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Small cap stocks can prove to be great investments, if chosen wisely. We have seen some small companies grow and become giants. While looking at such success stories, one always wishes to have bought the shares when they were cheap. However, for every success story there are probably ten failures. So, we should be extremely careful when investing in small cap growth stocks.

While going through small cap stocks, I came across an interesting company, which I believe will grow substantially over the next five years. I decided to perform a detailed analysis encompassing its products, competition, market, growth potential and financial strength. The company I am going talk about is 8x8, Inc (NASDAQ:EGHT), first of all, I will start with a brief introduction of the company.

What the Company Does and History

8x8 develops and markets cloud-based business communications services encompassing internally developed Voice over Internet Protocol ("VoIP") technologies. These services enable telephony and video applications as well as web-based conferencing and unified communications capabilities. The company also provides managed hosting and cloud-based computing services. As of December 31, 2012, 8x8 had approximately 31,500 business customers. Since 2004, substantially all of the revenue has been generated from the sale, license and provision of VoIP products, services and technology.

The company was established in 1987 as Integrated Information Technology, Inc (IIT). 8x8's early products were programmable semiconductors and related software for the videophone and videoconferencing sectors. So, the focus of the company was on videophone and videoconferencing from the start. In 1996, the company changed its name to 8x8, Inc. The company explained that focus on videoconferencing and MPEG markets was an important factor for changing the name.

According to the management, the new name better aligns with the products and services offered by the company. An 8x8 block of pixels is the basis for many video algorithms and enables the system to support video conferencing. So, the company changed its name to 8x8, Inc from Integrated Information Technology, Inc. In 1998, the company started its IP telephony efforts by introducing Audacity Internet Telephony Processor. Later, IP telephony became the focus of the company.

However, there were still twists and turns in the story and the next two years were no less than a circus. The company shifted its strategy to voice and data services over the IP, and stopped offering consumer videophone services. Furthermore, the company changed its name to "Netergy Networks", combining the words "Network" and "Synergy". The rationale behind the name was that the new strategy focuses on creating synergies out of voice and data services on the IP networks.

Over the next two years, the company tried to expand and made some acquisitions; however, most of these acquisitions failed and the company face substantial losses. In 2001, the company decided to change its name back to 8x8, Inc, and the company introduced VoIP services to high-speed internet customers in the shape of Packet8.

Since 2001, the company had mixed success and raised funds through stock issues. Furthermore, the company has been able to introduce innovative products. As a result, the company has been able to increase its customer base and product portfolio. At the moment, there are about 31,500 business customers availing services of the company. Strong portfolio of customers and products is propelling the company towards success.

Products & Services and Customers

The company has five different product offerings, tailored for different business sizes and needs. 8x8 provides products and service by business size, need or product type. By business size, the company provides services to home offices, small, medium and large businesses as well as government. Business needs can be any need from a number of options. A business may choose to avail services with a view to decrease telephone costs, international calling, and video conferencing or to upgrade business phone system etc. There are five product offerings by the company, namely, Virtual Office, Virtual Office Pro, Virtual Contact Center, Virtual room and Virtual meeting. 8x8 offers all of the vital calling features, including call waiting and caller ID. Each line is also equipped with conference calling and voicemail abilities that allow users to include up to three callers on single call. All of these products focus on cost reduction for businesses along with other features. Detailed information about these products and packages can be found here.

Customers of the company are mainly small and medium businesses. Major chunk of its revenue comes from services directly provided to small and medium businesses. Furthermore, the company also caters to large businesses as well as government. One thing I like about the revenue mix of the company is that none of the customers for 8x8 contribute more than 10% of its total revenue. It shows that the company has a diversified customers mix. As a result, bargaining power of the customers is low, and the company is not dependent on any single customer. While there is substantial diversification for 8x8 in the customers mix, geographic diversification is minimal. At the moment, the company generates almost all of its revenues from the U.S. market, and the revenue from other markets is negligible. However, I believe the current strategy of focusing on the domestic market is solid as there is a lot of room to grow in this market.

Competition and the Market

8x8 operates in an extremely attractive market. The market is growing at an exceptional rate, and it is still at the early stages of its growth, therefore, there is a massive opportunity for the company to grow. While there are a lot of operators offering VoIP services; the biggest competitors for 8X8 are Vonage (NYSE:VG), Voip.com, RingCentral and Nextiva. Most of these businesses are operating as private operators.

Vonage caters to both residential and business customers. The company has a good set of plans according to the needs of residential as well as business customers. Vonage allows you to keep your original number if you are moving from landline and all in-network calls are free. Monthly fees are low for Vonage; however, its plans require an annual contract, a setup fee and a cancellation fee in case of termination.

Voip.com also caters to business and residential customers. Voip.com's plans allow you to choose between monthly payment and one or two year contract. Voip.coms features are mainly basic that can be found with other operators in the market.

RingCentral mainly offers services to businesses. The company offers 30 day risk-free trial package, and telephone and fax services. Like other operators, RingCentral also offers free installation.

And finally, Nextiva is another important player in the business VoIP services market. Nextiva offers most of the basic services offered by other operators in the industry, along with some extension options.

Monthly rates in the market do not fall much apart for good service providers such as 8X8 and Vonage. 8X8 charges one dollar less than Vonage for its monthly subscriptions. However, cancellation fees can be an important factor while comparing these two companies. 8X8 charges almost double ($59.99) than the industry average, which can be a negative for the company.

Competitive Advantage

There is an emphasis on being the low-cost services provider in this market. So, in order to provide low-cost services, the companies have to maintain their costs at a lower level. It will not wise to compete on price in a market where the focus is on low-cost services. Instead, the company should have a differentiation strategy. Only by being the best services provider the company can attract customers. Business will be happy to pay small premium for good services, and this small premium will still keep their overall cost below the traditional landline services.

I believe 8X8's competitive advantage is its strong patent portfolio. The company has almost 70 patents in its portfolio, which make it one of the biggest patent holders in the market. The company has been innovating in the field of VoIP and cloud based services; as a result, 8X8 currently has a unique competitive advantage over its competitors. The company has deep knowledge of the technology, which it is using to its advantage. Furthermore, the Company offers a fully integrated suite of cloud-based services to any device, at any location, across all networks. The company has a versatile cloud services portfolio, which gives it an advantage over the competition.

Conclusion

8x8 has shown exceptional growth over the past three years. Revenue figures have been growing at an impressive pace. The company has been able to grow revenue at an average of over 12% per year during the past three years. Furthermore, net income and cash flows have also improved substantially. At the moment, the market is experiencing solid growth, and strong position of the company should allow it to grow well into the future. Cisco Systems (NASDAQ:CSCO) is aggressively buying into the cloud computing segment. 8x8 can also be an attractive acquisition target. However, even if the company carries on its own; it will be an extremely attractive investment for the next five years. At the moment, the stock is trading at P/E ratio of 6.3.

Source: A Small-Cap Stock To Hold For The Next 5 Years