With so many small/medium-sized businesses (SMB) out there, it stands to reason that there are many companies built around serving this market. Investors are likely at least passingly familiar with names like Intuit (Nasdaq:INTU) and Paychex (Nasdaq:PAYX), but perhaps it's time to dig a bit into 8x8 (Nasdaq:EGHT) as well. After all, with phone services being a critical link in almost every business and 8x8's hosted VoIP services offering substantial savings, it would seem to be the right sort of company in the right place today.
Better Revenue to Close The Year, But Where Are the Margins?
8x8 did well on its top-line. Revenue rose 33%, with revenue from business customers improving 44%. Encouragingly, customer counts continue to track higher, as does average revenue per customer (up almost 20%) and services per customer (up 23%). Although churn is still significant as a percentage of total customers, it has been declining.
Where I'm less sanguine about the 8x8 story is on the margins. Overall gross margin did improve almost one point, but service margin declined two points and that's the meaningful business on an ongoing basis. I'm also not exceptionally encouraged by the 6% growth in operating income; yes, emerging businesses need to spend on sales and marketing to grow, but there has to be a balance.
Can 8x8 Convince Customers That They're Underserved?
It may sound a little shallow, but I don't believe anybody that has tried to deal with a large telecom service provider like Verizon (NYSE:VZ), Frontier (Nasdaq:FTR) or Comcast (Nasdaq:CMCSA) will argue that the customer service experience is often lacking.
While individual consumers have been trained to just accept this (or find alternatives like dropping landline service or switching to a provider like Vonage (NYSE:VG)), it's a more serious matter for SMBs. Consequently, many SMBs have found their needs better served by smaller carriers, but they've been disappearing.
What 8x8 offers, though, is a move to VoIP. With this move, customers can cut their upfront costs and their operation and administration costs - all in all, some customers can see savings in excess of 30% on their monthly bills by moving to 8x8. In addition to phone service, 8x8 is also looking to offer cloud hosting, video conferencing and other services - all of which would better-leverage their existing infrastructure and the money they've already spent on customer acquisition/retention.
See: How To Pick The Best Telecom Stocks.
Will the Margins Develop?
The trouble with serving the SMB market is that there are a lot of individual businesses, a lot of competition and a lot of turnover. While 8x8 is a leader in the hosted VoIP space, more and more telecom service providers like Time Warner Telecom (Nasdaq:TWTC) are at least paying lip service to better serving that SMB market.
While 8x8 can host hundreds of customers on a single server, there's a delicate balancing act when it comes to the infrastructure - having too much unused capacity hurts margins and drains liquidity, while running too tight risks service quality. Similarly, the money that 8x8 has to spend on customer acquisition only makes sense if those customers stick around to amortize the cost.
The Bottom Line
If 8x8 can attain critical mass in the SMB space, it is pretty likely that somebody will make a bid for the company. Rough comparables like Savvis, NaviSite and Terremark all eventually got bids. That said, Terremark and Savvis were considerably bigger in revenue terms (5-10x) when they got their bids, so investors banking on the buyout may need to get comfy for a while.
Even though 8x8's core organic growth rate is much larger than service providers like Frontier, CenturyLink (NYSE:CTL) and TW Telecom, the revenue multiple doesn't seem to reflect the difference. On the flip side, the company has a lot left to prove in terms of sustainable margins and returns on capital.
While the lack of quality sell-side or institutional support is a risk factor here, this could be an emerging growth story worth checking out. There seems to be a real potential market here and the relative lack of direct competition suggests a potential first-mover advantage that a good management team should be able to leverage into an interesting story.
See: Cities With The Fastest Internet Speeds.
Use the Investopedia Stock Simulator to trade the stocks mentioned in this stock analysis, risk free!