Infrastructure Headwinds And Slow Deployments Will Test AI Usage Potential Over Time

Catalysts

About Sangoma Technologies

Sangoma Technologies provides communications infrastructure and applications that support voice, data and AI-enabled services for business customers.

What are the underlying business or industry changes driving this perspective?

• Although data networking and voice networking are described as performing well with approximately 9% and 17% year-over-year growth, the scale of these units is smaller than the applications portfolio. As a result, any slowdown in adoption of these infrastructure services could limit their ability to offset pressure in other segments and cap revenue growth.
• Although rising AI agent usage is expected to increase always on voice and data interactions and drive higher consumption on Sangoma's networks, a slower than expected pace of AI deployment by customers or alternative infrastructure choices could restrict usage based revenue and temper earnings.
• Although larger multiproduct deployments with 3 to 5 year terms and multi-quarter rollouts can deepen customer relationships, elongated implementation cycles and customer capacity constraints to execute rollouts, such as the 6 to 8 month deployment time lines discussed, may continue to delay when contracted MRR is recognized and weigh on near term revenue and net margins.
• Although recurring services tied to carrier voice, MSP access and advanced SIP trunking are growing in the mid teens and supported by long duration contracts, any moderation in traffic volumes or pricing pressure from other infrastructure providers could pressure usage economics and limit future margin expansion.
• Although cash generation is currently strong with year to date adjusted EBITDA to operating cash conversion of 87% and free cash flow of $3.6 million in Q3, ongoing reallocation of spend into AI capabilities and infrastructure, combined with continued low single digit declines in the applications portfolio, could slow any improvement in adjusted EBITDA margins and constrain earnings growth.

Assumptions

How have these above catalysts been quantified?

• This narrative explores a more pessimistic perspective on Sangoma Technologies compared to the consensus, based on a Fair Value that aligns with the bearish cohort of analysts.
• The bearish analysts are assuming Sangoma Technologies's revenue will grow by 2.8% annually over the next 3 years.
• The bearish analysts are not forecasting that Sangoma Technologies will become profitable in next 3 years. To represent the Analyst Price Target as a Future PE Valuation we will estimate Sangoma Technologies's profit margin will increase from -3.0% to the average CA Communications industry of 8.1% in 3 years.
• If Sangoma Technologies's profit margin were to converge on the industry average, you could expect earnings to reach $18.7 million (and earnings per share of $0.57) by about June 2029, up from -$6.5 million today.
• In order for the above numbers to justify the price target of the more bearish analyst cohort, the company would need to trade at a PE ratio of 12.9x on those 2029 earnings, up from -18.3x today. This future PE is lower than the current PE for the CA Communications industry at 20.0x.
• The bearish analysts expect the number of shares outstanding to decline by 0.53% per year for the next 3 years.
• To value all of this in today's terms, we will use a discount rate of 8.61%, as per the Simply Wall St company report.

Risks

What could happen that would invalidate this narrative?

• The UCaaS and broader applications portfolio is described as commoditized and under pressure, with low single digit declines year to date and pricing pressure across software and UCaaS markets. A prolonged period of weaker pricing power or further commoditization could limit Sangoma Technologies' ability to grow services revenue and could keep consolidated revenue and net margins under strain.
• Management highlights that larger integrated infrastructure contracts often take 6 to 8 months, and in some cases up to 8 to 12 months, to deploy. Management also notes that customer capacity constraints and rollout complexity are slowing implementation. If deployment timelines remain extended or lengthen further, the lag between bookings and go-live MRR could continue to weigh on reported revenue and earnings.
• International markets have been affected by geopolitical events, trade disruptions and higher shipping and fulfillment costs, with revenue from outside the U.S. described as weaker and gross margin down from 74% in Q2 to 71% in Q3 partly due to these factors. If trade routes, logistics costs or regional demand do not normalize, international revenue and consolidated gross margin could remain under pressure, affecting net margins and cash generation.
• The business is reallocating spend into data and voice infrastructure and AI capabilities while trimming other areas, and management acknowledges uncertainty around the timing and volume impact of AI agent driven usage. If AI related traffic does not scale on Sangoma Technologies' networks as expected or if customers choose alternative infrastructure providers, the anticipated usage based uplift could fall short and limit future revenue growth and margin expansion.
• The Board led review of strategic alternatives, combined with ongoing M&A evaluation, introduces the possibility of portfolio changes, ownership shifts or integration requirements. If any transaction diverts management attention, adds leverage or results in the sale or restructuring of cash generative units, this could affect the stability of free cash flow, adjusted EBITDA margins and ultimately earnings.

Valuation

How have all the factors above been brought together to estimate a fair value?

• The assumed bearish price target for Sangoma Technologies is CA$8.01, which represents up to two standard deviations below the consensus price target of CA$9.92. This valuation is based on what can be assumed as the expectations of Sangoma Technologies's future earnings growth, profit margins and other risk factors from analysts on the more bearish end of the spectrum.
• However, there is a degree of disagreement amongst analysts, with the most bullish reporting a price target of CA$11.18, and the most bearish reporting a price target of just CA$8.01.
• In order for you to agree with the more bearish analyst cohort, you'd need to believe that by 2029, revenues will be $231.0 million, earnings will come to $18.7 million, and it would be trading on a PE ratio of 12.9x, assuming you use a discount rate of 8.6%.
• Given the current share price of CA$4.94, the analyst price target of CA$8.01 is 38.3% higher.
• We always encourage you to reach your own conclusions though. So sense check these analyst numbers against your own assumptions and expectations based on your understanding of the business and what you believe is probable.