The European telecom vendor Ericsson (ERIC -1.03%) announced this week an agreement to acquire the communications specialist Vonage Holdings (VG) for $6.2 billion in cash. With Ericsson's share price down following the news, the market doesn't look excited by the company's largest deal ever.
The synergies between Ericsson's 5G business and Vonage's unified communications platform seem limited. However, Ericsson has a long-term plan that could boost its enterprise services business over the long term. Let's dig in.
Limited short-term synergies
Over the last several years, Ericsson has consolidated its leadership in the 5G markets. For instance, it increased its share in the radio access network market in North American from 48% in 2018 to 53% in 2020.
Of course, it benefited from the geopolitical tensions that led to the exclusion of the Chinese tech giant Huawei from several important areas. But it also managed to gain market share thanks to its focus on investments and innovation to develop its 5G portfolio of hardware and services it sells to telecommunication service providers. And last year, it acquired Cradlepoint to expand its footprint in enterprises with solutions that provide 5G connectivity to all sorts of sites and devices.
So given Ericsson's business focus, the acquisition of Vonage seems odd, as Vonage doesn't provide any solution that seems to enhance or complement Ericsson's 5G portfolio.
Vonage's legacy business, which consists of offering cheap voice and messaging services to U.S. consumers, is poised to keep declining because of the free internet audio and video communications provided by applications such as Whatsapp. Unsurprisingly, revenue from that segment shrank to $70 million during the third quarter, down 15% year over year.
But that's not the whole story. In contrast, Vonage's communication platform (VCP) represents solid growth potential over the long term. It provides enterprises with communication solutions for employees and contact center capabilities for customer relationships. It also proposes application programmable interfaces (APIs) to embed communications into enterprises' workflows.
Overall, VCP's total addressable market should grow 17% annually to reach $69 billion by 2025, with API being the fastest-growing activity at an expected annual growth rate of 30% during that time frame. Revenue from VCP grew 23% year over year to $288 million during the third quarter, which suggests the company gained some market share.
In the short term, Ericsson plans to leverage its large research and development capabilities to enhance Vonage's core offering and sustain above-the-market growth. Indeed, those types of investments seem necessary, as various research firms ranked Vonage's solutions behind leading competitors.
For instance, Gartner positioned Vonage's contact center-as-a-service solution as a challenger in terms of ability to execute and completeness of vision in its 2021 magic quadrant, behind the leaders Nice Systems, Genesys, and Talkdesk. Similarly, it placed Vonage's unified communications-as-a-service offering at a disadvantage to many competitors, including Zoom Video Communications and Microsoft.
But beyond the investments and synergies that would lead to market share gain in Vonage's businesses, Ericsson has an intriguing long-term plan for the combined entities.
During an earnings call about the acquisition, management indicated its intention to create an open platform for enterprises to easily access 5G capabilities. To that end, Ericsson will integrate 5G capabilities in Vonage's communication APIs. It also plans to leverage Vonage's large pool of more than one million registered developers to grow an ecosystem of 5G solutions for enterprises based on that platform. For instance, Vonage's APIs could provide enterprises with an easy way to implement 5G's network-slicing technology, which can be used to prioritize network resources for mission-critical applications over less time-sensitive applications such as email.
It remains to be seen how Ericsson will monetize that long-term opportunity. But the development of such a platform could boost the company's 5G business in enterprises, which will also reduce its exposure to the more cyclical telecom industry.
A good deal?
Ericsson agreed to pay $6.2 billion in cash to acquire Vonage, which will consume the company's large cash balance in excess of debt that coincidentally amounted to $6.2 billion (54.9 billion Swedish kronor) at the end of the last quarter.
That represents 4.4 times Vonage's expected full-year revenue, which seems reasonable in the context of anticipated 12.5% year-over-year revenue growth. In addition, revenue growth seems poised to accelerate going forward given Ericsson's planned investments in Vonage's large and growing market opportunities that will dwarf the shrinking legacy consumer business.
More importantly, management's plan to develop an open platform to encourage the deployment of 5G solutions in enterprises represents an extra option for attractive long-term growth opportunities.
Thus, Ericsson shareholders should welcome the $6.2 billion acquisition of Vonage, which is scheduled to close during the first half of 2022. Also, following the market's negative reaction, Ericsson stock is trading at modest forward price-to-sales and price-to-earnings ratios of 1.3 and 14.4, respectively. Accordingly, investors looking for exposure to the 5G industry should consider buying the stock.