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RGA Investment Advisors Bullish on Nuance Communications (NUAN)

Alex Smith

RGA Investment Advisors, LLC is an independent investment management firm based in New York. Jason Gilbert is the firm’s founder and managing partner. Recently, RGA Investment Advisors released its Q1 2020 Investor Letter – a copy of which can be downloaded here.

In the said letter, Jason Gilbert highlighted that the firm bought Nuance Communications Inc. (NASDAQ:NUAN) stock in the first quarter. Nuance Communications is a computer software technology company based in Massachusetts. Year-to-date, NUAN stock gained 6.2% and on April 23rd it had a closing price of $18.54. Its market cap is of $5.36 billion, and NUAN is trading at a price-to-earnings ratio of 22.63x. Here is what Jason Gilbert said:

"Early in the first quarter, we made a new investment in Nuance Communications. Nuance provides conversational artificial intelligence to healthcare (two thirds of revenue) and enterprise end markets. Within healthcare, in addition to owning a functional monopoly in radiology documentation with PowerScribe, the company has a strong suite of products powering the digitization of the industry. Nuance is best known for its Dragon medical dictation product, used by 55% of doctors in the United States. 11 They are currently transitioning Dragon medical dictation into a high margin, recurring revenue, cloudbased product called Dragon Medical One. Dragon Medical One grew revenue 54% last quarter, showing clear progress in the transformation.

Beyond Dragon Medical One, Nuance is developing a more disruptive product to evolve and enhance the dictation industry—Dragon Ambient eXperience (commonly referred to as “ACI”), built in partnership with Microsoft. 12 ACI “uses ambient sensing technology to securely listen to clinician-patient encounter conversations while offering workflow and knowledge automation to complement the Electronic Health Record (“EHR”)”.13 ACI is compatible with all major EHR and telehealth platforms, but has an especially promising relationship with Epic Health Services. Epic, who boasts 80% market share amongst the largest hospital networks in the US and has partnered with Nuance to bundle ACI as an add-on to all its EHR customers. This has effectively unburdened Nuance of distribution to a huge installed base. Based on conversations with industry experts, ACI is revolutionary, possesses capabilities far beyond competing software, and is expected to have high levels of physician demand. These sources validate Nuance’s estimated serviceable addressable market for ACI of at least $6.6 billion in the United States. 14 For context, this is over four times larger than FY 2019 sales for the entire company (excluding discontinued operations).

The world has drastically changed since we initiated our position in Nuance early in the first quarter. Despite COVID-19, the company affirmed that it had “not experienced any significant changes in our business” as a result of the environment.15 Nuance is well positioned to continue avoiding significant negative impacts as it provides mission critical software to busy healthcare professionals and Fortune 100 enterprises. Although cCOVID-19 could delay uptake of Nuance’s products by new customers, it could accelerate the adoption of ACI by existing ones when physicians and hospitals get past peak resource utilization from COVID-19. Accelerated uptake of ACI would fuel faster revenue growth and a better margin profile for Nuance and most importantly, for clients, ACI helps solve two major problems exacerbated by this present crisis: physician burnout and large patient backlogs. The COVID-19 crisis has undoubtedly increased physician burnout. ACI measurably decreases the time physicians spend on documentation, while improving patient throughput. In beta mode, a major orthopedic clinic reported “their providers were not only happier and more focused, they were also able to see 24% more patients and brought in an additional $1.35 million in revenue during one quarter”.16 Helping clinics meaningfully grow revenue is another positive side effect from ACI.

Mark Benjamin has demonstrated strong strategic vision and execution since he joined the company as CEO in April 2018, and we expect that to continue with the ACI rollout. Strong execution will be critical for realizing the full potential of ACI. In his first two years, Benjamin has revitalized the culture by simplifying the company’s business and strategy around a few core verticals. He improved the capital structure while aggressively repurchasing shares and investing in research and development. He divested and spun off non-core business. Benjamin has built a reputation for providing conservative projections, best evidenced by the 2019 Investor Day guidance through 2023 which ignores all potential ACI revenue streams. Nuance currently trades at a 5% FCF yield and a 30% discount to a DCF based on Benjamin’s guidance. It is not unreasonable to argue investors are getting potential upside from ACI for free at current prices."

In Q4 2019, the number of bullish hedge fund positions on NUAN stock increased by about 34% from the previous quarter (see the chart here).

Disclosure: None. This article is originally published at Insider Monkey.