Nuance Communications (NUAN) Pays a 41% Premium for Rival Transcend Services (TRCR)

Last week, speech-recognition software manufacturer Nuance Communications (NUAN: Charts, News) acquired its rival Transcend Services (TRCR: Charts, News) for $313 million, its largest purchase in nearly four years.

The deal offers an acquisition premium of 41%, or $29.50 per share, over the previous day's closing price. Transcend investors rejoiced as shares surged 39% to $29.18 last Wednesday on the news, its highest price since 1996, and finished the week at $29.20.

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Nuance, based in Burlington, Massachusetts, creates speech and imaging applications across multiple industries, but its software most recently made headlines as the wizard behind the curtain powering Apple's (AAPL: Charts, News) Siri voice recognition application. Nuance also creates automated telephone, medical transcription, optical character recognition and desktop imaging software. It even owns a small business segment focused on exclusive development for the U.S. military and government agencies.

Over the past four years, Nuance has been focused on expanding its reach in the medical industry, acquiring rivals eScription and Webmedx in 2008 and 2011, respectively. Over the past year, Nuance has been especially active, spending a record $400 million on eight acquisitions. Mergers are nothing new to Nuance, which formed out of a series of mergers and acquisitions over the past decade, most significantly the merger between rivals ScanSoft and Nuance in 2005.

Although Nuance's acquisition offer of Transcend looks generous at first glance, a quick comparison to past deals reveals otherwise. Nuance's $313 million offer only values Transcend at 2.4 times trailing sales. Nuance had paid 8.1 times trailing sales for eScription four years ago. Some analysts believe that this was due to eScription's stronger operating margin of 39% compared to Transcend's 16% at the time of acquisition. For now, Transcend's shareholders seem content with the deal, and few expect a higher offer. The Transcend acquisition is another step in the widespread consolidation of the entire industry, in which Nuance is the clear leader. Transcend's chief rival, MedQuist, which has a short history of acquisitions, also purchased three companies within the past two years.

Nuance shareholders haven't had a smooth ride over the past month. Since the company announced its first quarter earnings on February 9, shares have dropped 15% while the rest of the market rallied. The company earned non-GAAP earnings of 34 cents per share on revenue of $382 million, missing earnings estimates on both. Analysts had expected 36 cents per share on revenue of $392.5 million on the same basis. However, this was a significant improvement over the zero cents per share on revenue of $303.8 million.

Nuance's gross margin rose 80 basis points to 66.7%, operating margin grew 360 basis points to 8%, and net margin improved 260 basis points to 2.6%. For the current quarter, Nuance expects earnings of 38 cents per share on revenue of $405.3 million. For fiscal 2012, the company forecasts revenue of $1.68 million, exceeding the average analyst forecast of $1.59 billion.

Although investors should expect Nuance to make more headlines due to Siri's popularity, investors should remember that the iPhone software does not comprise a significant part of the company's revenue. The stock trades at 14.75 times forward earnings and has a 5-year PEG ratio of 1.03, which signifies slow but steady growth potential down the road. Although the company is destined to be one of the last speech recognition software companies standing after the market consolidation concludes, investors should remember that the largest company won't necessarily perform the best, as acquisition indigestion can eventually erode margins. The company doesn't currently pay a dividend.

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Published on Mar 12, 2012
By Leo Sun
Leo Sun
Leo Sun is a freelance finance writer and position trader. He focuses on a combination of value and momentum investing, with a strong interest in the trading philosophies of Warren Buffett and Peter Lynch. Leo also has experience writing articles to help small business owners acquire loans and manage their finances. He regularly contributes to the Stock of the Day analysis.

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