Description

ELEVATOR PITCH

·        We have been long RNG since 2017, which has been over a 4x return thus far, and have continuously tracked the UCaaS space over that time. We now see a similar opportunity in EGHT as it has become unsustainably cheap

·        EGHT has the potential to double in a base case and triple in a reward case over the next 18 months as the company beats and raises on top and bottom lines

·        EGHT trades a fraction of the multiple of its closest peers (4x NTM revenue vs SaaS companies growing >20% at 8-15x NTM revenue) as the market believes that ZM and RNG will own the market

o   We believe the market is still in the 2nd inning (15m seats penetrated vs 450m global seats) and that EGHT will maintain a solid DD share

·        EGHT has a new CEO (former COO of RingCentral) that we believe will drive significantly improved operating performance

·        ZM acquisition of FIVN for >20x revenue provides a strong indication of the strategic value of EGHT’s Contact Center business (that one can buy for 4-5x revenue through the public equity)

THESIS

EGHT is both a turnaround and an early stage compounder – with a strong and improving product, proven unit economics and a large and growing total addressable market.  UCaaS has a total cost of ownership at a fraction of traditional on-site PBX, offers constant innovation (vs. license updates every 1-2 years), and is open source, providing integration across the majority of enterprise software.  In short, it is a better product that costs less.  UCaaS is a secular share gainer relative to on premise PBX models growing at 25%+ per annum and accelerating through COVID. 

EGHT has historically under-performed the industry growing in the mid-teens due to a lack of focus on the channel, lower brand awareness and limited product differentiation.  In December 2020, David Sipes was named CEO (former COO RingCentral - 8x8s most successful competitor). In May 2021 Sipes laid out a plan to address the legacy management teams shortcomings and primary research suggests that the industry believes that EGHT should be able to accelerate growth to industry levels and improve margins.

We believe that the company will experience accelerating organic revenue growth driving ARR from the high teens to the mid-20s over the next two years and that the company should sustain ~20-25% top line growth for the next decade. 

BUSINESS DESCRIPTION

8x8 (EGHT) is a top 3 provider of unified communication as a service and contact center as a service (“UCaaS/CCaaS”), a cloud based product that offers telephony, web conferencing, fax, messaging and collaboration to SMB, enterprise and call center customers.  EGHT is an open platform with many apps that integrate with CRM, ERP, collaboration tools, cloud suites and other enterprise solutions. EGHT charges a monthly subscription fee of ~$20-80/seat with either a long-term contract (where they offer discounts) or on a month to month basis providing a highly predictable business model with revenue retention ~100%.  

EGHT was a first mover in unified communications with a solid product but was poorly managed commercially for the better part of 2 decades.  8x8 was founded in 1987 as IIT, a chip designer making PC microprocessors and GPUs. By 1990, the company identified a niche in manufacturing semiconductors for phone and videoconferencing products. 7 years later, the company homed in on VoIP chips and added a software offering and went public in 1999.  In 1999 EGHT acquired two companies for their network and server technology and by 2002, 8x8 was the second largest company in enterprise VoIP and continuously expanded its offerings until it had a full UCaaS product suite in 2009.  Since then, 8x8 has made 7 acquisitions across contact center, video, CPaaS and other technology tuck-ins.  None of them were well integrated driving a disparate set of code and a sprawling geographic footprint.  Under its previous 2 CEOs, the DNA of the company was product-centric, but their differentiation wasn’t significant enough to drive customers to their product.  They employed a ‘build it and they will come’ approach vs competitors that focused on strong sales execution with products that were ‘good enough’.

Vik Verma was made CEO in 2013 and while he helped the company make the transition from on premise to the cloud, he was unable to establish the company as the leader in the market and consistently lagged RingCentral in growth. He underinvested in go-to-market and decided to build products vs partnering with best in class point solutions for video, messaging and contact center. 

In December 2020, EGHT hired David Sipes, the then COO of RingCentral who has been credited with helping grow RNG from $10m in revenue to $1.5bn over a decade.  Sipes recently hired two of his lieutenants from RingCentral: Amritesh Chaudhuri as CMO and Walt Weisner as Chief Customer Officer and is in the process of replacing a handful of other senior roles.

EGHT currently generates ~$600m of run-rate service revenue with a market capitalization of ~$3bn. It has compounded revenue at 20% (teens organic) and gross profit at 12% from 2015 to 2020 vs industry growth of 20-30%. Due to this dramatic underperformance, EGHT is one of the cheaper SaaS companies, trading at ~5x current revenue vs middle of the road peers at 9-15x and best in class at 20x+.

Sipes has laid out a multi-faceted strategy to improve the product, reduce churn, and re-engage the channel with a unique value proposition.  Primary research suggests that his message is resonating with both customers and the channel that there is a niche market that EGHT is uniquely positioned to serve. We believe the new strategy has the potential to dramatically accelerate growth and expand margins driving a material re-rating in the company’s multiple over the next 2-3 years which, in a base case, we believe will drive a 2-3x in the stock and, in a reward case, a 5x plus.

VARIANT PERCEPTION

EGHT has a strong runway for growth despite RingCentral and Zoom’s success to date – the market perceives the UCaaS market to be a 2-horse race with RingCentral in the lead and Zoom attempting to make the transition from a video platform to a broader UCaaS solution.   We believe that this is a narrow framing, and there is more than enough room for EGHT to be a strong #3 in the industry, implying HSD to LDD share.  The UCaaS market in North America is ~10-15% penetrated across 100 million seats and the global market is <10% penetrated across the total 400 million seats – it is still early days.  EGHT has a strong product and is the only company to own its tech stack across both UCaaS and CCaaS.  Primary research suggests that many enterprise buyers (ranging from 25-60% of the market) prefer to buy UC/CC together from a single vendor as it reduces costs and increases the ability to use Artificial Intelligence and Machine Learning.  

Sipes identified this “niche” market as EGHT’s core SAM where they have a competitive advantage relative to RingCentral (that partners with NICE/InContact) and Zoom (that doesn’t offer CCaaS).  Sipes is in the process of accelerating investment in the CC product to move it from Gartner Challenger to Gartner Leader.  Over the next year we believe Sipes will address product gaps (scalability, omni-channel features) that will change the perception of the market, positioning EGHT as the only cloud native company that is a Gartner Leader in both UC and CC which will significantly improve customer win-rates.  

EGHT currently generates >30% of its ~$600m ARR from UC/CC customers. UC/CC customers are stickier with 33% less churn and the market grows 30-40% per-annum.  The market recognizes EGHT as one of the leaders in UC/CC combo with 80% of its top ten bookings in bundled deals.  Over the next 2-3 years, we believe that the company will book more bundled deals driving accelerating organic growth and higher LTV.  We believe the market doesn’t appreciate EGHTs unique position (UC/CC Combo) as its multiple is a fraction of best in class peers with RNG at >14x and ZM at 20x+ EV/Revenue while EGHT trades at <5x

RING EV/Revenue (yellow) – 14x vs EGHT EV/Revenue at ~5x

FRAMEWORK: EARLY STAGE COMPOUNDER

Total Addressable Market: the Global TAM is ~$60bn (of which EGHT currently accounts for ~$600m or ~1%) growing 20-30% each year.  As of 2021, the North American market is estimated to be ~10-15% penetrated by cloud-based services while the global market is estimated to be <10% penetrated. Relative to the SAM of ~$15-20bn (UC/CC Combo), EGHT has a ~1% share (as EGHT has ~$150-200m of UC/CC combo revenue today).

Unit Economics: EGHT has been profitable at the unit level since the mid-2000s and ran with positive EBITDA margins from 2010-2017 growing revenue in the mid 20% range.  In 2018, EGHT recognized that RingCentral was investing more aggressively and dramatically increased investments in SG&A and R&D to accelerate top line and improve the product driving EBITDA margins negative.  The investments were unsuccessful as the company focused on hiring internal sales people vs investing in the channel (who owned the mid-market and enterprise customers). This caused growth to slow.  We believe the former CEO misallocated capital both in SG&A and R&D.  From 2018-2020, EGHT has been in the penalty box with the stock roughly flat while most SaaS companies are up 100-500%.  We believe that David will be able to reallocate capital and dramatically improve operations and growth.

Products - 8x8 X Series:

·        Hosted SaaS product with 4 tiers:

o   X1 (phone only) at $12/seat/month

o   X2 (phone, video, message, chat) at $24/seat/month

o   Premium at +$40/seat/month – the company regularly discounts for larger customers

·        Contact Center seats are estimate at $100-150/month

·        Prices have modestly declined over time for enterprise customers

·        EGHT leases or sells 3rd party hardware with a modest mark up (Cisco, Avaya, Polycom, etc).

·        Customers can either bring their own device, lease from a 3rd party or purchase new hardware (~$100-200/line). Taxes and fees are added (~$5-10/month)

Gross Margin Profiles:

·        Service gross margins for UC are ~70-85% and for CC are ~55-65%

·        CPaaS (very small business they acquired) had GMs in the teens for wholesale text (they are shutting this business down which should be margin accretive)

·        Historically, the company ran with negative professional service margins that were a big drag on total GMs, but they believe they can get this to breakeven in the next 1-2 years and 10-15% profit (inline with RingCentral) over a few years

·        Product gross margins were also historically negative as they discounted phones, but in the past 2 years, they started leasing phones which has driven GMs to breakeven and best in class peers make 10-15% GMs on the phones (their goal over time)

Retention:

·        While customer churn is estimated to be LDD, this driven mostly by SMBs. Overall, net revenue retention is just over 100%

·        SMBs historically have a higher churn (~50-60% of revenue) while mid-market and enterprise have net revenue retention of 110-135%

·        UC/CC combo net revenue retention is estimated to be 130% and currently accounts for ~33% of total revenue growing at 30-40% per annum

·        As the company mixes to medium and enterprise customers as well as the UC/CC combo, they will naturally drive higher net revenue retention, which will improve LTV and allow the company to spend more on customer acquisition thus accelerating top line growth

·        EGHT is keenly aware that they need to dramatically improve net revenue retention and hired a Chief Customer Officer from Ring Central that we believe is a game changer

·        Primary research on Walt Weisner has come back extremely strong with contacts suggesting churn will immediately cut by 1/3 to 50%; while we think this is hyperbole, we believe EGHT understands that net revenue retention is a key investment factor and is investing accordingly

Operating Expenses:

·        Sales and marketing accounts for ~40-45% of revenue as EGHT is aggressively investing to capture the rapidly expanding market

·        Channel partners (~40% of bookings) are paid a commission up front of 1-5 months and receive a residual of teens to low 20% (through the sales and marketing line)

·        R&D and G&A are ~15% and ~10% of revenue; the company guides to leverage on these operating expenses, targeting a non-GAAP operating margin of 20%+

·        The faster the company signs up accounts and generates positive working capital, the faster the flywheel turns as they reinvest aggressively in marketing to accelerate growth

Competitive Advantage:

Lowest Cost Operator: EGHT offers an enterprise grade SaaS product for a fraction of the price of traditional PBX service providers. At ~$10-40/month and limited upfront capex, the product replaces services that cost $50-100/month with hundreds to thousands of dollars of capex.  They also eliminate the need for small businesses to have secretaries (by offering virtual assistants with call routing) and for mid-market and large enterprises to have IT professionals. The additional benefits include lower maintenance costs, accelerated innovation, device flexibility (can use your own mobile phones), location independence (for multi-tenant and multi office users) and integration with the majority of cloud based applications (Salesforce, G Suite, Skype, Slack, etc)

Network effect: app and software developers have produced dozens of apps/integrations with other SaaS products which increases the value to the end customer (example is when you get a call from a customer and Salesforce CRM tells you the entire history of the interaction before you pick up the call).

Further, the channel partners are increasingly improving distribution of the EGHT product suite which is driving accelerating adoption

Customer Captivity: once customers learn the EGHT product suite they are less likely to switch as they do not want to invest the time to learn another system driving lower churn

Value Proposition:

Overall: low price with high value.  EGHT allows its customers to rapidly deploy their service on either legacy or new equipment with a richer feature set at a lower price

Small Businesses: the key differentiators are ease of use and low cost.  Unlike Cisco/Avaya/legacy carriers, EGHT can be deployed over night by most SMBs reducing their need for a dedicated IT person and a secretary.  Many SMBs did not have access to enterprise grade UCaaS before the cloud as the service was too expensive.

Mid-Market and Enterprise Businesses: the key differentiators are cost scalability.  Many companies use EGHT when they are setting up a new office and want to get the system up and running and be able to add incremental lines as they scale.  While traditional providers required long lead times, high upfront costs, and long-term contracts, SaaS provides them the flexibility to add and remove services as needed with limited overhead.  Cost savings of 30-50% are common (if not more).

FRAMEWORK: TURNAROUND

New CEO/CMO/CCO

·        In December of 2020, EGHT hired David Sipes as CEO replacing Vik Verma (who had been there since 2013).  Sipes was the COO of RingCentral and is credited with having helped scale that business from $10m in revenue to $1.5bn. 

o   He was the leader of their go-to-market strategy and headed up operations and product.  We believe that he has the perfect skill set to improve 8x8.

·        In H1 2021, Sipes hired:

o   Amritesh Chaudhuri as CMO (former SVP and Global Head of Marketing for RingCentral)

o   Walt Weisner as Chief Customer Officer (former SVP of Global Customer Care for RingCentral)

o   We think these are both excellent hires as they address key deficiencies from the former Management Team

Problems under the previous management team

·        EGHT is perceived to have a solid product (some would argue better than RingCentral) but was mediocre to poor at go-to-market and misallocated resources – a few examples:

o   Didn’t offer e-commerce to SMBs – required human interaction for all transactions which was costly and not scalable

o   Ran significant losses on professional services and hardware sales

o   Under-invested in customer success post sale which limited upsell and higher same customer growth

o   Over-invested in internal sales and under-invested in the channel – company thought they could do it on their own but didn’t have enough leads for their internal sales team and, in turn, had low sales productivity

·        Under-invested in marketing relative to RingCentral and Zoom

·        Made poor acquisitions rather than partner with best in class point solutions- Jitsi in Video (vs. partner with Zoom) and WaveCell in CPaaS

o   Both loss making, margin dilutive with modest growth and didn’t integrate the acquisitions or reduces costs

·        Established R&D centers of excellence & customer service hubs in high-cost countries vs peers in low-cost countries

·        Under-invested in Contact Center and product integrations with 3rd party applications

The Plan

1)    In 2019/2020 EGHT, streamlined the e-commerce experience driving improved customer experience for SMBs – Sipes likely will accelerate investment in SEO marketing which will accelerate SMB sales

2)    In 2019/2020, EGHT moved to leasing hardware which is improving economics but will likely increase pricing on hardware sales in line with RingCentral which will improve margins; EGHT will also start charging for Professional Services in line with RingCentral. As they ramp channel sales, they will push more of the service onto the channel which both parties prefer as it improves unit economics on both sides

3)    Hired Walt Weisner to dramatically improve customer experience and drive improved retention and upsell – he has moved quickly to improve communications, address product gaps and provide a roadmap for innovation

4)    Sipes et al built the channel program at RingCentral that was responsible for its incredible success; since Sipes arrived, he is re-engaging the channel and accelerated onboarding of new large channel partners

1.  EGHT is one of the only companies offering wholesaling, which is a key differentiator relative to RNG/ZM who sell exclusively on their own paper

2.  Primary research suggests this has the potential to be a big advantage for channel partners that prefer to own the customer relationships (in line with the legacy sales motions from on premise)

5)    Hired Amritesh Chaudhuri to re-brand and simplify the company’s marketing; in Q2 2021 they launched a new marketing campaign (XCaaS), which focuses on the unique attributes of the 8x8 product (single tech stack for UC/CC). Primary research suggests this is a differentiated offering relative to all competitors that are point solutions

6)    Sipes is shutting down the wholesale CPaaS business as the product is not strategic and doesn’t meet the ROIC threshold to invest; we expect him to better integrate Jitsi/CCaaS and CPaaS, reducing cost and improving the product over 2-3 years

7)    EGHT is reducing labor in San Jose and London and accelerating hires in Eastern Europe, India and eventually the Philippines

8)    Sipes is growing their CCaSS R&D investment by 4x this year with a roadmap to improve scalability and offer omni-channel and improved APIs

9)   Sipes laid out reasonable base case targets where he expects revenue growth to accelerate and margins to expand materially – if the company hits these numbers we believe the stock will double to triple

KEY INVESTMENT FACTORS

Revenue

1)    Monthly Recurring Revenue – subscription-based revenue which is based on # of subscribers and ARPU

Gross Margins

2)    Sipes believes he can drive a 1,000 bps increase in gross margins through improved execution in professional services/hardware sales, reducing labor in high cost countries and replacing with lower cost, driving scale in their cloud infrastructure and renegotiating with 3rd party vendors

TOP DOWN DRIVERS

·        Mobile/distributed/flexible workforce – more of the workforce is on-the-go, either working on the road or from home post COVID. Further, more businesses are expanding either nationally or internationally. Communications must be easily integrated across devices and offices for seamless communication.

·        Cost conscious – small and medium businesses want to maintain low overhead by outsourcing secretary/IT functions.

·        Wholistic customer service – customers want to be able to transact and communicate with companies by phone, fax, text, email, chat and social media.  UCaaS is the only solution that links all communication platforms seamlessly to drive improved revenue generation and customer retention.

RISKS

Recession – the first order impact of a recession is failing business, especially small and medium size businesses.  Historically, SMB has been EGHT’s core customer which leaves them vulnerable to a slowing the economy.  That said, the shift to mid-size and enterprise customers will reduce the volatility and a recession typically forces companies to look more closely at costs which could drive increased adoption of UCaaS (the lower cost alternative).

Competition – EGHT faces modest competition from traditional PBX providers and carriers but significant competition from pure-play SaaS companies like RingCentral and Zoom who are both excellent operators

PBX providers – Avaya/Cisco have historically had the majority share of on-premise seats.  They are experiencing secular decline in their core business and have been forced to offer both hybrid on premise/cloud and standalone cloud products.  They have strong brands and the trust of their customers. That said, they have conflict of interest in that they are diluting their core profit pool and have inferior products with more limited innovation.

Traditional carriers – Verizon/AT&T/Comcast/CenturyLink/Mitel are all higher cost and do not offer the entire suite of UCaaS products. They offer telephony but lack the features and innovation of UCaaS and are more expensive.

UCaaS pure play – RingCentral/Zoom are both larger/growing faster but the market is underpenetrated and we believe that 8x8 has a solid niche offering in UC/CC combo

PRE-MORTEM

Revenue growth slows materially due to a product issue (website crash/cyberattack), a poorly explained price increase, significant competition from an established player or innovator, or general economic growth slows.

VALUATION/PRICE IMPLIED EXPECTATIONS

We value EGHT based on a discounted cash flow model with an 8% terminal discount rate which implies $40-50/share of base case fair value (assuming 0 to 3% terminal growth). In our reward case the fair value is $86-120 or ~3-4x the current stock price.  Risk case price of $15-20 with strong downside protection as we believe they would be an excellent M&A target for MSFT (with TEAMs), CRM or AMZN.

Base case assumptions include:

·        Revenue growth accelerates from mid-teens this year to mid-20% in 24/25 with 10-year CAGR of ~17% revenue growth

·        Implies a TAM penetration of HSD

·        Non GAAP EBITDA margins expanding from 5% this year to 25%

Reward case assumptions include:

·        Revenue growth accelerates from mid-teens this year to mid-20% in 24/25 with 10 year CAGR of ~21% revenue growth

·        Implies a TAM penetration of LDD

·        Operating margins expanding from 5% to ~32%

Fiscal Q1 Update

Over the past couple weeks, there have been key events worth briefly addressing in relation to 8x8: ZM’s announced acquisition of FIVN and earnings from 8x8 itself as well as RNG.

ZM – FIVN Deal

Overview

·        On 7/19, ZM announced it would be acquiring FIVN $24B in an all stock transaction implying a ~26x NTM sales multiple. The transaction is expected to close in the first half of next year

·        ZM has been leveraging its expansive user base on the video side to cross-sell UCaaS and has become a legitimate player in this space despite inferior technology due their strong brand

·        As discussed above, CCaaS is a very difficult product to do well so ZM has taken a similar approach to RNG has with NICE by partnering with FIVN to offer their CC solution

·        A longtime friendship between ZM and FIVN CEO’s was a significant driver of the corporate relationship

·        Additionally, ZM confirms that the highest growth opportunity in the market is now CCaaS

·        While ZM has had success with SMB’s, larger accounts had issues that were difficult to troubleshoot between the two technologies when they weren’t integrated

·        ZM recognized the end user wants a single vendor and tech stack to manage

·        Since the two products co-exist on the front-end, the hope is that back end integration will not take too long

Significance for 8x8

·        This deal will make ZM a more formidable competitor in the UC/CC cloud transition but we see this as validation for 8x8’s XCaaS product as customers are clearly telling the market they want to deal with a single vendor for their cloud communication needs

·        Importantly, ZM and FIVN will need anywhere from 12-24 months to successfully integrate their technology to be at par with 8x8

·        8x8 has an 18-month head start to communicate to customers how their product today is what ZM is hoping to offer by 2023

·        Furthermore, EGHT is trading at ~4x NTM Revenue which makes it a highly strategic acquisition candidate for larger cloud companies

Earnings

·        8x8 reported Q1 results that beat expectations and raised FY22 guidance as the new CEO Sipes’ strategy begins to take hold and the industry backdrop remains strong

·        ARR growth accelerated for the 3rd straight quarter to +24% y/y

·        Enterprise spend +41%

·        Enterprise logos +35%

·        Estimated Net Dollar Retention improved to ~110%

·        EBIT margin is back to positive and is expected to remain there

·        Gross Margin was a key driver and the CFO reiterated confidence in getting to the high 60% range in the near term through low-hanging fruit and mix shift

·        While Q2 guidance and the raise to FY outlook were above consensus, both are likely still too low. The conservatism is appreciated but it will likely take another beat and raise for the market to realize 8x8 new guidance approach

·        RNG grew ARR by +37% y/y including +60% at the Enterprise level and raised FY revenue growth guidance to >30% while calling out an increase in demand for CCaaS

·        RNG’s exceptional results and the following muted market response highlight two things:

(1) The room that 8x8 has to accelerate growth to catch up to its best in class comp

(2) The market not appreciating the growth & whitespace opportunity due to:

(A) The perception of a COVID pull forward that will lead to a slowdown

(B) The notion that competition is intensifying, ignoring the industry level growth

Catalyst

Please See Above