No matter how the coronavirus pandemic pans out, the world will remain hungry for cloud communication services. And investors may struggle to find stocks at a reasonable price to get exposure to such an attractive industry. With its low valuation ratios relative to its peers, the cloud communications specialist 8x8 (EGHT -0.77%) looks like an exception, though. Yet investors should stay prudent, as the stock could become a value trap.
8x8 seems cheap
Thanks to acquisitions and internal developments, 8x8 has built a comprehensive cloud communications portfolio that includes unified communications, video conferencing, and contact center solutions. In addition, the company proposes APIs (application programming interfaces) for enterprises to integrate communication services such as SMS into their applications.
Given its broad offerings, 8x8 addresses a large market that management estimated at more than $60 billion. But the competition looks scary: It includes many high-growth companies such as the unified communication players Zoom and RingCentral, virtual contact center outfit Five9, and communications API specialist Twilio.
As a result of its expanding businesses, 8x8 more than doubled its revenue from $209.3 million in fiscal 2016 to $446.2 million in fiscal 2020, ending on March 31.
And with its market cap at 3.9 times trailing 12-month revenue, the company seems valued at an attractive discount. The stocks of 8x8's competitors RingCentral, Five9, and Twilio are trading at much higher price-to-sales ratios in the range of 22 to 26. And Zoom remains in its own league with its stellar ratio of 91.
A justified discount
A part of 8x8's significant discount relative to its peers is due to its lower top-line growth, as the company didn't manage to take advantage of the coronavirus-induced surge in cloud communications. During the last quarter, revenue increased 17.9% year over year to $129.1 million, which paled in comparison to Zoom's extraordinary last-quarter revenue growth of 335%. And 8x8 also lagged RingCentral's, Five9's, and Twilio's revenue growth of 30.1%, 33.9%, and 51.8%, respectively.
Looking forward, management anticipates fiscal Q3 revenue growth to decelerate to a range of 11% to 12%. That outlook may need an update because of the potential implications of Pfizer's and BioNTech's coronavirus vaccine candidate, though. But in any case, the forecast low-double-digit revenue growth isn't likely to improve should the threat of the coronavirus wane, which would reduce the need for remote communications.
In addition, 8x8 has yet to improve its profitability. Its various products involve elevated research and development and sales and marketing expenses relative to its modest revenue base to remain competitive.
Granted, the X Series platform released in 2018 to cross-sell the company's different solutions has been gaining traction. As an illustration, 22 out of the 48 new deals with annual recurring revenue above $100,000 during the last quarter involved up-selling or cross-selling opportunities. But cost synergies didn't materialize yet: Despite revenue growth during fiscal Q2, losses of $38.4 million barely changed compared to the prior-year quarter losses of $40.9 million.
During the last earnings call, management expressed confidence in improving profitability thanks to its updated go-to-market strategy that involves a broader set of partners to acquire customers at a lower cost. However, that will require solid execution in the context of intensifying competition. For instance, Twilio recently released a free version of its API video offering, and tech giants Microsoft and Cisco Systems have both been improving their respective communication platforms Microsoft Teams and Webex to keep up with Zoom's innovations.
A potential value trap
Besides its operational challenges, 8x8 must also deal with a less-than-ideal balance sheet that could involve expensive refinancing during economic uncertainties. At the end of the last quarter, total debt exceeded cash, restricted cash, and investments by $124.9 million, while the company has yet to generate positive free cash flow.
Thus, despite 8x8's apparently attractive valuation relative to its peers, investors should keep in mind that management must provide flawless execution against solid competitors for the cloud communications stock to not become a value trap.