A Huge Deal for 8x8

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8x8 (NAS: EGHT) , a communications and cloud computing service provider, says it has completed the acquisition of privately held Contactual, a developer of cloud computing-based call-center solutions. Reacting to the news, shares of 8x8 jumped, ending at $4.70. Let's take a closer look at what shareholders stand to gain from the deal.

According to the deal, 8x8 will acquire Contactual for about 6.7 million unregistered shares of its common stock. This effectively makes the deal worth $29.4 million based on 8x8's Sept. 12 closing price. The deal was originally for 6.7 million shares, but the number was reduced to 6.5 million as 8x8 agreed to pay statutory tax withholding on behalf of five of Contactual's ex-executives.

It made sense to acquire Contactual, since 8x8 has been reselling its contact-center service offering since 2007. The acquisition will allow 8x8 to own the major software technology rooted in its service offerings. The company will now be able to produce lightweight, cheaper versions of the software that would appeal to smaller, cost-conscious customers. 8x8 also hopes to strengthen its footing in the cloud-based communications and IaaS infrastructure-as-a-service space. The move will boost 8x8's capability and services in the hosted software-as-a-service call-center marketplace as well. The acquisition will immediately add to 8x8's net income after taking into account acquisition and amortization expenses.

The company is also looking at larger clients as it rolls out its plans to grow through the acquisition route.  

Intense competition
Competition for 8x8 has always been intense. Not only has it had to go up against numerous similar small companies such as Neutral Tandem (NAS: TNDM) and Vonage Holdings (NYS: VG) , but it also has to contend with the bellwethers of the telecom industry, such as AT&T (NYS: T) and Verizon (NYS: VZ) , which provide the broadband services 8x8 uses to deliver its services. Still, 8x8's revenues have managed to increase over the last five quarters. Gross margins, meanwhile, have more or less remained steadfast at a remarkable 67% for the past seven quarters.

But what's disappointing is that the company's latest quarter shows selling and administration margins at an incredibly high 50% -- compared with Boingo Wireless' 20% and Neutral Tandem's 14.5%. Net-income margins are also disappointing at a low of 10.5%, but they're at least comparable to Boingo's 8% and Neutral's 10.8%.

It looks as though 8x8 has a lot of room for improvement in terms of controlling its costs and, in effect, increasing its profitability. With Contactual under its belt, I'd expect 8x8's margins to show some signs of improvement. But without significant cost-cutting measures, it would be difficult to achieve higher net-income figures.

The Foolish bottom line
Since the announcement of Contactual's acquisition, the stock has rallied by around 11%. I think Contactual will reflect its benefits, but the purchase doesn't make 8x8's dominant competitors disappear. Uncertain economic conditions in the eurozone and United States don't help the matters, either.  

It will be interesting to see what impact this deal will have on the company's margins over the next few quarters. For now, I remain moderately positive with regard to the company's earnings outlook for the short to medium term.

At the time this article was published Fool contributor Keki Fatakia holds no shares in any of the companies mentioned in this article. The Motley Fool owns shares of Neutral Tandem.Motley Fool newsletter serviceshave recommended buying shares of AT&T. Try any of our Foolish newsletter servicesfree for 30 days. We Fools don't all hold the same opinions, but we all believe thatconsidering a diverse range of insightsmakes us better investors. The Motley Fool has adisclosure policy.

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