eGain: 2 Dreaded Words Investors Need Not Fear (NASDAQ:EGAN)

(Source: shutterstock)

Customer engagement solution provider eGain Corporation (EGAN) put up some pretty decent numbers for Q1’21 recently, beating on both the top and bottom lines. But the investment community wasn’t happy and punished the stock pretty severely, dropping from a recent high of $20 down to less than $11.50, a fall of nearly 45% from its high in July.

eGain <span class='ticker-hover-wrapper'>(NASDAQ:<a href='https://seekingalpha.com/symbol/EGAN' title='eGain Corporation'>EGAN</a>)</span> stock chart

(Source: Yahoo Finance)

The stock price is now sitting near a three-month low, and in my opinion, presents a golden opportunity to invest in a company at the heart of the digital transformation movement. Customer engagement solutions is an area of business that has a very promising growth forecast of 12.65% CAGR for the next five years. Given the recent beatdown, I believe that eGain’s stock is quite undervalued at the current price and I am giving it a buy rating.

Customer engagement global revenue from 2020 - 2025

(Source: Mordor Intelligence)

Mr. Market: Bearishness on eGain

eGain’s Q1’21 quarterly performance was actually quite good. In particular its Software-as-a-Service (“SaaS”) revenue was up by 29% YoY. Quarterly revenue was $19.1 million and GAAP EPS was $0.07. Both revenue and EPS were above analysts’ estimates. That was the good news.

The bad news was that management disclosed that the company had lost two customers during the earnings call, resulting in a loss of $750 million in quarterly recurring revenue:

“In Q1, we had a couple of out of plan [ph] one attrition and one termination which clients those two put together will negatively impact our quarterly SaaS revenue by $750,000 quarterly in Q2. One of the clients decided to implement an on-premise solution in their private cloud and the other consolidated our capabilities that we’ve offered them onto a larger CRM platform, while these two put together a significant in dollar terms. We do see them as somewhat isolated incidents.”

eGain has a limited number of customers, approximately 150. So, the loss of two customers has a substantial impact on performance and is one reason why the stock price has been beaten up.

Those Two Dreaded Words…

With the bad news out of the way, company management then guided for a subdued Q2, with SaaS revenue growth of 5% to 8% and overall revenue growth of 0% to 3% YoY. In addition, management used the two words that every investor dreads to hear: ‘investment year’.

In general, when a company declares that it is an investment year, it means that it is lowering the bar for future performance, particularly with regards to the bottom line. In eGain’s case, the company plans on an increased level of spending with no measurable improvement on revenue for the coming year. eGain will be spending on the following activities:

  • Increased brand awareness: Higher level of spend on digital marketing programs and virtual events.
  • Increased partner support: Provisions for more technical and sales resources, including CRM platforms provided by Salesforce.com (CRM), Microsoft (MSFT), and ServiceNow (NOW).
  • Vertical-based partnerships: Establishing new partnerships within specific verticals, starting with financial services.
  • Increased Direct Sales: Intent to double sales capacity in fiscal 2021 in two phases, November and March.

The good news is that the increased spend will likely translate into higher revenue growth but investors should not see an impact this year.

Competition Within the Customer Engagement Market Segment

I have already identified some of eGain’s partners, including CRM partners Salesforce.com, Microsoft, and ServiceNow. The company also has a developing partnership with Avaya (AVYA). All of these players are partners with eGain, but in general, the relationships are not exclusive. Therefore, these companies are also competitors in some sense. Other companies that operate in the customer engagement space are:

  • LivePerson, Inc. (LPSN)
  • NICE Ltd. (NICE)
  • Nuance Communications, Inc. (NUAN)
  • Pegasystems Inc. (PEGA)
  • Verint Systems Inc. (VRNT)
  • Zendesk, Inc. (ZEN)

There are also some large companies that have products in the customer engagement space, including International Business Machines (IBM), Oracle (ORCL), and Open Text Corporation (OTEX) where customer engagement solutions makes up a small percentage of their total operations.

Stock Valuation

My followers will recognize my technique for valuing stocks. For those readers not familiar with my scatter plots, please refer to this recent article for more details.

Scatter plot of fundamentals for 200+ digital transformation stocks

(Source: Portfolio123/author’s private software)

The above scatter plot represents stock valuation on a relative basis, based on the company’s estimated future revenue growth (X-axis) and EV/gross profit estimate (Y-axis). The red line represents the best-fit line of fundamentals for the 200+ stocks in my digital transformation stock universe.

eGain is identified with a blue circle while its main competitors are highlighted. One observation that I draw from this scatter plot is that the customer engagement market segment is slightly undervalued as all of the highlighted stocks are either fairly valued or undervalued. eGain is the most undervalued of the group.

Investment Risks

The current market action for cloud computing stocks is somewhat reminiscent of the dot.com era, immediately prior to the crash starting in 2000. Technology stocks were performing well beyond what many analysts considered acceptable valuations. It wasn’t long before the market turned into a disaster, and the same could happen here, although I believe that there is much more substance behind cloud-based companies than existed 20 years ago.

eGain is a relatively small company ($350 million market cap) with limited product offerings. Given the current economic conditions, many businesses are consolidating software vendors which is a big plus for software companies with large platform offerings. It is possible that eGain’s two lost customers were the result of consolidation onto larger software platforms. This could be the start of a trend.

Unfortunately, with the lack of new government stimulus in the USA, businesses are really hurting. The longer the pandemic persists, the longer and deeper the recession will be. Many companies will suffer and potentially cut back on spending.

Summary and Conclusions

eGain is a relatively small company ($350 million market cap) that offers customer engagement solutions. While the company’s Q1’21 quarterly results were strong, the management provided soft forward guidance for Q2, and no guidance for the rest of the fiscal year. The soft guidance is a result of losing business from two customers plus the poor economic conditions. Guidance for Q2 YoY revenue growth is for 0% to 3%.

Company management has also indicated that this year will be an investment year. Sales and marketing expenses will be increased fairly substantially, thus impacting the bottom line, with no appreciable benefit in higher revenue this year. Next year is another story, however.

Growth for the customer engagement solutions market is projected to be 12+% CAGR for the next five years. I view the recently battered stock price to be an opportunity to invest in this promising company, which is converting to an SaaS business model. The SaaS recurring revenue grew by 29% YoY in Q1, and although Q2 will be less impressive, I expect that this company will get back to strong double-digit growth once the pandemic is over. I am giving eGain a Buy rating.

Digital Transformation is a once-in-a-lifetime investment opportunity fueled by the need for businesses to convert to the new digital era or risk being left behind. And the pandemic has dramatically accelerated this paradigm shift. You can take advantage of this opportunity by subscribing to the Digital Transformation marketplace service. 

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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