Can 8 x 8 Be Great?

If you only focus on its share price, 8×8, Inc. (EGHT) is one of the more successful companies of the past years. Shares have gained 40% thus far in 2016 and have climbed over 75% during the past two years, delivering these gains despite having a universally agreed upon overvaluation based on most metrics, poor execution and a complete lack of profitability.

So what’s driving the stock price and can the fundamentals catch up, to not only justify the current valuation, but push shares even higher in 2017?

Before drilling down into its business, income statement and prospects let’s be clear; 8×8 is a pretty volatile and speculative stock. Not only does its valuation metrics remain elusive, but the share price can swing wildly. There’s an 85% gap between the stock’s 52-week highs and lows, which fell just five months apart. And this was done on an average dollar volume of less than $10 million, which is on par with lots of penny stocks from the Pink Sheets. It doesn’t take much to move these shares.

With the stock held right near support at its 50 dma, near the $14.50 level, this could be a decent risk/reward entry point.

eght-chart-11-28-16

Bursting Into the Cloud

8X8 Inc was founded in 1987 as a voice over internet phone (VoIP) company. It still operates in that space competing with market leaders such as Vonage (VG), but over the past few years it has shifted focus to providing cloud-based, enterprise-class software solutions.

Solutions are delivered through the Software as a Service (SaaS) business model. Its segments include Americas and Europe. Its software platform brings together cloud, mobile, collaboration, video and data science technologies. Through a combination of open application program interface (API) and pre-built integrations, its solutions leverage critical customer context from internal data systems and customer relationship management (CRM) systems.

Right now it’s still a very small player in a fragmented field. It currently has just 720 employees, with an expected revenue of $212 million for 2016. This compares to the dominant firms such as CRM, which has over 40,000 employees and over $7 billion in sales for 2016.

8×8’s size creates both challenge and opportunity. On the positive side is with the whole Software as a Service (SaaS) and Communications Components space enjoying double digit growth, there is a sense this rising tide will lift all boats in an industry, as there can be broad trends taking place in a segment that are boosting securities across the board.

This is arguably taking place in the Communications Components space as it currently has a Zacks Industry Rank of 58 out of more than 250 industries, suggesting it is well-positioned from this perspective, especially when compared to other segments out there.

Meanwhile, 8×8 is actually looking pretty good on its own too. The firm has seen solid earnings estimate revision activity over the past month, suggesting analysts are becoming a bit more bullish on the firm’s prospects in both the short and long term.

When the company reported earnings on October 27 it beat analyst estimates on the back of strength from mid-market, enterprise and channel sales and the company raised guidance.

Overall revenue was up 24%; service revenue (the bulk of revenues) grew 23%, to $57.7M. The share of that from mid-market and enterprise customers (itself the bulk of service revenue) grew 36% organically.

Average monthly service revenue per business customer was $409 vs. a year-ago $360; gross monthly revenue churn came in at 0.6% (vs. prior 0.7%). For fiscal 2017, the company boosted revenue guidance to $251M-$254M (up from $249M-$253M, and vs. consensus for $251.5M) and reiterated guidance for non-GAAP net income of $16M-$20M. The stock had mixed reaction, first jumping over 5% before closing some 4% lower; this basic sums up the competing bull and bad case.

As mentioned the cloud service industry is highly fragmented, with smaller firms such as RingCentral (RING), InContact, (SAAS) and Five9 (FFIN) jockeying for position among the giants such as Microsoft (MSFT), Alphabet (GOOGL), CRM and Cisco (CSCO).

Among this heavy competition it is becoming increasingly important to offer scale with a full suite of products and services to potential customers. Investing to achieving such scale while moving towards a profitable path has proved challenging and elusive.

Despite growing revenue quarter after quarter, the company still cannot manage to turn a profit. Much of this is due to the company’s reluctance to leverage their excellent balance sheet and take on more risk. I think the company is just being too conservative and won’t be able to profit on an international level unless they take advantage of economies of scale.

As with most new cloud companies, the case for investing in EGHT revolves around its ability to reach critical mass, supplant the incumbents, grow into the large communications market, become profitable, or any combination of the above. 8×8 is not an upstart hoping to break through. The company has been accumulating losses for over two decades.

The next few quarters will likely be crucial for EGHT ; it either makes some big bold moves to become a greater and profitable company, or is likely to head towards the dustbin.

I’m willing to use call options to take a leveraged, but limited risk bullish position.

I’m targeting the 15 strike calls that expire May 2017 and are trading around $1.50 per contract.

— Steve Smith

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About the Author: Steve Smith