RingCentral’s growth and margins both improve. Why does Morgan Stanley maintain its Equal-weight rating?
Third-quarter subscription revenue growth returned to 6% and margins reached a record high, but overall ARR growth eased slightly and the customer cohort not using paid AI weakened. Morgan Stanley raised its price target from $41 to $91, while arguing that the higher valuation premium has raised the bar for further earnings estimate upgrades.
Original source：Morgan StanleyFirst published on Unhidea：Original source date：
Key takeaway
Morgan Stanley acknowledges RingCentral’s operational improvement, but with its valuation now above that of core peers, further upside depends more on upgrades to earnings forecasts. The divergence between expansion among AI customers and slowing overall ARR is a key constraint.
How much did subscription growth improve, and how did the fourth-quarter bar change?
RingCentral’s third-quarter subscription revenue rose 6.0% year over year, above 5.6% in the first quarter and 5.8% in the second. Growth accelerated for a third consecutive quarter, ending six consecutive quarters below 6%. However, the improvement each quarter was still only about 0.1–0.2 percentage points, a gradual recovery.
Third-quarter subscription revenue was about 1.05% above the midpoint of company guidance, a larger beat than the approximately 0.50% in the second quarter. The midpoint of fourth-quarter subscription revenue guidance was about 0.55% above market consensus, implying year-over-year growth of 5.4%: initial guidance was more upbeat, but implied growth was below the third-quarter actual rate.
Why has expansion among AI customers not accelerated overall ARR?
Customers using at least one native paid AI product now account for nearly 15% of the company’s total annual recurring revenue (ARR), up from approximately 10% and 13% in the first and second quarters and double the year-earlier level. This measures the size of the AI-adopting customer cohort and includes revenue from other services purchased by those customers; it is not the share of revenue from AI products themselves.
Overall ARR growth nevertheless slowed to 6.4% year over year, down 0.1 percentage points from the second quarter and 1 percentage points from the fourth quarter of 2025. Morgan Stanley estimates that ARR for the customer cohort not using paid AI, which accounts for about 85% of total ARR, shifted from roughly flat year over year in the second quarter to a decline of about 2%. Expansion among AI customers and weakness among the remaining customers occurred at the same time; management has not yet quantified AI’s direct contribution to revenue growth.
Management believes AI currently handles only a small fraction of the billions of calls on the network, and that AIR Pro can also take on more complex, higher-value workflows. The opportunity for further commercialization therefore comes from both adoption by more customers and broader use by existing customers.
Why can cash flow grow faster when revenue is growing modestly?
Third-quarter non-GAAP operating margin reached a record 24.7%, up 1.9 percentage points year over year and 0.9 percentage points above the midpoint of company guidance. GAAP operating margin also rose 3.2 percentage points year over year to 8.0%. Profitability improved under both measures.
Management said the AI business’s gross margin is broadly close to the company average, and that pricing discipline, inference efficiency and shared infrastructure help control expansion costs. The company raised the midpoint of its 2026 non-GAAP operating margin guidance from 23.8% to 24.1%.
Third-quarter free cash flow rose 21% year over year, and the midpoint of full-year guidance was raised to 625 million dollars, implying approximately 23% growth in free cash flow per share. Morgan Stanley believes margin expansion, lower stock-based compensation, and buybacks and dividends together support per-share cash flow growth.
Why does the rating remain Equal-weight after the price target doubled?
Morgan Stanley raised its price target from $41 to $91. The main changes included an increase in the valuation multiple from about 7.5 times to 12 times, and a roll-forward of the valuation basis from approximately 645 million dollars in 2027 free cash flow to approximately 691 million dollars in 2028. Over the same period, free cash flow forecasts for 2026 and 2027 were raised by only about 1% and 3%, respectively, so the price target increase far exceeded the upgrades to operating forecasts.
The share price’s implied 2027 free cash flow multiple has risen from about 8 times previously to 12 times, above the approximately 10 times for core communications software peers. The bank believes room for further multiple expansion has narrowed and future returns depend more on upgrades to performance forecasts; considering slowing overall ARR and AI-related competitive risks, it maintains its Equal-weight rating.
