Wednesday, February 03, 2016

Fusion Telecommunications International In Cloud Services

Fusion Telecommunications International (ticker FSNN) is a small player in cloud services. The management team has experience in previous telecommunication and networked communications enterprises, which is part of the cloud computing spectrum but not the whole enchilada. Their current CTO at least has data center experience. Big companies like Google, Amazon, and Salesforce dominate the cloud sector. Anyone muscling into their market share must bring serious computing power.

A simple rundown of this company's summary statistics from Yahoo Finance reveals their present condition.

Profit Margin (ttm): -11.88%
Operating Margin (ttm): -6.41%
Return on Assets (ttm): -5.89% 
Return on Equity (ttm): -138.70% 

Those annual numbers are discouraging. It's even more discouraging to search FSNN on Reuters and find long-term financial highlights. Fusion's 5yr sales growth exceeds the industry's average but they are still not profitable. Revenue and net income per employee both underperform the industry. The company's 5yr ROA, ROI, and ROE are all negative. The management team has its work cut out.

One simple math comparison illustrates the competitive disadvantage Fusion faces. Customer acquisition cost, or CAC, is a make-or-break metric in cloud computing. Analysts can approximate a company's aggregate CAC without even knowing its detailed product pricing or the seat count of the solutions it sells. We can divide the cost of revenue by gross revenue to find a rough CAC percentage. It's really the inverse of gross profit, but it's worth finding to see whether other expenses are contributing to a problem. Let's use the numbers in Yahoo Finance for the most recent quarter to show current conditions.

Fusion's rough CAC percentage in this method is $13.5M/$24.5M, or 55.10% for the quarter ending September 30, 2015. Compare this rough CAC to the figures for Oracle (ticker ORCL) and Salesforce (ticker CRM). Oracle came in at $1.85B/$8.99B, or 20.58% for the quarter ending November 30, 2015. Salesforce clocked in at $0.42B/$1.71B, or 24.56%. Fusion thus spends twice as much for a dollar of revenue as its larger competitors. What's really hurting the company is that SGA expenses have remained stubbornly high as a percentage of revenue even while revenue increased for several years. Oracle's SGA is usually a smaller percentage of its revenue than Salesforce's comparable numbers, which is partly why it is more consistently profitable than Salesforce. Mitigating both SGA and the cost of revenue will be a challenge for Fusion while growing its revenue.

Data storage is now a commodified supply chain input where the low-cost providers are market winners. I do not know whether Fusion can scale its services to the point where it mitigates its cost disadvantage. The company's retained earnings deficit of -$172M has grown year by year, quarter by quarter. It is not obvious how a smaller cloud provider can compete against larger companies without maintaining a cost advantage. Any investor who bought into FSNN in late March 2015 when it was over $4/share, only to see it close under $2/share in early February 2016, learned that the hard way.

Full disclosure: No position in FSNN at this time.