Billionaire activist Carl Icahn has had a quite busy year, from taking a large stake in Transocean LTD (NYSE:RIG) to a charged confrontation with Bill Ackman on CNBC. Icahn’s latest move, according to a 13G filed with the SEC, has been building a position in Nuance Communications Inc. (NASDAQ:NUAN) up to a total of over 29 million shares. This gives him 9.3% of the total shares outstanding of the $6.8 billion market cap software company whose products include dictation, speech recognition, and other language and voice services; its software is often used in smartphones. Icahn’s 13F for the fourth quarter of 2012 does not show him owning any shares of Nuance Communications Inc. (NASDAQ:NUAN) at the beginning of January, and also suggests that this Nuance position would be one of his larger holdings. Find Icahn’s favorite stocks.
The first quarter of Nuance Communications Inc. (NASDAQ:NUAN)’s fiscal year ended in December, with the company experiencing a 28% increase in revenue compared to the same period in the previous fiscal year. Costs were up strongly, however, resulting in negative earnings (as opposed to a small amount of profits a year earlier). Nuance’s net losses do flip to profits if we add back R&D (which some analysts argue is appropriate for technology based companies, since these can be considered a form of investment rather than purely an operating expense) but we still get the quantity of earnings plus R&D as decreasing despite the rise in sales. Currently the stock trades at 39 times trailing earnings, as both markets and sell-side analysts expect high growth; some investors- including possibly Icahn- might also be hoping for the company to be acquired. Analyst expectations give a forward P/E of only 11. The stock price has fallen 23% in the last year as financial performance has lagged, and the most recent data shows that Icahn’s stake is offset by the 11% of outstanding shares held short.
We can compare Nuance to other specialty application software companies including Open Text Corporation (USA) (NASDAQ:OTEX), Manhattan Associates, Inc. (NASDAQ:MANH), and Msci Inc (NYSE:MSCI). All of these companies also carry fairly high trailing P/E multiples- not as high as what we see at Nuance Communications Inc. (NASDAQ:NUAN), but still solidly above 20 and close to 30 in the cases of OpenText and Manhattan. However, these three companies have all been doing fairly well in terms of their recent financial performance: in their most recent quarterly report each experienced earnings growth higher than 15% versus a year ago. In each case net margins had widened but revenue growth had been strong as well. Interestingly, in some of these cases- Manhattan in particular- the sell-side is considerably less optimistic (that stock’s forward earnings multiple is 21, not too much of an improvement from the trailing results, suggesting that future earnings growth is expected to be low). Of course all three peers have some prospect of being bought out as well.
Icahn’s stake in Nuance is passive, so he seems to think that the company’s strategy is developing well as it is. We do think that speech and voice recognition provides a potentially strong market, but the recent financials don’t show the company doing very well in terms of converting its revenue growth to strength on the bottom line. We have a good deal of respect for Icahn as an investor, and so Nuance might be well placed on a watch list for further developments, but at this time the stock looks too speculative to us.
Disclosure: I own no shares of any stocks mentioned in this article.
