I have a history of being bullish about cloud-based communications veteran 8x8 (EGHT -2.15%). In fact, I have liked the entire sector for years. A breakthrough in the high-volume mainstream always hovered just beyond the horizon. The benefits of low-cost voice calls, conducted over the open internet with a plethora of built-in extra features, were surely destined to result in incredible business growth.
Well, 8x8 just reported financial results for the third quarter of fiscal year 2024. Let me take this opportunity to review where 8x8 stands today and where the company may go from here.
8x8 by the numbers
First, here are the raw numbers.
Total revenue fell 1.8% year over year, landing at $181 million. Your average Wall Street analyst expected approximately $183.5 million. Oops. Well, times are tough -- a small sales dip might be OK. What else?
On the bottom line, 8x8's adjusted earnings nearly doubled from $0.07 to $0.12 per share. Here, the analyst consensus stopped at $0.10 per share. All right, not too shabby.
The company's management team has a favorite non-traditional metric called cash flow from operations per share. On that note, 8x8's operating cash flow rose from $15.5 million to $22.4 million -- a 45% jump. But the share count increased by 4% over the same period, so that coveted per-share reading of operating cash flows rose by a somewhat milder 39%.
The company seems to do just fine in terms of important profit metrics. But how did 8x8 deliver these solid numbers?
It looks like an effective cost-cutting program. For instance, the third-quarter budget for research and development decreased by $1.8 million, or 5%. Sales and marketing costs fell by $11.8 million, or 15%.
Uh-oh. Those are the costs I would like to see stablize or rise in any tech company worth its salt, even in a challenging market. Today's research is the lifeblood of tomorrow's business growth, and that marketing budget comes in handy for finding new customers. But 8x8 is slashing these expenses, and not by a little.
A cost-cutting conundrum
A quick look at the long-term trends confirms it. 8X8 essentially gave up on its long-term growth ambitions over the last year. R&D expenses have been trending downward since the end of calendar year 2022. The sales and marketing downtrend started in the following quarter:
EGHT Research and Development Expense (Quarterly) data by YCharts
But wait -- the lower expenses lead to higher cash profits. That has to be good, right?
Unfortunately, I'm not terribly excited about the company's plans for that extra cash. 8X8 is boosting its operating cash flow in order to facilitate debt repayments. CEO Sam Wilson certainly spun the debt payments as a positive trend for shareholders.
"We are aggressively delevering on our way to creating a fortress balance sheet," Wilson said in the earnings call. "All things being equal, this should drive increased shareholder value as a greater proportion of our enterprise value accrues to our equity holders."
Fair enough, I suppose. With $274 million of long-term debt and $169.5 million in cash equivalents on the balance sheet, the net debt accounts for roughly 14% of 8x8's enterprise value -- arguably the most complete measurement of any company's total market value. Lifting that weight should bring some relief to the stock price.
Still, I'm not convinced that this is 8x8's best way to create shareholder value. I would have preferred share buybacks or maybe even dividends, or -- even better -- simply leaving the extra cash committed to more and better R&D efforts.
Is 8x8 a good turnaround investment, then? Sadly, I don't think so.
All things considered, the main takeaway from this review was that the stock is down for good reason. 8x8's market cap peaked at $4.1 billion three years ago, and share prices are down more than 90% from the record highs. The mixed third-quarter report didn't really move 8x8's needle, and management's business review would have sounded more appropriate coming from a small bank than a growth-oriented tech expert.
So now I know why 8x8 and its much larger rival, RingCentral (NYSE: RNG), are the only pure-play cloud communications specialists left standing. Telecom infrastructure giant LM Ericsson (NASDAQ: ERIC) bought Vonage for $6.2 billion in the summer of 2022. magicJack VocalTec took the private equity exit in 2018 for a mere $143 million. And after a couple of chained buyouts starting in 2014, Cbeyond has been a subsidiary of financial giant Morgan Stanley (NYSE: MS) since 2022.
At this point, I wouldn't be surprised to see 8x8 seeking a similar exit ramp. Buyout speculation is not my favorite investing strategy, especially if the potential buyout target might have to go through a bankruptcy protection process before finding a new parent company.
The times, they are a-changing. Cloud communications with a voice-call focus don't seem so hot anymore, given the wide availability of cheap or free calling platforms with high-definition video and other bonus features.
8x8 may trade at bargain-bin valuation ratios like 6 times free cash flows and 0.6 times sales today, but those low multiples don't always highlight a deeply discounted value play. In this case, they look like red flags instead. I'm giving up on cloud-based communications in general, and 8x8 in particular, until further notice.
