What the hell is going on at Synchronoss?

The appointment of former AT&T exec Glenn Lurie was the third change of CEO at Synchronoss in a year that has seen enough corporate drama to last a lifetime.

When we got the opportunity to interview Lurie recently, it was the first time we had checked in with Synchronoss for a while. Reviewing the Synchronoss press page immediately before and then after the interview revealed some rather intriguing announcements, so we decided to dig a bit deeper. Here’s what we found.

At the start of this year we reported that Synchronoss had moved out of its legacy handset activation business by selling it to a company called Sequential, which soon after appointed former AT&T exec Kent Mathy as its new CEO.

This disposal had been performed hand-in-hand with the acquisition of secure cloud messaging provider IntraLinks in early December 2016. The whole manoeuvre was positioned by Synchronoss founder and CEO Stephen Waldis, a former AT&T exec, as a strategic pivot to become a more general B2B cloud services provider. The incoming IntraLinks CEO, Ron Hovsepian, was appointed as CEO of the combined company, still called Synchronoss, with Waldis moving up to the Chairman role.

But before long there was significant turmoil at the top. Long-standing CFO Karen Rosenberger retired in February 2017 and was replaced by former Avid exec John Frederick. Just two months after Frederick’s appointment, however, it was announced that both he and recently appointed CEO Hovsepian would be leaving, with the latter serving as a consultant ‘to ensure a smooth transition.’ Waldis once more took the reins as CEO.

Within days Synchronoss had rescheduled its Q1 2017 earnings call, filing and release, prompting a letter from the NASDAQ notifying it of non-compliance with its rules. On 8 June Synchronoss announced its financial statements for the whole of the 2015 and 2016 fiscal years could no longer be relied upon and would need to be restated. All of the stuff we have covered so far had sent the Synchronoss share price right down the toilet – with the company losing around 80% of the value it had before the IntraLinks/Sequential move was announced.

It seems this caught the attention of Siris Capital Group, which knew a potential bargain when it saw one, and in June Synchronoss announced it had received an indication of interest from Siris to buy the whole company for $18 per share, which promptly stabilised the share price at that level.

The next few months were spent ‘reviewing strategic alternatives’, which usually means working out whether there is more value to shareholders from selling or from likely future growth. By October Synchronoss announced it had concluded the best strategic option would be to sell IntraLinks to Siris for around $1 billion and receive a further investment from Siris of $185 million in the remaining company. This investment would be convertible into 19.8% of Synchronoss common stock.

By 14 November that process was completed and Lurie was announced as the new CEO of Synchronoss two days later, with the strategic imperative of doubling-down on the white-label cloud business. As part of his inducement package Lurie was granted extensive stock options at an exercise price of $10.04 per share.

All of the above is taken from Synchronoss public statements, but, as you might expect from such a rollercoaster ride, Synchronoss has caught the eye of other market observers. The most significant of these has been an organisation called the Southern Investigative Reporting Foundation, which has the stated aim of ‘providing in-depth financial investigative reporting for the common good.’

SIRFing the web

On 24 February 2017 SIRF published a story entitled Synchronoss Technologies: The Friends and Family Plan. It started by outlining the IntraLinks/Sequential transaction and highlighted the extent to which the Synchronoss share price had already declined by that date. It also noted that Synchronoss had been trying to lure Hovsepian away from IntraLinks since May 2016.

But the most remarkable aspect of the SIRF piece was its finding that Sequential had only been formed in the month before the transaction and that its website was registered by one John Methfessel, who also became its Chairman. SIRF said Methfessel was also a former neighbour of Waldis as well as an early-stage investor in Synchronoss.

Also uncovered was a research note from Stifel Analyst Tom Roderick that stated Sequential Technology International is a unit of Omniglobe International, which is a business process outsourcing company that works with Synchronoss on its AT&T activation work. Omniglobe was also listed as a ‘related party’ in the 2006 Synchronoss IPO prospectus, which included details of an equity interest on the part of Waldis and three other Synchronos execs. Those investments were made through a holding group called Rumson Hitters, other members of which eventually bought out the Synchronoss execs’ stakes in Omniglobe.

SIRF then interviewed Omniglobe President and Chairman Jaswinder Matharu, who revealed that Rumson Hitters owns half of Omniglobe and that its investment is controlled by John Methfessel. Sequential’s press page has no releases other than the 12 January announcement about the Synchronoss transaction and the appointment of Mathy. The only other item is a 27 February interview conducted by Sequential CSO Tom Miller, who was an EVP at Synchronoss before its IPO.

So intrigued was SIRF by all this that it published a follow-up piece a month later entitled ‘Synchronoss Technologies: You Probably Wouldn’t Buy a Car From These Guys’. The piece took a closer look at Synchronoss accounting practices and was published long before the company announced its previous two years’ accounts could no longer be relied upon.

The picture this second SIRF piece paints is of a company constantly looking to maximise the revenues from its cloud business and resorting to some questionable book-keeping to achieve that. Among those include the allegation that the revenue contribution from the acquisition in March 2016 of Openwave Messaging, a messaging software firm, was deliberately downplayed, and the accounting of $9.2 million of the Sequential deal as revenue. The piece also claims the company’s three most senior execs sold an exceptional number of their shares over the past two years.

By far the most dramatic apparent consequence of the SIRF reports is the commencement of a class action civil law suit against Synchronoss ‘for violations of the federal securities laws’, and on behalf of anyone who bought Synchronoss shares during a period that was eventually extended to between 3 February 2016 and 13 June 2017. The suit was initiated on 1 May 2017 but has since been joined and amended several times.

Class acts

—–What follows is our summary of version 38 of the suit, filed on 21 November 2017—–

Allegations

Company background

Synchronoss was set up by former AT&T exec Stephen Waldis to offer mobile device activation services to AT&T. In the light of the expiration of AT&T’s five-year license to exclusively distribute the Apple iPhone, Synchronoss started to reposition itself as a consumer and enterprise cloud services provider in 2013.

The cloud business grew rapidly and by 2015 accounted for a greater proportion of revenues than the activation services. The company publicly acknowledged the attention investors were paying to the cloud business and also prioritised the cloud business in executive compensation.

On 5 December 2016 Synchronoss acquired IntraLinks and at the same time divested the bulk of its activation business to Sequential. There was no mention of the $9.2 million licensing deal in the associated filing.

Alleged fraudulent accounting practices

These were committed in part because the company was struggling to maintain the rapid growth of the cloud services segment and took the form of manipulating accounting rules to make it look like the company had hit financial targets when it had actually missed them.

The Sequential licensing transaction is a likely illustration of this, as the $9.2 million licensing fee should not have been recognised as revenue because it was a component of the transaction to sell the activation business to Sequential. This is likely to be recognised in the financial restatement along with the accounting for a contract with Verizon and certain transactions with AT&T – its two biggest customers – with two anonymous insiders providing testimony to support those assertions.

Other significant details highlighted in the court document

Sequential was a new company that, according to the 24 February SIRF piece, is owned primarily by people affiliated to Synchronoss executives. Sequential was previously known as Omniglobe, which was part owned by Waldis. Synchronoss sold 70% of its activation services business to Sequential for $146 million, although only $18.1 million of that was paid in cash up front.

On the same day Synchronoss announced the acquisition of IntraLinks for $821 million in cash, some of which was paid for by $900 million of new debt. The incoming IntraLinks CEO – Ronald Hovsepian – would take over from Waldis as overall CEO of Synchronoss.

Rosenberger got a ‘release agreement’ payoff in the region of $2 million.

Hovsepian resigned on 27 April and received a lump-sum of $3.2 million as well as a two-year consulting contract worth $1.5 million. Waldis was re-appointed as CEO. A conference call was announced at which all this stuff would be discussed, but it was subsequently cancelled and soon after the company announced the need to restate its financials. This still hasn’t happened. Synchronoss is currently under pressure from NASDAQ to demonstrate compliance with its rules or face delisting.

The SEC repeatedly asked Synchronoss to make public the details of some of its deals with Verizon and the company refused. The allegation is that the timings of these deals would have revealed accounting fraud. A former company insider alleges that Synchronoss booked $7 million in revenue from two AT&T transactions in late 2015 that never materialised, which in turn allowed the company to show cloud growth in a quarter that would have otherwise been flat.

The desired outcome of this civil action is for a jury trial to be granted.

—–This marks the end of our summary of the suit—–

Analyse this

Mentioned in both the first SIRF piece and a prominent questioner on the 8 February 2017 earnings call was Stifel Analyst Tom Roderick. SIRF had been unable to reach him for comment but we were more fortunate and started our phone interview with him by asking what he thought of all the stuff that has been going on with Synchronoss.

“This is, without a doubt, the most head-scratching story I’ve followed in 15 years,” said Roderick. He went on to say that three or four years ago he was recommending Synchronoss stock but then started to be less keen on what he saw. It seems some of the aforementioned accounting irregularities caught his eye and he was especially struck by his inability to find any record of Sequential when the IntraLinks deal was announced.

Here’s the opening paragraph from Roderick’s 4 February 2016 research note in which he downgraded his recommendation for SNCR from ‘buy’ to ‘hold’. His target price for the stock prior to his downgrade had been $60 and he declined to state an updated target price in lieu of greater clarity.

Following Synchronoss’ Wednesday morning earnings call, shares of SNCR dropped nearly 11%, which we perceived all day to be an attractive entry point. However, as we evaluated our model more completely, and after examining the implications of the company’s “Net Income Attributable to Noncontrolling Interest” line, we have become convinced that the quality of the 4Q15 Cloud outperformance wasn’t nearly what we thought it was. We believe the Verizon Joint Venture contributed at least $18mn in one-time Cloud revenue in 4Q, leaving us incrementally concerned about what positive factors need to emerge to drive the company’s Cloud business up by 24% in FY16, as guidance suggests.

On 20 February 2017 Roderick wrote a research note entitled ‘Crossing “The Bridge”: Making Sense of SNCR’s Continuing Operations Figures’. The ‘bridge’ is a reference to reconciling Synchronoss historical financials and its projected estimates. “Let’s start with what many people don’t understand: ‘Cloud’ now includes a sizable chunk of historical ‘Activation’,” opened the analysis. It went on to say that isolated ‘cloud’ growth is more like 9%, far lower than the 30% investors had been used to, and to express scepticism that growth can ‘re-accelerate’. That report put a price target of $32 on Synchronoss shares, but by the time Hovsepian and Frederick had left the building Roderick had cut that to $10.

We asked Roderick what he thought of the civil suit and he described it as “a shocking development,” adding that actions like these often take years to play out and are often settled out of court. If that does turn out to be the case it will surely be another dark day for Synchronoss shareholders.

On the likely future of Synchronoss, Roderick reckoned the most positive set of circumstances would be for Siris to continue to back the company as it did with Xura (now known as Mavenir). On the flip side he thinks it’s imperative that Synchronoss diversify away from CSP white-label cloud, which is becoming commoditised, and its over-reliance on the two big US operators. To be fair that’s pretty much what Lurie told us it wants to do.

Asked for a summary of everything that had occurred, Roderick said: “At the very best it will be a case study in poor communication with Wall Street and at worst it’s a case of classic financial manipulation.”

Roderick has just published an update on the Synchronoss situation, focusing on the civil lawsuit, entitled ‘Another Brick in the Wall’. While he has sadly refrained from further Pink Floyd analogies he focuses on the testimony of the two anonymous insiders we mentioned in our summary of the case, referred to in the document as CW1 (confidential witness) and CW2. Here’s his summary of that.

It goes without saying that interviews in a civil lawsuit cannot be verified as fact, nor do we claim to have direct conversations with either CW1 or CW2. It also goes without saying that such civil suits will often cherry pick the most damning commentary and facts. However, given that we have also been on the record as being critical of what we have perceived to be SNCR’s aggressive accounting and weak financial disclosure policies – dating back to our downgrade of the stock on February 4, 2016 – such allegations from former employees do not strike us as altogether shocking.

Distilling all this information into one paragraph, the impression given is of a senior management intoxicated by the rewards associated with the initial rapid growth of its white-label cloud business and then becoming increasingly desperate when that growth started to decline. Big question marks still hang over the business, such as the civil action and potential NASDAQ delisting, but at the same time it needs to ensure there’s still a viable business left if those go its way. Good luck with that Glenn.