greenbutterfly
8×8 Inc. (NASDAQ:EGHT) is a $516m market cap cloud communication software provider for organizations. The company offers a platform of unified and integrated communication tools, such as business phone system, unified messaging and audio/video/web conferencing (70-80% of revenues). Other major offering is software for call center customers, with services such as interactive voice response system, automated call routing and automated dialers, among others (20-30% of sales). EGHT also integrates communication tools into other platforms, such as Salesforce.
Recently, reports appeared that the company might become an acquisition target of RingCentral (NYSE:RNG). Potential acquirer a $3.5bn market cap cloud communications software provider and one of EGHT’s main competitors in the space. A potential transaction would help RNG expand its rather stagnant market share in the increasingly commoditized unified communications software space (currently estimated at 21%). Most importantly, a potential merger would allow RNG to acquire EGHT’s contact center software business. EGHT management has noted that contact center software segment is the company’s “crown jewel” and its integration with unified communication offerings is a strong competitive advantage. Preference for bundled solutions has become more pronounced in recent years given significantly lower total cost for large organizations versus acquiring software from multiple vendors. This year’s macroeconomic headwinds have only exacerbated this trend. As noted by EGHT during the Q2’FY23 earnings call:
Our unified XCaaS platform remains a competitive advantage for us, and this advantage is only amplified in a more cautious spending environment. Recent research from Metrigy showed that organizations deploying a unified solution to achieve a 56% lower total cost of ownership versus a multi-vendor strategy.
Not surprisingly, EGHT’s bundled offerings (35% of ARR) have continued rapid sales growth – 40% YoY in Q2’FY23 versus 25% growth for entire company. An important aspect is that combined unified communications-contact center software offerings have higher margins, lower churn and higher stickiness. Notably, EGHT is the only industry player offering both unified communications and contact center software that is certified and integrated within MS Teams. Meanwhile, RNG currently does not have its own contact center solution and instead partners with another vendor NICE.
On a broader level, contact center cloud-based software industry seems have a lot of growth runway. EGHT’s contact center software-focused peer Five9 (NASDAQ:FIVN) has noted that the industry – which has $24bn in TAM – is only 20% penetrated by cloud solutions. The rest is still captured by legacy on-premise business phone system providers, such as Avaya, Genesys and Cisco. Interestingly, one of the largest on-premise providers Avaya is rumored to shortly file for Chapter 11. Moreover, in Oct’22 Genesys discontinued its second attempt at a cloud-based contact center software solution this year. These points suggest RNG might potentially be incentivized to capture customers flocking from legacy providers. Notably, contact center space competitors NICE and FIVN have already seen migration of large customers from Avaya.
Acquisition attempt would come after massive YTD price decline across communication software stocks driven by macro headwinds. EGHT has declined 74% YTD, meanwhile, RNG and Zoom (NASDAQ:ZM) have fallen 81% and 63%. EGHT’s management has cut FY2023 (ending March) revenue growth guidance from 21-24% expected in May’22 to 17-18%. Moreover, the company recently initiated layoffs of up to 10% of its workforce. EGHT currently trades at 1.3x TTM revenues (64% TTM gross margins) – below 3x-7x multiples fetched during FY2022-FY2019. For reference, RNG (68% GM) trades at 2.5x whereas ZM (76%) fetches 4.7x. However, both competitors have grown significantly faster since 2016 than EGHT (17-29%) – ZM at 55-300+% and RNG at 28-35%, justifying higher multiples. Having said that, EGHT’s competitive advantage in combined offerings might potentially warrant a higher than current 1.3x TTM revenue valuation. For reference, Vonage – unified communications and contact center software provider – was this year acquired by Ericsson at 4.4x 2021 revenues. EGHT’s management seems to agree that the company is cheap – as part of a recent refinancing agreement, EGHT repurchased $60m worth of the company’s stock at $5.61/share (21% above current levels).
It is worth noting that EGHT has recently initiated management shuffles. Shortly after recent rumors, EGHT’s CEO David Sipes (in the position since 2020) left the company. Sipes was previously the COO of RNG for 12 years, successfully driving the company from $10m to $1bn+ in sales. I am not entirely sure what is the meaning of this recent move, however, the timing seems rather interesting in light of recent acquisition rumors.
8×8
EGHT’s growth in recent years has been driven by new clients migrating from legacy on-premise business phone system offerings. The digitalization trend has been exacerbated with the onset of COVID, with businesses migrating to cloud-based telephony and other enterprise communication tools given their cheapness versus on-premise offerings. Moreover, the company has pursued several acquisitions, such as unified communications business Fuze ($250m, completed in Jan’22) and Wavecell ($125m, Jul’19). In late 2020, EGHT commenced a strategic turnaround, appointing the new CEO David Sipes. Sipes subsequently hired several other executives from RingCentral. The new management has managed to implement several initiatives, such as a partnership with technology distributor Westcon (to offer 8×8’s software to enterprise customers) as well as product innovation, resulting in EGHT’s contact center software being certified by MS Teams.
The business, however, has been quite severely impacted by macroeconomic headwinds this year, with revenue guidance cut for FY2023. It is worth noting here that FY2023 figures include revenues from acquisition of Fuze ($28m in Q2’FY23). Having said that, since Q1’FY23, EGHT’s management has reiterated that the company’s focus has been on profitability as opposed to growth, expected to be driving by cost savings measures, such as lower sales and marketing spend. The company targets a 5.5% operating margin for FY2023 compared to 2-4% guided previously and 10% in fiscal 2024.
The impact of further macroeconomic headwinds might be somewhat limited given EGHT’s customer structure. 58% of EGHT’s customers have been enterprises as of Q2’FY23 – this compares to 18% for mid-market companies and 24% for small businesses. Importantly, EGHT customer segment has been showing impressive growth 42-54% through the first two quarters of FY2023 – compared to more moderate expansion in mid-market segment (22-23%) and a decline in small market segment (negative 7% to negative 2%). As noted by the company, enterprise customers have generally displayed higher retention rates, better efficiency and longer term commitments.
Importantly, the company has put significant focus on its contact center software business which is expected to be the main growth driver going forward. Despite the segment still being relatively small compared to unified communications software, EGHT spends 75-80% of its R&D on the segment. The company has noted that a significant part of MS Teams customers require contact center software, showing the importance of this segment in the company’s offerings.
RingCentral
Similarly to EGHT, the business has expanded at a steady 28-35% pace since 2016, driven by COVID, customer shift from legacy providers as well as strategic partnerships with legacy unified communications software providers, global service providers (such as AT&T) and channel partners (such as CDW). Among notable partnerships is $850m (cash + stock) deal with on-premise unified communications software provider Mitel (announced in Nov’21). Moreover, since 2019 RNG has had a partnership with Avaya whereby RNG agreed to sell Avaya-branded unified communications software.
RNG’s management has noted the importance of the contact center offering amid broader industry tailwinds, including large yet underpenetrated TAM as well as increasing consumer preference for bundled offerings. From RNG’s CEO during the recent investor conference:
It’s a strong market, smaller in UCaaS, but it’s earlier in digital transformation. That means that growth in CCaaS is probably going to be above that in UCaaS. Analyst community, I think it’s to see that the same way.
Interestingly, RNG’s CEO has kind of hinted the company might consider potential acquisitions:
Ryan Patrick MacWilliams Barclays Bank PLC, Research Division – Research Analyst
Excellent. Vlad, you had a lot of great partnerships and you have made some acquisitions in the past. Going forward, do you think RingCentral could be a potential industry consolidator in the UCaaS market.
Vladimir G. Shmunis RingCentral, Inc. – Founder, Chairman & CEO
Just by the cycle alone. So another way to ask it is, look, there is a number of players in the industry now. It’s a very large industry but we had a much larger list of players before as they had some consolidations and some people just fell off, frankly. Will there be more players or less players 5 years from now, I would say there is less players. It will not be a one player. It will not be just Microsoft or just Zoom. It should be at least 3 players with us being at least a third player. Why? Because message video phone and [DT], we have the best phone. Zoom, good video and Microsoft, best messaging with that. Okay. So never say never. It did make sense.
Risks
- Both EGHT and RNG have somewhat significant debt burdens, with D/E ratio of 0.7x for EGHT and 0.4x for RNG. While this suggests that an all-cash deal might be unlikely, a significant stock component in merger consideration might very well be a possibility, particularly considering a similar YTD decline in the share price of both companies. Notably, in Aug’22 EGHT announced refinancing of its convertible senior notes due 2024 ($404m) with newly issued convertible notes due 2028 ($202m) and cash ($182m).
- Another risk here is EGHT management’s potential unwillingness to sell the business. The company’s leadership and insiders have a minimal 1.3% ownership stake, moreover, EGHT’s executives have received sizable salaries in recent years.
Conclusion
Given seemingly high strategic rationale, a potential acquisition might be highly strategic for RNG. I expect EGHT to warrant a premium to current prices in a company sale scenario, suggesting investors might potentially be looking at an interesting setup here.
Be the first to comment