Description

With 8x8’s stock down -90% since covid highs, shareholders have been handed an absolute beating. The once covid darling is now believed to be a mediocre business, and its valuation has been rightfully punished by its mixed recent execution, competitive pressures, bad capital allocation, and management turnover, all while the industry it competes in nurses a massive covid hangover. With essentially no topline growth, decent financial leverage, and a small market cap, there are few investors in the space that will go near the stock.

But its dirt cheap valuation of ~5-6x CY24 FCF which is well below its peer comps of damaged-goods "software" businesses such DOCU, ZM, TWLO, BAND, and RNG. Even Zoom which has the same low single digit revenue growth level trades at 15x P/FCF, three times the multiple of 8x8. 8x8’s management team has showed recent success in improving profitability while reducing SBC, and is targeting to grow operating cash flows by 20% per year for the next several years.

8x8 has a market cap of $417M with the prospect of generating ~$80M of FCF in FY25 (March FYE so FY25 is approximately CY24) putting it at a FCF yield of 19%. The company has net debt of ~$340M so its EV is $758M, implying it trades for ~1.0x EV/Revenue. Between FY25 and FY27, I expect the company to generate $325M of FCF which it can use to pay down its debt (and reduce interest expense). In December of 2025, with net debt down to call it $145M and Fwd FCF up to $127M, applying a 7.5x FCF multiple would get you to a share price of $7.00 vs. $3.50 today (~100% upside over 2 years). While this pitch can mechanically work just based on FCF generation and debt pay down, its worth noting that consensus expectations are de minimis, any improvement to the business fundamentals could work to improve the multiple substantially. An upside scenario where that does happen could result in significantly higher returns.

Business Description

• 8x8 is a cloud communications vendor that enables businesses of all sizes to streamline their digital communications across multiple channels and geographies. The company offers a range of services that cover everything from voice & video conferencing, to enterprise messaging, to contact center applications, to SMS APIs. 
• The company offers communication services in 3 main product areas:
  • Unified-Communications-as-a-Service (UCaaS): Consolidates multiple enterprise communication services into one offering which provides cloud-based voice telephony (replaces on-premise PBX), video conferencing, fax, messaging and chat functionality. This market is generally regarded as quite competitive with pressures from RingCentral, Vonage, Zoom, and Microsoft but there is still a large opportunity to replace the legacy on-premise vendors and the majority of Microsoft Teams customers will bring an independent UCaaS vendor to provide voice support for Teams (8x8 has 400K Teams seats growing >60% Y/Y). 100M domestic seats at $15/user/month puts the US UCaaS TAM at $18B with penetration today around 20-25M seats, so still a large replacement opportunity over the next decade as the cloud delivery model takes share.
  • Contact-Center-as-a-Service (CCaaS): A fully fledged cloud-based application which enables contact center agents to handle customer support traffic across voice, chat, email, SMS, social with advanced functionality for IVRs, intelligent call routing, call transcription, quality management, agent coaching, speech analytics, CRM integrations, reporting and analytics, AI-based virtual agents. 8x8 has typically targeted the lower-end of the contact center space (deals with agent seat counts in the 10-250 range) with limited success with mid-to-large scale deployments (500-10K seats). 8x8 packages it CCaaS offering together with its underlying UCaaS channels powering the CCaaS application and it has re-branded the UC/CC combo as XCaaS (eXperience-Communications-as-a-Service) which is intended to be one platform to simplify the experience.
  • Communications-Platform-as-a-Service (CPaaS): Programmable communication APIs that help software developers to integrate SMS, voice, video, and in-app chat functionality into their applications. This is the market that Twilio pioneered and 8x8 entered through its acquisition of WaveCell in July of 2019. WaveCell was a Singapore-based company with a large presence in APAC markets like Vietnam, Thailand, Indonesia, and the Philippines. The company doesn't currently disclose the CPaaS revenue scale but its generally been declining given weaker usage trends of the market.
• The company does $707M of ARR (2% growth Y/Y) which is split into:
  • 58% Enterprise, 18% Mid-Market, and 24% SMB
  • 41% XCaaS, 59% Standalone UCaaS/CCaaS/CPaaS 
  • 73% US-based, 27% International
  • 60% Channel, 40% Direct Sales
• The company should deliver FY24 revenue of $735M (-1% growth, Y/Y):
  • Gross margins are 72% (up from 59% GM in FY20)
  • R&D is 15% of revs, S&M is 33%, G&A is 11%
  • FY24 Adj. EBIT should be ~$95M with operating margins in the ~13% range (up from 8% in FY23)
  • FCF should be >$60M in FY24 with uFCF closer to Adj. EBIT ($30M of cash interest expense)

2-3 Year Backstory

• August 2021: EGHT was written up on VIC and I'd suggest reading that post for more context on the business history and the turn-around plan in place at the time under then CEO David Sipes.
  • Sipes had been the Chief Operating Officer at RingCentral and joined 8x8 as CEO in December 2020 with a plan to accelerate growth by re-engaging with the channel, simplifying the company's marketing strategy, and re-focusing the company's R&D efforts with an emphasis on the UC/CC conversion.
  • Sipes outlined a plan to deliver 20%+ revenue growth in the medium term while driving operating margins from breakeven to 5-10%.
• December 2021: EGHT announced its intention to acquire Fuze for $250M (half cash / half stock)
  • Fuze is a cloud communications competitor of 8x8 that was founded in 2006 and primarily focused on VoIP as a replacement for hosted PBX solutions. The company targets UCaaS in the enterprise market (75% of ARR came from accounts with more than 275 seats, largest deal >30K seats) and was predominantly taking share from legacy players like Mitel, Cisco, and Avaya, although they did also run into 8x8 and RingCentral. They tried to differentiate themselves by focusing on enterprise-grade features, global permits, international data-centers, dealing with regional data requirements (GDPR), languages, taxes, mobile use cases, etc. Fuze derived ~80% of its revenue from voice, with limited success for its collaboration tools (video, chat, etc.). The company didn't have a CCaaS product and opted to partner with Five9 and InContact.
  • Fuze reached ~$100M of ARR in 2019 and then saw growth stagnate as competition, churn, and downsell became larger issues. The company had mid 50s gross margins and under-invested in marketing which led to lower brand awareness relative to 8x8 and RingCentral, and poured money into new products which customers saw limited value in (Ex-VoIP products never got traction). In the SMB and mid-market, I believe RingCentral was replacing Fuze often. At the end of 2019, Fuze fired its CEO and laid off 25% of staff, and decided to only focus on enterprise. Fuze had raised $484M through May 2018 (doing a down round from a $765M valuation in Mid-2017 to $400M in mid-2018), failed to go public in 2019, and burned most of it's cash by the time they got acquired by 8x8 in late 2021 for $250M. During the pandemic, Fuze's poorly timed layoffs and general internal turmoil (leadership turnover) made them ill equipped to compete against the likes of Zoom (on both video and Zoom Phone) and RingCentral who took massive share with better products, brand recognition, and sales execution. The company failed to reach profitability and burned another $30M of cashflow in 2020, and at the end of 2020 they had ~$90M of net debt which was coming due.
  • 8x8 acquiring Fuze has proven to be a distraction that brought a whole host of challenges. These included technical integration challenges, continued customer churn on the Fuze base, sales attrition from the Fuze team. When they bought Fuze its revenues were declining due to the attrition issues and the fact that they began trying to convert customers onto the 8x8 platform instead which inevitably kicked off some RFP processes where customers would re-evaluate the options and potentially leave to a competitive solution. Additionally, the Fuze acquisition didn't bring 8x8 any new major channels, just better features for the enterprise UCaaS use cases as well as some enterprise UC customers to cross sell EGHT's CCaaS solution to (and that cross-sell opportunity has been poorly executed on). The asset was acquired for ~2.5x recurring revenue (more than double EGHT's current revenue multiple) and had dilutive gross margins and was still burning cash. The asset has continuously been a scapegoat for EGHT's decelerating growth, often blamed (along with CPaaS) when EGHT misses guidances.
• December 2022: David Sipes was fired just two weeks after rumors that RingCentral was considering purchasing 8x8 (stock price was $4.75/share). The CFO Samuel Wilson was made interim CEO and would be made permanent CEO in May 2023.
  • Throughout FY23 organic ARR growth decelerated considerably from mid-teens in 4Q-FY22 to mid-single-digits by 2Q-FY23 with it deteriorating further to just 2% in 4Q-FY23 (March 2023)
  • In addition to the ongoing Fuze churn, 8x8's organic growth deceleration has been a result of CPaaS volume decline with a pull back on marketing campaigns, pressures on the SMB segment with macro weakness and an internal decision to focus more on the enterprise, supply chain issues impacting hardware availability and revenue attach, FX headwinds, a pull-back on demand-gen marketing to drive margins, and overall pricing/competitive pressures (mostly Microsoft Teams). 
  • The success of Microsoft Teams in collaboration has really made it much more competitive for collaboration tools beyond VoIP (similar to what happened to Fuze) and the EGHT offerings outside of voice (video/chat) have really been disrupted by Teams even though EGHT can partner with Teams on the voice side. EGHT has tried to compete less with Teams (unlike RingCentral and Zoom) and partner more
  • The questionable capital allocation combined with execution issues on the organic base and failure to drive growth in-line with the turn around plan that David Sipes outlined at the beginning of his tenure is the reason for Sipes' termination. The board felt that change was necessary.
  • The new CEO Sam Wilson effectively described his strategy as pulling back on GTM and re-focusing on R&D to drive a more product-led growth story by paying close attention to solving problems that customers have.
    • Sam Wilson also successfully re-financed $404M of the company's $500M of 2024 convertible notes and has since repurchased $33M of the remaining 2024 notes and early re-paid $25M of the new term loan
• March 2023: the company unveiled numerous AI enhancements to its product portfolio and also highlighted an important change in strategy to focus more heavily on the CCaaS market with the aim of landing customers in CC and then expanding to UC (vs. in the past where they attempted to land with UC and expand to CC). The move signals an ambition to be less reliant on the competitive UCaaS market and acknowledges the struggle of cross sell when not every UC seat needs a CC seat, whereas every CC seat also need UC.
  • This is a really important change in marketing for the company and effectively acknowledges the unattractiveness of the pure UCaaS market right now as ARPUs compress given lack of differentiation and the Microsoft risk.
  • Some other points stressed by the new CEO:
    • R&D on the CC side has 4x'd in the last 5 years, and S&M has declined each quarter since the Fuze acquisition. CC now accounts for 80% of R&D dollars.
    • XCaaS has increased at a 30s CAGR and now represents >40% of total ARR
    • The company has done 2 layoffs (1 in October 2022 and 1 in January 2023)
    • CEO moved compensation structure to be much more focused on cash comp vs. stock comp (controlling dilution and increasing quality of FCF, although P&L SBC charge will take time to adjust given how it works)
• August 2023:
  • Missed the mid-point of 1Q24 revenue guidance by $4M, but beat operating margin guidance midpoint by 165 bps
  • ARR growth in 1Q24 was 2%
    • Core UC/CC ARR had solid performance and Microsoft Teams seats grew 80% Y/Y.
    • In Q1 CPaaS continues to be weak given carrier price increases which were passed on to customers to maintain positive gross margins and that price increase caused customers to pull back on SMS traffic volumes.
    • Fuze ARR was weaker in Q1 with customer churn increasing and subscription contract rightsizing on renewal.
  • 1Q24 Adj. EBITDA margins were 19% and 1Q24 operating cash flow margin was 14%.
    • S&M spend decreased $12M Y/Y as synergies from Fuze have continued to be realized. Total Adj. Expenses were down $20M Y/Y.
• November 2023:
  • Beat the mid-point of 2Q24 revenue guidance by $2M and beat operating margin guidance midpoint by 180 bps
  • ARR growth in 2Q24 was 2% Y/Y
    • UC/CC businesses performed in line with expectations
    • CPaaS trends have improved, with a new leader brought in at the start of CY23 starting to make an impact
    • Continued pressure on Fuze in terms of contraction and logo churn
    • Pipeline for AI-powered intelligent customer assistant in CC is up triple digits Q/Q
  • MGMT established new financial goals:
    • Get ARR growth back to MSD or HSD with better execution in CC/UC strategy, controlling churn on Fuze, better CPaaS performance in APAC
    • Grow operating cash flow by an average of 20% between FY24-FY26 
      • I have $83M of operating cashflow in FY24 and growing that 20% in FY25 and FY26 gets you to $120M
    • Stated goal of returning $250M of capital to investors by the end of FY26 (March 2026) which equates to 60% of the market cap
  • New CRO / New CMO
    • Lisa Martin (CRO)
      • 15 years of experience in the CC and Comms markets with recent experience servicing as the VP of North American GTM for Twilio Flex (programmable CCaaS solution) and 6 years of experience in sales at Genesys
      • Will optimize sales operations and sales enablement
    • Bruno Bertini (CMO)
      • 15 years of experience in the Contact Center and Customer Experience markets
      • Led demand generation at Freshworks and partnerships/alliances marketing at Genesys
      • Will focus on improving lead generation and brand visibility in the CCaaS market

Why did growth slow down and is there any case for it returning?

• Growth slowdown
  • Between FY10 and FY22 the company 10x'ed in size from $63M of revenue to $638M of revenue which represented a rev growth CAGR of 21%. This was driven by the large replacement opportunity of legacy on-premise PBX solutions (>300 million PBX seats out there) as cloud-based UCaaS took share. Today, Avaya has 70M UC seats, Cisco has 60M, NEC has 60M, so there is still a large opportunity for replacement here which should fuel growth going forward.
  • Between FY22 and FY24 growth has slowed from high-teens to low single digits and to summarize here are the primary drivers of that slowdown:
    • Macro headwinds have created general IT budget tightening and seat based pressures as contracts come up for renewals. If a customer has done a 20% layoff then upon renewal they look for a 20% seat reduction in the UCaaS contract.
    • ARPU pressures driven by competition (MSFT, Zoom, RingCentral, Slack) and a de-valuing of the collaboration (ex-VoIP) components of the UCaaS bundle.
    • CPaaS volume declines driven by carrier price increases and SMS marketing campaign pullbacks given macro environment (similar to the volume trends seen at TWLO).
    • FX headwinds as the dollar has strengthened and pressured the USD conversion of international ARR (27% of total).
    • Continued revenue churn on Fuze which after the acquisition became a meaningful % of ARR.
    • Supply chain pressures limiting the availability of certain hardware required for UCaaS deployments.
    • An internal decision to restructure the company to drive profitability which included a pull-back in demand-gen marketing spend and 2 RIFs amounting to 17% of employees (mostly in S&M).
• CEO on 1Q24 earnings call:
  • "We expect to exit Fiscal 24 with low single-digit growth and then show acceleration in Fiscal 25 and Fiscal 26 with a goal of getting to 8-12% Y/Y revenue growth as soon as possible... growth will come by building innovative products, expanding our channel, and developing our employees... my confidence is built on the accelerated pace of new product introductions, the early customer response to these new products, our recent financial performance and the improvements in the sales process and go-to-market we will achieve under the leadership of our new Chief Revenue Officer, Lisa Martin."
• Case for growth re-accelerating
  • Strategic re-focusing on the SME Contact Center market over UCaaS as the priority for the company
  • New product introductions like Intelligent Customer Assistant which is an AI-powered chat bot solution to help with self-service customer support and offload calls that previously would go to the contact center
  • New GTM leadership with experience in Contact Center
  • Stabilization of CPaaS business (in 2Q24 CPaaS returned to Y/Y growth for the first time in many quarters as SMS volumes picked up)
  • Getting past the FX headwinds and supply chain issues which are sort of 1 time in nature

Quality of FCF

• The company has historically had a high degree of share-based comp which has overstated the FCF generation. This is a topic that's prone to spark a lively "show me the real FCF" debate, so I want to pre-empt that with some thoughts and also highlight the steps being made by the company to reduce dilution.
• MGMT dilution reduction plan
  • "Increasing cash flow from operations while reducing shareholder dilution is our financial North Star" - CEO, 2Q24
  • The company has reduced RSU grants by 50% in FY24 and transitioned all non-executive employee to an all cash compensation plan
  • This has been a headwind to Adj. EBIT margins in FY24 as cash compensation goes up materially, but despite that Adj. operating margins have still increased 800 bps Y/Y
  • This will have a 3-year lagged impact on the income statement SBC expense line item because you still have to waterfall out the grants issued (at higher stock prices) in FY21/FY22/FY23
  • Share dilution is expected to drop from 6% to 4%
• FCF in FY23 was $34 million and SBC was $90M, so backing that out real FCF was -$56M
  • Quarterly SBC has already been reduced from $37M/Qtr in 1Q22 to $15M/Qtr in 2Q24 (part of that is the phasing out of earlier cohorts which were struct at higher prices)
  • I expect FY24 FCF to be $63M and SBC to be $62M so real FCF of $1M
  • In FY25 I expect FCF to be $82M and SBC to continue declining to $40-50M
  • By FY26 I think the changes made to cash/equity comp will have trickled through and FCF will be $116M and SBC will be $30-40M
  • So over the next 2-3 years I expect the SBC as a percent of FCF to drop from 100% today to 30%, dramatically increasing the quality of FCF and hopefully the market FCF multiple.
• SBC-driven cash generation can be used by the company to pay down debt and reduce the high interest expense which would in turn increase FCF in real terms. MGMT's debt reduction plan is to:
  • Use some of the ~$150M gross cash position to pay down the $63M of remaining 2024 convertible notes upon maturity in Feb 2024
  • Then use excess cash flow to pay down the remaining $225M of the term loan to Francisco Partners
  • The term loan is SOFR+6.6% so its costing them 12% of $225 = $27M of interest expense thats a headwind to OCF which can be reduced over time
  • In my FCF projections I have interest expense declining $34M in FY24 to $20M in FY26

Path from Here

• This stock has been a disaster as its failed to find a bottom with growth slowing to 2% Y/Y and no credit given for Adj. EBIT margins getting from breakeven to ~13% in relatively short order. We are onto a new CEO with a new turnaround plan after the last one failed. I think there's some areas to be more optimistic about and the change in strategy to focus on CC while UC becomes more commoditized makes sense and there are some good new hires trying to re-invigorate the GTM. However, I acknowledge the risks to the UC business, the slowdown in CPaaS, and the bad M&A with Fuze, but I think the current FCF yield compensates us enough for these challenges. 
• In my base case, there is a slight improvement in growth and margins, with the company delivering on its plans to grow OCF ~20% per year with cash being returned to shareholders via debt pay-down. At an un-demanding 7.5x FCF this gets you to a $7/share price target for a roughly 2-year double.
• I also think there's an upside case where growth can get back to MSD and CAGR at 6% through FY27 and FCF margins can get into the high-teens in which case we could see the multiple re-rate more in line with peers around 13x FCF in which case the stock could be worth $13-14/share.
• The company also would be good acquisition target for someone like RNG, Cisco, Avaya, Mitel given the financial profile and strategic fit and opportunity to consolidate the UC market and get a better foothold in CC/CPaaS

Range of outcomes on the stock for December 2025 (2-year returns) looking on FY27 numbers (approx. CY26)

• Base Case: 
  • Revenues CAGR at 4% from FY24 to FY27 resulting in $825M
  • FCF margins reach 15% ($127M of FCF)
  • Net debt is reduced from $340M to $145M
  • FCF multiple of 7.5x & EV/Revenue of 1.3x
  • Price Target = $7.00/share (100% upside, 42% IRR)
• Downside Case: 
  • Revenues decline at a 1% CAGR to $720M in FY27
  • FCF margins reach 11% ($80M of FCF)
  • Net debt is reduced from $340M to $210M
  • FCF multiple of 4x & EV/Revenue of 0.7x
  • Price Target = $2.36/share (32% downside, -17% IRR)
• Upside Case: 
  • Revenues CAGR at 6% from FY24 to FY27 resulting in $875M
  • FCF margins reach 17% ($145M of FCF)
  • Net debt is reduced from $340M to $120M
  • P/FCF multiple of 13x & EV/Revenue of 2.3x
  • Price Target = $13.90/share (303% upside, 99% IRR)
• "Dream the Dream" Upside Case: 
  • Revenues CAGR at 10% from FY24 to FY27 resulting in $975M (... this was a 20% compounder for many years before the current slowdown so 10% CAGR in a dream-the-dream scenario isn't too crazy, it's also in line with MGMT's growth goal of 8-12%)
  • FCF margins reach 20% ($195M of FCF)
  • Net debt is reduced from $340M to $70M
  • P/FCF multiple of 18x & EV/Revenue of 3.7x
  • Price Target = $26/share (650% upside, 170% IRR)

Catalyst

Operating cash flow growth, FCF generation, deleverging, possible growth uptick