This article was originally published on Forbes on Aug 13, 2020,11:01pm EDT

Shelter-in-place has led to a surge for many stocks across e-commerce, online streaming, video conferencing and gaming as these subsectors are seen as the primary beneficiaries of covid-19. In many cases, this boost in usage is temporary as it requires people to spend an unnatural amount of time indoors, not to mention the effects of covid are fully priced-in to most of these stocks. 

The market can be myopic due to the sheer number of swing traders and machines driving the market. Therefore, strong consideration should be given to the long-term effects of covid even if the gains are not immediate or overnight. One trend I am monitoring closely for the more permanent effects is the disruption of telecom hardware systems through cloud-native communications. 

Cloud-native voice customers will be permanent and won’t revert back post-covid because it’s cheaper, can be scaled depending on immediate needs, and can also be built into collaboration platforms for increased productivity or used as a stand-alone. Session Initiation Protocol (SIP) enables reliable voice over a Tier-1 Network with a phone line as cheap at $0.35 compared to the typical phone bill that ranges between $20 to $30 per phone line.

Although there are many tech giants with products in the cloud-native communications space, such as Microsoft, Google and up-and-comer Zoom, the Tier 1 Network powering many of these voice features is offered by a little-known company called Bandwidth.

Hardware-as-a-Service Powered by Tier 1 Network

Where dedicated, daily user behavior within enterprises around VoIP and cloud native conferencing apps may have been many years out, covid-19 has sped up this more permanent trend. We were looking at growth of about $1.7 billion in 2017 to $6.7 billion in 2022 for this market. According to IDC, the global market will reach $17.2 billion by 2023. 

Corporations have been announcing permanent work-from-home policies with many discussions on earnings calls about the improvement in margins that is caused by not providing physical space. With many empty office buildings across metropolises, the common concern is what will happen to real estate prices and commercial rent. However, inside the buildings are miles of telecom wires that lay dormant at $20 to $30 per line per month. 

This need to re-envision the post-covid office extends beyond enterprises to also include SMBs, who will want to cut costs as stay-orders are extended, such as retail outlets, attorneys, dentists and insurance agents, to name a few.  

The company Bandwidth delivers SIP that enables voice-over-internet-protocol (VoIP) by defining the messages sent between endpoints and managing the actual elements of a call. SIP supports voice calls, video conferencing, instant messaging and media distribution. Bandwidth works with the very largest VoIP and video/audio conferencing companies with some important catalysts: (1) work-from-home migrating budgets (i.e. the customers), (2) large investments and innovation from Bandwidth’s customers including Zoom and Microsoft (i.e. the providers), and (3) the potential for global expansion. Phone lines offered by Bandwidth are as low as $0.35.

Major customers for Bandwidth include Zoom, Google, Cisco, Microsoft, Skype, RingCentral and Square. In this case, we do not need to predict or speculate who will take market share from the telecom hardware systems as all of the bigger players use Bandwidth (we do need to have conviction that cloud-native will replace telecom hardware).

Bandwidth offers a Voice over Internet Protocol (VoIP) network of 70 million phone numbers. The category of Communications Platform as-a-service (CPaaS) is cloud-based middleware that facilitates cloud-based hosting and management of application programming interfaces (APIs). This helps simplify the programming process for real-time communication by embedding voice and messaging APIs into enterprise applications. 

While Twilio’s strength comes from native mobile applications with a loyal following of mobile application developers, Bandwidth’s strength and customer base comes from cloud-native companies.

The difference between these companies is important to review. Twilio enables communications for mobile applications, such as voice or text. When you text or make a call inside of a mobile application, you are likely using Twilio’s APIs. The company works with over 1,000 mobile carriers in over 150 countries for voice and text/SMS services. The features that come pre-packaged with Twilio are ideal for companies who want to cut down on development time, such as startups or pureplay apps. Examples include customer service calls on Zendesk and messaging home owners inside the AirBnB app.

However, large companies in the video and phone conferencing space (including business apps), with a primary focus on communications, are unlikely to incorporate an expensive third-party for out-of-the box development. As a network carrier, Bandwidth undercuts Twilio on pricing with cheaper outgoing and incoming calls plus free incoming SMS. This option is entirely focused on voice and SMS while its customers develop any additional features in-house. Twilio costs $1 for a dedicated number while Bandwidth costs $0.35 per dedicated number. This is why Bandwidth is the network provider for Google, Microsoft enterprise apps and Skype, and also Zoom.

Bandwidth’s product differentiation comes from the national IP network platform, which in turn, delivers reliability for audio calls. Bandwidth makes a fraction of a penny for every call or message that is sent over the Tier 1 network. Therefore, Bandwidth’s revenue is not up to par with Twilio’s at about $300 million on an annual run rate compared to $1.5 billion. Another contributing factor is that the mobile app economy has been fully built-out while cloud communications is very nascent. Therefore, as the trend grows, this should help deliver acceleration across Bandwidth’s financials.

Bandwidth owns the network and can serve enterprises who are seeking price efficiency. As stated in the IDC MarketScape analysis: Worldwide Cloud Communications PaaS analysis, this allows a high-level of reliability and quality. The companies who choose Bandwidth over Twilio are looking for “mission-critical” communications.

According to Gartner, Bandwidth’s direct competitor is actually AT&T when it comes to being a network provider with APIs, such as 911 access. Bandwidth recently announced Duet for Microsoft Teams, which provides direct routing with 911 capabilities as emergency calling is something CIOs must provide for in the event an employee needs to contact first responders. Bandwidth is one of two providers with E911.

More on Bandwidth (stock ticker: BAND):

This quarter highlighted Bandwidth’s ability to service the increasing communications needs of enterprises. The company accelerated revenue in Q2 to $76.8 million, up 35% year-over-year. This beat the consensus of 22% year-over-year growth, or $69.4 million. This is the best growth rate the company has ever recorded, up from 29% in Q1.

Dollar-based net retention rate improved from 113% to 133%. Forward guidance for Q3 came in above Street estimates and the company raised its full year outlook to 28% year-over-year at the midpoint.

The company highlighted broad-based growth across existing enterprise customers as they continue to elevate usage in their cloud-based communications services. Demand for messaging services was especially strong at 108% in Q2. The outperformance was due to higher A2P messaging surcharges, which are application-to-person messages that come from chatbots, appointment reminders or marketing messages.

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Management estimates the net impact of covid to be about 6% of revenue in Q2: “While it is becoming increasingly difficult to differentiate COVID-19-related usage from organic usage growth, we estimate that COVID-19 revenue impact in the second quarter to be in the range of $4.5 to $5 million.”

Despite management guiding for lower contribution from covid in the second half of the year, they raised the FY outlook 5.5% above the number they gave after Q1. With that said, momentum is on Bandwidth’s side after the company announced record total revenue growth (+35%), record CPaaS revenue growth (+40%), and a record dollar-based net retention rate (133%). 

There are a number of growth drivers in place for Bandwidth to see sustainable 25%+ growth over the next year:

1. Existing enterprise customers continuing to scale usage:

Bandwidth prices its services per API connection (i.e. per minute on calls or per message) so they will continue to grow with any permanent migrations.

Last month, Zoom announced two hardware-as-a-service options including hardware for “Zoom Phone” and “Zoom Rooms” and has announced ServiceNow will be using Zoom as hardware-as-a-service to displace its current phone system and legacy hardware. In the July announcement, ServiceNow stated, “Going forward, with the addition of Zoom Phone, we're getting a head start on an even more robust experience with Zoom— one-touch communication and collaboration features, plus Zoom-connected conference rooms.”

The two HaaS options Zoom launched allow companies working remotely (or in the office) to consolidate Zoom software and hardware for one consistent experience. Bandwidth is downstream from these products as they will increase the number of minutes and messages on its Tier 1 network.

Microsoft Teams competes with Zoom on both audio and video while using Bandwidth for audio. Aternity’s Productivity Tracker released a study in Mid-June showing that Microsoft Teams usage grew by 894% as of June 14th, compared with its base usage during the week of February 17th.

As more enterprises and businesses seriously consider replacing legacy phone systems, I believe they will go with the direct routing and E911 option in Microsoft Teams for reliability and safety concerns as the price is very competitive. Microsoft Teams competes with Zoom on both audio and video while offering Bandwidth for direct routing and E911. Aternity’s Productivity Tracker released a study in Mid-June showing that Microsoft Teams usage grew by 894% as of June 14th, compared with its base usage during the week of February 17th. 

2. Enterprises increasingly migrating to the cloud from on-premise legacy solutions:

Only 7 percent of Americans worked from home prior to covid-19. This number is likely to be much higher even after shelter-in-place is over. According to Sarah Walas, VP of Investor Relations at Bandwidth, calls over the voice network spiked 30 percent overall in March, with meeting-solutions clients like Zoom increasing usage by as much as 66 percent.

Bandwidth management announced a significant customer win in Q2 – a five-year multimillion-dollar agreement with a Fortune 100 company that is one of the nation’s 10 largest banks. The announcement between ServiceNow and Zoom Phone also point towards long-term or permanent hardware replacement.

Overall, the company ended Q2 with 1,900 active CPaaS customers (+30% YoY). Bandwidth is in an ideal position to continue to win large new customers looking for a migration partner with an attractive pricing model. We may see more growth here as the year goes on. Twilio released a survey in July that showed enterprise decision makers stating they believe their digital communications strategy has been accelerated by an average of 6 years. 

Analyst Estimates May Be Too Low

Wall Street consensus estimates are calling for FY21 revenue growth of 14.6% YoY. Just as Bandwidth blew past Street estimates in Q2 by 11%, estimates for 2021 remain very beatable.   Bandwidth is ideally positioned to be a sustained beneficiary of the digital transformation, even as the covid tailwind dissipates. 

As mentioned, management estimated that covid had a 6% impact on Q2 revenue, meaning they recorded a 26.4% purely organic growth rate, a number that would have still beat consensus estimates comfortably. Management also guided for less expected contribution from covid in the second half of 2020 and is still expecting 28% growth YoY.

The following year (2021) will present tougher comps, but with the trends driving Bandwidth’s growth firmly in place for the future, I think they can beat these low projections.

Conclusion:

As office buildings remain empty, traditional phone bills will be challenged by cloud-native phone systems. Not only is there a shift away from physical offices placing pressure on telecom hardware but companies are wanting to improve margins by cutting costs. Many trends are temporary or covid-dependent while telecommunications equipment could be permanently eradicated.

Twilio has benefited from the mobile app ecosystem. However, with the mega-trend driven by Zoom, Slack and Microsoft Teams, we may be transitioning towards a boom in unified communications and cloud productivity tools. If this is the case, Bandwidth could become a solid stock as their customer roster is full of large competitors in need of an independent Tier 1 network.