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15 May 2013 By Robert Cyran

Over the past decade, Nuance Communications has been on a frenetic shopping spree. The $6 billion firm now encompasses businesses ranging from medical transcription to powering Siri on the iPhone. But Nuance, the M&A machine, is sputtering. Margins are falling, the stock hasn’t advanced in five years, and debt is accumulating. Moreover, Carl Icahn recently upped his stake in the company from 9 percent to 11 percent in what could signal an end to acquisitions – even the start of a breakup.

Acquisitive companies in fragmented industries often follow a similar trajectory. At first, growth is easy, with a plethora of rivals to buy. Investors, excited by fast expansion, attach a high multiple to the company’s stock, allowing it to buy rivals cheaply and putting a higher value on the acquired profits. As a company gets bigger, though, it needs more or larger deals to grow. And managing all the acquisitions, never mind integrating them into a cohesive whole, becomes more difficult as size increases.

After laying out roughly $4 billion on purchases, Nuance now appears to have hit this familiar wall. Routinely spending more on acquisitions than the company’s free cash flow means debt has rapidly increased to $2.3 billion. Organic growth has stalled, and the company was in the red last quarter. Nuance blamed trouble integrating recent acquisitions. Falling margins in all its businesses may signal deeper problems. Furthermore, free cash flow is falling.

This could be merely a quarterly hiccup. A recently announced $500 million stock buyback could rev up Nuance’s shares, making them a valuable currency again. Plans to slow its acquisition pace and focus on smaller companies could be the pause that refreshes. And the company thinks organic revenue growth should resume in 2014. But the buyback may simply reduce the amount of dry powder the company has on its balance sheet for deals.

Icahn’s presence should act as a further brake. He is a passive investor now. But his investment history suggests that will change if Nuance’s position worsens. Icahn likes to tell companies to simplify themselves. Nuance has no shortage of well-defined operations such as medical, enterprise, and consumer that could be sold or spun off. One more stumble, and Icahn’s views will become clearer – and probably won’t involve much nuance.


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