Plenty Of Risks And Rewards With This IT Company


Unified communications specialist Polycom is one of the most interesting high risk/reward situations in the market place today. It's not a stock for widows and orphans, but if you looking for a speculative investment with a lot of upside then Polycom might fit the bill.

High risk...
There are three key concerns with Polycom. The first is that it is a small company (around $1.75 billion) competing against a giant in the tech world, namely Cisco Systems . The latter can easily subsidize an aggressive market share grab, so Polycom is likely to be forced into constantly innovating in order to retain its position.

The second is that unified communication systems are seen as part of discretionary IT spending. In other words, corporations tend to invest in these video-conferencing systems when they are in growth mode, rather than in the current cautious spending environment. Indeed, you can see this by looking at the recent growth in Polycom's sales and Cisco's collaboration segment revenue.

source: Company accounts

While the first two risks are considerable, they can also be opportunities if Polycom gets product innovation right and if the macro-environment improves. However, the third risk comes with a more significant long-term threat.

Simply put, Polycom and Cisco's collaboration segment may be operating within a market in a structural decline.

  • Current trends in IT spending are in favor of outsourcing and virtualizing IT infrastructure into the cloud, rather than purchasing dedicated hardware solutions

  • Corporate IT departments are getting used to using open platforms, and the desirability of being tied to one solution provider for video conferencing is questionable

  • Mobility has been one of key buzzwords of IT spending this year, and investing in a solution that may require a fixed location is not really in line with this trend

The shift to cloud and mobility based solutions doesn't look like it is slowing anytime soon, and the question for Cisco and Polycom is whether they can continue to attract purchasers to their dedicated video-conferencing systems?

...and high reward
The arguments above present existentialist dangers to the long-term viability of its business, but investors should not lose sight of the potential reward in buying the share. Arguably the stock is being priced with the assumption of long-term revenue and cash flow declines in mind.

Indeed, the company has been keen to point out how cheap it is. For example in its second quarter results it highlighted how it ended the quarter with cash and investments equivalent to $4 a share, and generated trailing operating cash flow of $195 million.

In other words, given its current price of ~$11.00, the stock has nearly 39% of its market cap in cash and investments. Similarly, the trailing free cash flow of around $135 million means it has just generated around 11.8% of its enterprise value in free cash flow. This stock is cheap.

Current trading
In its recent results the company gave forecasts for a "very modest low single-digit growth rate" in the second half of 2013. Moreover the mid-point of its guidance for the third quarter assumes that revenues will be flat for the quarter. This means that it is forecasting a return to growth in the fourth quarter, and analyst forecasts have the company on a 3.8% revenue growth rate in 2014.

This sounds good, but readers should note that it has released a new series of products, which it claims are helping win market share from Cisco. The danger here is that the company is getting trapped into a long-term game of investing in new technologies in order to wring out any bit of growth from a market in decline. If this is the new reality then its free cash flow could start to degenerate in future years.

On the other hand, if it hits analyst targets for 2014, and a better economy encourages some more discretionary IT spending, the stock is a great value.

Where next for Polycom?
Ultimately, an investment decision here will boil down to your opinion on the long-term viability of Polycom's solutions. Risk seeking investors may love the proposition here, but for more cautious investors a piece-meal approach probably works best. You could always monitor the next few quarters of Polycom's results in order to see if it is hitting its targets. Meanwhile, it would be useful to see if Cisco can start to report some growth in its collaboration segment.

Polycom is an attractive stock, but it doesn't come without risk. No one said investing was easy!

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Lee Samaha has no position in any stocks mentioned. The Motley Fool recommends Cisco Systems and Polycom. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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Originally published