Nuance Wins Big After Risky Bet on Voice Recognition

Shares of software maker Nuance (NUAN) are on a tear. Investors have driven the price of stock in the Burlington (Mass.)-based company up 68% in the past year, partly on speculation that it might be taken over. Nuance's voice-recognition technology, which translates spoken words into digital information, would be attractive to several companies.

Nuance wouldn't come cheap, and integrating its various divisions might prove too tall an order for would-be acquirers, says Richard Davis, an analyst at Needham & Co. in Boston. "What investors need to understand is that Nuance doesn't have some single kernel of software code that scales up from a device as small as a Blackberry to a huge server," he says. "They're all totally different products that just happen to have some similarities."

A buyer would also have to win over Nuance's largest investor, private equity fund Warburg Pincus, which holds about a 20% stake.

Best known for its Dragon dictation software that runs on personal computers, Nuance has recently made a push into smart phones such as Apple's (AAPL) iPhone with voice-activated search and messaging applications. Nuance also makes voice applications that are used in industries as diverse as health care, call centers, and automotive entertainment.

Health care: in 2009, 44% of sales

Nuance shares surged 7.6% on the Nasdaq Stock Market on Mar. 5 amid talk that Google or Microsoft might make a bid. Representatives of both companies declined to comment on the speculation. On Mar. 19, Nuance shares rose 3¢, to 17.08.

While Google is interested in voice-recognition technology, it may not be keen on Nuance's health-care operations, Davis says. Along with dictation operations, health care accounted for more than $418 million, or about 44% of Nuance's sales in 2009. The division includes Dragon Medical, a desktop product aimed at doctors, and eScription, which lets doctors phone in comments that are converted to text in medical records. Customers include the Mayo Clinic and Tenet Healthcare (THC).

Nuance's latest medical product is a dictation application for doctors that runs on Apple's iPhone. "You could certainly cleave the company in half," Davis says. Potential buyers of the health-care unit might include established health-IT providers that include Cerner (CERN), or larger IT firms such as Hewlett-Packard (HPQ) or IBM (IBM). (Kelli Christman, a spokeswoman for Cerner, declined to comment, as did IBM spokesman Dan Miller and HP spokeswoman Marlene Somsak.)

Nuance also makes consumer-focused voice-recognition applications, including one for searching the Web and one for sending e-mail and text messages. With call center and automotive-products operations, they are part of Nuance's $462 million mobile-enterprise division, which counts FedEx (FDX), Wells-Fargo (WFC), and Ford (F) among its customers. When you call your bank to check your balance and are prompted to say your acount number, chances are you're talking to Nuance. If you drive a late-model Ford with a sync system controlling your music, you're again talking to Nuance.

Then there's the price. At $17 a share, Nuance's market cap is $4.83 billion, making it affordable to a short list of cash-rich would-be suitors such as Apple, Microsoft (MSFT), and HP. In many instances, however, these companies have tended to focus on smaller targets with narrow business lines. (Apple spokesman Steve Dowling declined to comment.) Any acquirer would also have to contend with Nuance's debt, which was $888.6 million as of Dec. 31.

Warburg Pincus: "long-term growth"

Nuance has acquired some 30 companies over the last decade, closing deals as big as $357 million for Dictaphone, a medical dictation company founded by telephone inventor Alexander Graham Bell, and as small as $7.8 million for X-Solutions, a document-scanning firm. Nuance has already closed two deals in 2010: On Feb. 12, it paid $12.2 million for MacSpeech, a maker of dictation software for the Mac that had based its product on Nuance's technology, and on Feb. 17 it paid $13.4 million for Language & Computing, a Belgian software maker.

Nuance's largest shareholder is Warburg Pincus, which held about a 20% stake as of Dec. 31, acquired at a cost of some $422 million over five years. Warburg managing director William H. Janeway has held a seat on Nuance's board of directors since 2004. "We're interested in the long-term growth of the company," Janeway says. "That has been the basis of our investments going back five or six years." Janeway declined to comment on takeover rumors.

Nor is CEO Paul Ricci in any hurry to sell. Ricci set Nuance on a strategy to become a powerhouse in speech technology nearly a decade ago. In 2001, Nuance, then known as ScanSoft, was a money-losing software company devoted to document-scanning and text recognition. Two years earlier it had been spun out of Xerox (XRX).

Nuance finished 2000 with a $53 million loss on sales of $49 million. To turn things around, Ricci settled on speech—a technology that at that time was frustrating to use and terribly inaccurate. Ricci essentially bet the company that speech tech would improve.

His timing was fortuitous. In 2001, the leading speech software vendor—Belgium's Lernout & Hauspie, once a high-flyer with a $10 billion market capitalization—collapsed into bankruptcy following an accounting scandal. With a combination of debt, issued stock, and cash raised from a private placement with the State of Wisconsin's Investment Board, Ricci acquired Lernout and Hauspie's assets out of bankruptcy. Nuance effectively doubled its size overnight. Dozens of acquisitions followed. "When we decided to start investing in this technology, we knew we had to be patient," Ricci says. Shareholders holding out for a takeover may need to show forbearance, too.

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