Ooma's Growth Saga: Decent But Not Stellar

When it comes to investing, you can't just look at a company's performance in isolation. Sure, a company like Ooma, Inc. (NYSE:OOMA), a nifty small-cap SaaS outfit valued at about $380 million, may look good on paper. They’re boosting their earnings, and they've got a clear runway for further profit growth ahead. But here's the catch - is their growth rate impressive enough?

That’s a key question that needs answering. Simply achieving growth may not cut it. Even though Ooma has been successfully growing its revenue and enhancing its earnings, and despite them having a fantastic product and promising prospects for further top and bottom-line growth, it's not always enough to seal the deal. So let's delve in a little deeper, shall we?

About Ooma

Let's first talk about Ooma’s business. Ooma delivers SaaS-based communication services and other related technologies for both homes and businesses. Their offerings include multi-user communication systems like Ooma Office and Ooma Enterprise, as well as products like Ooma AirDial and OnSIP. Home users aren't left behind either, with services such as the Ooma Telo phone service and the Talkatone app. Revenue-wise, Ooma Business brings in about 56% of the company's total, with Ooma Residential covering the remaining 44%.

What sets Ooma apart? Well, in my view, it's their Ooma Office. It's a hit among small and medium businesses, with the capacity to integrate with Ooma Enterprise to cater to larger corporations. The popularity of Ooma Office is unquestionable. It has consistently bagged the number one spot in PCMag's yearly user survey for a decade now. That's no small achievement when you're going head-to-head with heavyweights like Google Voice from Alphabet (GOOGL) (GOOG), Microsoft Teams from Microsoft Corp (MSFT), and Zoom Phone from Zoom Video Communications (ZM). Yet, despite these formidable adversaries, Ooma has managed to stand its ground and carve out a dominant position in this niche.

Revenues & Earnings Growth

Over the past decade, Ooma has demonstrated consistent revenue growth, rising from $53.7 million in FY2014 to a noteworthy $216.2 million in FY2023. Recent figures from the quarter ending April 30, 2023 (Q1-FY2024) underscore this trend with revenues up by 13% YoY, reaching $56.9 million. Projected revenues for the full year stand between $235.5 million and $238.5 million, indicating continued top-line growth.

Data Source: Seeking Alpha, OOMA

But it's not just about revenue - earnings have been on the upswing too. Like many SaaS peers, Ooma's early days were characterized by annual losses. However, from FY2020 onward, the company began posting positive adjusted EBITDA figures, with adjusted profits appearing from FY2021. This trend carried on into the first quarter of FY2024, with an adjusted income of $4 million or $0.16 per share, a step up from $3 million or $0.12 per share the year prior. Looking ahead to the close of FY2024, Ooma is aiming to boost its adjusted profit to around $15.5 million, up from $13.59 million last year.

Data Source: Seeking Alpha, OOMA

Potential for Future Growth

Ooma's proven its ability to drive revenue and earnings growth, and in my view, it's ideally placed to maintain this momentum. Growth in both the number of users and revenue per user are key factors. I'm particularly impressed with Ooma's strategic focus on expanding its business user base, which offers greater value than residential customers. This value is evident when you consider the ARPU (average blended monthly subscription revenue per user) - in Q1-FY24, it stood at $14.28. This included business ARPU of almost $23, dwarfing the residential ARPU figure of around $9.

At the close of the first quarter, Ooma boasted 1.225 million core users, with business users making up 37% of this total. Despite their smaller numbers, business users accounted for 56% of the company's total subscription revenues in Q1-FY24, up from 50% a year earlier. This shift is the result of Ooma's deliberate strategy to boost its business user base, now a major engine for revenue growth. Q1's revenue growth was predominantly fueled by Ooma Business, witnessing a 27% YoY surge in subscription and services revenues (or 13% after adjusting for the OnSip acquisition). In contrast, residential revenues remained relatively stagnant, with a mere 0.3% uptick.

I foresee this trend persisting. Ooma's successful strategy of enhancing revenue per user through the rollout of superior features and services via Ooma Office Pro and Ooma Office Pro Plus has inspired customers to opt for higher payment tiers. Q1 closed on a high note with the launch of several new features and record-breaking adoption rates for its premium services. Over a quarter of its customers have already shifted to these premium tiers, a move set to boost revenues, earnings, and margins in forthcoming quarters. Ooma's roadmap for the current fiscal year includes new feature releases every quarter to stimulate growth and lift ARPU. It's worth mentioning that Ooma saw a 6% increase in ARPU in FY-2023, and with the anticipated robust adoption of Ooma Office Pro and Pro Plus, this upward trend is likely to continue.

Moreover, I appreciate the proactive approach of Ooma's management in exploring ways to expand Ooma Business across diverse sectors. The company is growing its footprint in the hospitality sector and has also entered a new partnership with NexHealth, a service provider for dentists and healthcare professionals. This move promises to accelerate Ooma Business's expansion within dental practices. Additionally, Ooma has bolstered its sales team with around 40 new hires in Q1, including two senior roles. This should further assist the company in boosting sales to business and enterprise customers.

Is It Good Enough?

But here's the crux of the matter - is Ooma's growth strong enough to warrant investment? To determine this, let's lean on the 'Rule of 40'. This rule is a popular performance metric for fast-growing SaaS companies and stipulates that a firm's revenue growth rate and profitability should jointly hit at least 40%.

According to this metric, Ooma has fallen short. Last year, Ooma achieved 12.4% revenue growth and its adjusted EBITDA margin was 8.0%. Adding these two numbers gives us a total of just 20.45%. Assuming Ooma meets its FY-2024 revenue target, it would result in 9.6% growth. If it then managed to boost adjusted EBITDA by 23% in FY-2024 (double last year's growth rate of 11.5%), its EBITDA would reach $21.4 million. This equates to an adjusted EBITDA margin of 9%, leading to a 'Rule of 40' sum of only 18.6%. Rather than inching closer to that 40% benchmark, Ooma might be drifting away, which isn't the best sign.

Data Source: OOMA, Author's Estimate

Although Ooma has successfully lifted both revenues and earnings and seems to be on the right trajectory, its growth has been relatively slow. This sluggish pace is why the company's performance, viewed through the 'Rule of 40' lens, appears less than stellar.

To put it in perspective, the SaaS industry faces tough economic conditions. With high inflation, rising interest rates, slower GDP growth, and increasing concerns about the economy, many companies are finding it challenging to grow their businesses profitably. In such a challenging climate where earnings are pressured, firms may focus on slashing expenses and safeguarding profits, demonstrating a hesitation to onboard new SaaS services.

Amid these challenges, many SaaS companies may grapple with achieving the 'Rule of 40'. However, some have exceeded this benchmark, such as Doximity (DOCS), whose sum of revenue growth and margins consistently surpasses 40%. Others like Everbridge (EVBG) score higher than Ooma on this metric, seemingly on course to meet the 'Rule of 40' in the future through increased revenues and expanded margins. And then there are established large-cap companies like Adobe (ADBE) who maintain substantial profitability while also delivering double-digit revenue growth.

For instance, Doximity, which operates the largest digital platform for U.S. medical professionals, posted an impressive adjusted EBITDA margin (ttm) of 44% - comfortably surpassing the 'Rule of 40' with its earnings alone. Similarly, industry heavyweight Adobe ended last year with a 38% EBITDA margin, combined with an 11.5% revenue growth. In these terms, Ooma lags considerably behind these superior industry players.

Final Thoughts

Ooma has shown promise with past revenue and earnings growth and seems to be moving in the right direction, particularly with its focus on expanding in the business market rather than residential. However, its revenue growth isn't quite dynamic and its margins are less than dazzling. Investors might discover more compelling opportunities elsewhere. My advice? Skip over Ooma and hunt for higher-quality players. Greater returns may be reaped with these superior companies.