Whitney Tilson thinks he may have found the next Netflix in magicJack VocalTec Ltd (NASDAQ:CALL). The stock is soaring today (up 20%) after positive earnings, so we wanted to revisit the bullish case.
“What do Amazon.com, Inc. (NASDAQ:AMZN), Costco Wholesale Corporation (NASDAQ:COST), Netflix, Inc. (NASDAQ:NFLX) and Southwest Airlines Co (NYSE:LUV) have in common?” Whitney Tilson wrote in a document reviewed by ValueWalk. “They offer their customers big savings and great service. Imagine investing in one of these stocks when they were small companies…,” he teased.
Whitney Tilson, the head of hedge fund Kase Capital and well known value investor, thinks the discount phone company, which started in the business with direct consumer cable advertising, could be the next big stock.
Whitney Tilson: Proper marketing now in place
When addressing the somewhat unprofessional initial advertising approach, Whitney Tilson notes the company’s success in the face of adversity. “Speaking of proper marketing, it’s hard to describe how incredibly unsophisticated and unprofessional magicJack’s marketing was under its former CEO – basically cheesy late-night infomercials,” he wrote. “The fact that the company was able to overcome this and have 3.3 million active subscribers and 5.6 million registered users of its smart phone app is a testament to magicJack’s value proposition.”
Whitney Tilson isn’t just bullish on magicJack VocalTec Ltd (NASDAQ:CALL) – he indicates this could be one of the all time great investments.
Whitney Tilson: Like buying Netflix at $54.44
Reminding investors of his recommendation to invest in Netflix at $54.44, made at his Value Investing Congress, Whitney Tilson notes ten characteristics to invest in stocks with “multi-bagger upside potential.” But Whitney Tilson’s recommendation comes from a business standpoint as well as a person product recommendation. “I’ve been using the product, both as a second phone line in my home as well as during a vacation in Costa Rica, and I think it’s fantastic,” he wrote. “It’s easy to set up and use, the sound quality is excellent, and I’m saving a ton of money.”
Whitney Tilson: Considering the risks
While Whitney Tilson notes positives, like an astute investor, he also considers risk and recognizes the possibility of negative returns. “I want to underscore, however, that this is a risky investment and should be sized appropriately,” he says. “It’s a small company with a checkered history, competing with giants, and there are some regulatory risks, which I think are minimal but shouldn’t be ignored.”
Then Whitney Tilson notes the position this stock takes in a portfolio. “For me, this stock is a small part of a portfolio of mostly conservative, value-oriented stocks like Berkshire, AIG, Citigroup, Canadian Pacific, Hertz, and Boeing,” he wrote.
Whitney Tilson: Ten “multi-bagger” characteristics
On a business level, Whitney Tilson compares the stock against his ten “multi-bagger” characteristics:
“1) A tainted company with a beaten-down, heavily shorted stock. magicJack VocalTec Ltd (NASDAQ:CALL)’s stock, at $13.75, is barely at half its peak reached in September 2012, trades at a mere 5.6x trailing EPS and 3.3x EV to EBITDA, and 29% of the company’s shares (and 43% of the float) are sold short.
2) Great management. I’ve met three times with the new management team (which has only been in place for a few months without interference from the founder and former CEO), and I’m extremely impressed with them and their track records.
3) Fixable problems. magicJack VocalTec Ltd (NASDAQ:CALL)’s problems – spotty customer service, unsophisticated marketing, unprofessional web site, and the tendency to manipulate the stock – were all attributable to the former CEO, and are rapidly being fixed.
4) An enormous, global market. In the U.S. alone, there are 70 million households with either plain old telephone service or a bundled “triple play” of TV, internet and phone service from their cable company. While the number of people “cutting the cord” and getting rid of their home phone line is growing, magicJack’s 3.3 million subscribers are only a drop in the bucket, so even if the total market shrinks over time, there’s still enormous room for magicJack to grow
5) Big, lumbering competitors that are resistant to change. Verizon Communications Inc. (NYSE:VZ), AT&T Inc. (NYSE:T), the cable companies…you get the idea…
6) A paradigm-shifting technology or way of doing business. MagicJack uses the internet (voice over IP or VOIP) to carry its calls rather than traditional phone lines, which cuts costs dramatically.
7) A position of market leadership in the new arena. There’s some ambiguity here because it depends on how one defines the “new arena”. MagicJack has 3.3 million active subscribers and 5.6 million registered users of its smartphone app, so it’s bigger than Vonage Holdings Corp. (NYSE:VG), which has 2.4 million subscribers. But if one defines the new arena as all internet calling, Skype is exponentially larger – but as I describe below, it’s comparing apples and oranges, as Skype typically doesn’t replace a home phone line.
8) Attractive economic characteristics: high margins, low capital intensity, robust cash flows, a strong balance sheet, and customer acquisition cost far lower than the lifetime value of each incremental new customer. In the first three quarters of 2013, magicJack’s gross and net margins were a mouth-watering 66% and 24%, respectively, cap ex was a mere $84,000, and free cash flow exceeded net income by a healthy margin. In addition, the balance sheet shows no debt and more than $60 million in cash, equal to nearly 25% of the company’s current market cap. Regarding customer acquisition cost, magicJack has said that its CPGA (cost per gross add) is in the $4-5 range, a phenomenally low number. I believe this includes the de minimis cost of renewing customers, however, so to be conservative I assume that the cost to attract each new customer is $10. This is still very low relative to the lifetime value of a new customer, which I estimate is around $80. In summary, I estimate that magicJack is getting an incredible 8:1 return on its investment in new customer acquisition.
9) A moat around the business to ensure that the company’s market leadership and attractive economic characteristics endure. The question I get most often is: “How does magicJack make such fat margins charging such a low price? It’s either unsustainable or it will attract many, larger competitors.” (Boy, does this remind me of the consensus thinking about Netflix over the years, yet Netflix, Inc. (NASDAQ:NFLX) continues to grab the lion’s share of all new streaming subscribers.) The key thing to understand about magicJack is that it’s a CLEC (competitive local exchange carrier), which means that, while magicJack has to pay “termination fees” when its customers make outbound phone calls, other carriers must pay magicJack when their customers call magicJack users. This incoming call volume allows magicJack to negotiate better rates with other carriers and significantly reduce network costs. You can see this in magicJack’s financial statements: in 2009, network costs were 22% of revenues, a number that has fallen steadily to less than 18% in 2013.
10) An extraordinary value