The past six months have been a windfall for Bandwidth’s shareholders. The company’s stock price has jumped 265%, hitting $53 per share. This was partly due to its solid quarterly results, and the run-up might have investors contemplating their next move.
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Why Do We Think Bandwidth Will Underperform?
Despite the momentum, we don’t have much confidence in Bandwidth. Here are three reasons you should be careful with BAND, plus one stock we’d rather own.
1. Long-Term Revenue Growth Disappoints
A company’s long-term performance is an indicator of its overall quality. Even a bad business can shine for one or two quarters, but a top-tier one grows for years. Over the last five years, Bandwidth grew its sales at a 13.9% annual rate. Although this growth is acceptable on an absolute basis, it fell short of our standards for the software sector, which enjoys a number of secular tailwinds.
2. Low Gross Margin Reveals Weak Structural Profitability
For software companies like Bandwidth, gross profit tells us how much money remains after paying for the base cost of products and services (typically servers, licenses, and certain personnel). These costs are usually low as a percentage of revenue, explaining why software is more lucrative than other sectors.
Bandwidth’s gross margin is substantially worse than most software businesses, signaling it has relatively high infrastructure costs compared to asset-lite businesses like ServiceNow. As you can see below, it averaged a 37.2% gross margin over the last year. That means Bandwidth paid its providers a lot of money ($62.77 for every $100 in revenue) to run its business.
The market not only cares about gross margin levels but also how they change over time because expansion creates firepower for profitability and free cash generation. Bandwidth has seen gross margins decline by 0.8 percentage points over the last 2 years, which is poor compared to software peers.
3. Operating Margin in Limbo
Many software businesses adjust their profits for stock-based compensation (SBC), but we prioritize GAAP operating margin because SBC is a real expense used to attract and retain engineering and sales talent. This metric shows how much revenue remains after accounting for all core expenses — everything from the cost of goods sold to sales and R&D.
Analyzing the trend in its profitability, Bandwidth’s operating margin might have fluctuated slightly but has generally stayed the same over the last two years. This raises questions about the company’s expense base because its revenue growth should have given it leverage on its fixed costs, resulting in better economies of scale and profitability. Its operating margin for the trailing 12 months was negative 1.8%.
Final Judgment
We see the value of companies addressing major business pain points, but in the case of Bandwidth, we’re out. After the recent rally, the stock trades at 1.9× forward price-to-sales (or $53 per share). This valuation multiple is fair, but we don’t have much confidence in the company. There are more exciting stocks to buy at the moment. We’d suggest looking at a safe-and-steady industrials business benefiting from an upgrade cycle.
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