% ROIC
Sources: New Constructs, LLC and company filings.
Figure 5 shows the ‘goal ROIC’ for CSCO as its weighted average cost of capital (WACC) or 6%. Even if LivePerson can grow revenue by 5% compounded annually with a 5% NOPAT margin for the next five years, the firm is worth less than its current price of $7/share. It’s worth noting that any deal that only achieves a 6% ROIC would be only value neutral and not accretive, as the return on the deal would equal CSCO’s WACC.
Figure 6: Implied Acquisition Prices For CSCO To Achieve 17% ROIC
Sources: New Constructs, LLC and company filings.
Figure 6 shows the next ‘goal ROIC’ of 17%, which is Cisco’s current ROIC. Acquisitions completed at these prices would be truly accretive to CSCO shareholders. Even in the best-case growth scenario, the most CSCO should pay for LPSN is $2/share (81% downside). Even assuming this best-case scenario, CSCO would destroy over $300 million by purchasing LPSN at its current valuation. Any scenario assuming less than 8% CAGR in revenue would result in further capital destruction for CSCO.
Weak Business Model Makes Expensive Valuation Even Riskier
Investors are willing to overlook losses for an extended period of time when a firm is growing revenue at a rapid pace. When that revenue growth stops, the resulting cut in valuation can be drastic. Over the past year, LPSN’s stock price has not reflected the deteriorating fundamentals of its business. Now the firm is guiding for a revenue decline in 2017, which makes us wonder if the 21% increase in share price has only set LPSN up for a fall.
LivePerson is betting its future on the ability to convince clients that its standalone messaging service is better than the integrated solutions in other platforms. Per above, we’ve seen the rapid decline in profitability brought on by competitors and as of yet, LivePerson has shown no signs of returning