There is Reason to Look into 8x8

By Tom Gibbs - July 10, 2012 | Tickers: EGHT, AMZN, T, CSCO, RAX, CRM | 0 Comments

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If we can primarily attribute the invention of the Internet to Al Gore’s genius, then we must also thank him for some of the fastest growing niches – including voice over IP (VoIP) communications and cloud computing – within the technology sector today.  Such technologies, using the Internet as their backbone, have not only enjoyed dramatic surges in popularity due to the new features/benefits they offer, but also because they give way to meaningful cost savings when compared to the older generation technologies they have begun to overtake. 

Due to the amount of emphasis investors have placed on such fast growing niches, it is usually rare to find a relatively small and underappreciated enterprise making a big splash within both VoIP and cloud-based computing solutions.  8x8 (NASDAQ: EGHT), a company with an enterprise value of only $278 million and a five-year projected PEG of 0.86, might be one of the least expensive and fastest growing players in both sectors. 

Company Background

Due to the corporation’s huge business transformation in the mid-2000s, 8x8 bestows start up-like growth and excitement but with a much healthier balance sheet and level of profitability.  The corporation, under the name of Integrated Information Technology, originally developed and sold semiconductors used in embedded videoconferencing and videophone products for large telecom players including AT&T throughout much of the 1990s.  In 2002, 8x8 shifted away from its large telecom supplying business and began selling its VoIP service direct to consumers, and three years later the corporation transformed its entire business plan to focus on cloud communications market for small and medium sized enterprises.   

Today’s 8x8

Investors looking into 8x8’s recent success should begin with the complete business plan shift in 2005.  The corporation has enjoyed average annual top line growth of around 18% over the past six years – and an even higher 22% year-over-year increase in the most recent fiscal year – through the offering of several key business solutions:

• 8x8 Virtual Office Business Telephone Service: Allows users with high-speed Internet connection anywhere in the world to be a part of a virtual exchange that includes several key services like conference bridges, call waiting, caller ID, voice mail with e-mail alerts, music on hold, 3-way calling, and more.  Most importantly, the service is received through a small or medium sized business’ existing Internet connection, eliminating the need for additional (and costly) phone lines.

• 8x8 Virtual Contact Center: An attachment to the basic telephone service, which allows smaller corporations “enterprise-class” contact center functionality.  The service offers skills-based routing (sending calls to the most suitable agent instead of simply choosing the next available agent), multi-media management, real time call monitoring and reporting, voice recording and logging, CRM integration with salesforce.com (NYSE: CRM) contact tools.  Salesforce.com, which has grown its top line by nearly 75% over the past two years, is its own beast that has integrated cloud-computing technology with all-too-important customer relationship management solutions.  With 8x8’s Virtual Contact Center add-on, the slew of existing salesforce.com customers can follow up with and manage contacts much more easily, without having to invest in any new and expensive hardware. 

• 8x8 Virtual Office Pro: This unified communications service allows 8x8 subscribers to manage all of their contact functions through a web-based portal accessible through their PCs, laptops, tablets, or smartphones.  In a world where small and medium sized business’ sales forces are constantly on the move, there is really no excuse for not having such functionality built into mobile-based communications products.

• 8x8 Cloud-Based Computing Solutions: Having entered this bustling niche in mid-2010, 8x8 may be competing with larger players including Amazon.com (NASDAQ: AMZN) and Rackspace (NYSE: RAX), but company management has mentioned it would not be surprised if such revenues eventually reached 50% of its total top line due to the huge success 8x8 has enjoyed in the division. 

Recent Performance

A large portion of 8x8’s post 2005 success can be attributed to its ability to successfully cross-sell its products to existing and prospective clients.  As hinted at in the service offering breakdown above, all of 8x8’s services are housed under a single cloud-based umbrella and allow for the easy add-on of additional functionality to the corporation’s base VoIP communications solution.  The corporation has not only grown its subscriber base at an astounding pace, but is now receiving more monthly service revenues per customer than ever before:

Alongside the increase in total customer count (79% CAGR over past three years) and the adding-on of additional services by existing customers, 8x8’s service offerings have become cheaper to provide.  Service gross margins have surged from 53% to 77% between the corporation’s business plan shift in 2006 and the most recent fiscal year.  Likewise, due to the increased penetration of service-based revenues (now represent 91% of total, up from 82% in 2006), total gross margins have enjoyed a disproportionate increase from 28% to 68% over the same time period. 

There are several exciting platforms from which 8x8 can continue to reward shareholders with such robust growth in the future.  First is the continued adoption of VoIP technology.  Due to the benefits of the alternative (cost savings, improved quality and reliability, new call monitoring and reporting features) hosted IP telephony is expected to experience huge demand throughout the 2010s:

Source: Frost & Sullivan

Likewise, although the corporation originally developed its platform to service small and medium-sized corporations, it does have a huge opportunity to penetrate the large enterprise side of the business in the future.  Now servicing several large enterprises including Intel, Allstate, American Express, General Electric, Sony, and New York Life, the relatively small 8x8 is starting to compete alongside the industry’s heavy hitters in Cisco (NASDAQ: CSCO), Shoretel, and Avaya.  Likewise, as governments and municipalities continue to push into cloud-based solutions for cost savings, 8x8 has a meaningful opportunity to tack on huge contracts with recurring revenue service streams.  Current federal contracts include the Federal Maritime Commission, U.S. China Commission, Administrative Conference of the U.S., Defense Nuclear Facilities Safety Board, and the Inter-American Foundation.  Despite the strides made in growing its large enterprise and government customer base, 8x8 is still just scratching the surface with more upscale clients.   

Investment Worthy?

It is not everyday that investors can find a player in a rapidly growing market niche that is consistently gathering market share and growing faster than the sector itself.  Coming off of a 22% year-over-year revenue increase in the most recent fiscal year, average analyst estimates for the year ending March 2013 calls for another low-20%s increase in top line to $105.6 million.   With a large control on the small and medium sized business market, a growing penetration of the large enterprise and government client market, and the general growth trends of the hosted IP telephony market, it is difficult to foresee a slowdown in 8x8’s business anytime soon. 

An investment in 8x8, as mentioned, offers the exciting top line growth of a start up due to the corporation’s recent business plan transformation.  The corporation, however, is not necessarily plagued with start up-like profitability or balance sheet (zero debt, $23 million in cash/equivalents).   With a 50+% potential upside based on median analyst price targets and a very real probability that 8x8 will be bought out by a larger competitor for an even higher multiple over the mid-term, there is no reason to not take a closer look into the corporation’s exciting growth story. 

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