Hot speech tech firm’s story is too complicated

October 26, 2011

By Robert Cyran
The author is a Reuters Breakingviews columnist. The opinions expressed are his own.

Getting machines to understand speech is a technology hot spot. Nuance Communications is a powerhouse in the field. Analysts even suspect the nearly $8 billion company has licensed technology to Apple for the new iPhone, though neither company will say. But Nuance’s sky-high valuation multiple is a stretch.

By Nuance’s preferred profit measure, the company reckons it should earn about $125 million this quarter. This figure ignores restructuring charges, stock compensation and some other items. Use standard accounting, and the firm is set to lose money for the period. Its market capitalization is more than 80 times estimated accounting earnings for the year ending September 2012.

The company’s rapid expansion clouds analysis of this lofty multiple. For example, Nuance claims the annual organic growth of its business is more than 10 percent, but the company’s definition of “organic” assumes it has always owned firms it acquires. That makes it hard to understand the underlying growth of the business.

Since 2003, Nuance has spent more than $3 billion on acquisitions, according to Avondale Partners. That has led to some bad blood. Rival Vlingo is suing Nuance, claiming the latter’s chief executive promised three Vlingo executives $5 million each if they convinced the company’s board to back a sale. This could be just sniping, but Nuance is aggressive: it has sued several firms before scooping them up.

And although Nuance threw off about $340 million in free cash flow over the past 12 months, it has spent more on acquisitions over the past five years than it has generated in free cash flow. Some targets are small, patent-rich outfits working with mobile devices, but its biggest deals have been for firms like Dictaphone in the rather pedestrian area of medical transcription and dictation.

More acquisitions could be in the cards. The firm recently sold $690 million of convertible debt. With interest running 2.75 percent per year, that’s cheap money. Nuance used some of it to buy back stock, a worthwhile use if its shares rise in value. The rest makes a handy war chest. But acquisitions often fail to bring the touted benefits. There’s huge potential in voice technology, but for Nuance the uncertainties make the analysis a bit too, well, nuanced to justify the company’s current valuation.

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