I realize that I have never posted anything about my holding JCOM. This is a fairly new position for me. I started it about 8 weeks ago at about $49, and have been adding small amounts ever since at slightly lower prices (current price is $47.35). JCOM now makes up about 4.5% of my portfolio, which makes it slightly less than an “average” position, which would divide out to 5.25% as I currently have 19 positions.
If you are familiar with JCOM it’s probably due to its eFax service. I’ve used eFax for at least 15 years, years before they were bought by JCOM. What eFax does is gives me a regular US phone number where I can receive faxes. What is different about this is that the fax comes to me as an email and I can print it out wherever I am. I can also send a fax from my computer, etc.
This sounds incredibly boring, but it’s a cash cow for JCOM, and brings in the cash which has allowed them to make a number of acquisitions in both cloud services and internet media. Everyone has been predicting JCOM’s fax service would die a painful death when email and scanning came out. However, believe it or not, while growing quite slowly, eFax is not only a cash cow, it’s still growing (very slowly, but growing), while the media and cloud services, which make up a smaller part of total revenue, are growing very fast.
This is interesting to contemplate. I really like companies where a small part of the business, with a long runway, is growing rapidly, while the rest is growing slowly. The part growing rapidly naturally becomes a larger and larger part of the business, and thus the business as a whole accelerates, but for the time, the growth is camouflaged by the slow growing part, allowing you to buy it more cheaply.
Below you’ll find my notes on JCOM. It’s mostly my cutting and pasting of articles so when the writer says me or my analysis it’s usually him, not me.
Saul
Feb 2014 – Reitmeister
Why Buy j2 Global? This is a very diversified internet play with growing businesses in cloud services and in media websites mostly focused on technology, like PC Mag.
Their recent 12% earnings beat gave ample proof of their quality growth opportunities. This has led to hefty estimate revisions and analysts pounding the table on the value story.
As for the estimates…looking at the full set of 5 analysts they were mightily impressed with the recent earnings beat. This has compelled them to raise their 2014 EPS estimate from $2.95 to $3.35. Estimates for 2015 also got a big lift from $3.18 to $3.78.
Using other industry resources I looked at the growth of the main web properties. Each is seeing ample traffic on the rise, which means they are doing something right. Especially AskMen.com and PCMag.com. Throw in growing cloud services business, such as email, phone, and online back up and you understand they are in a growing industry with profits markedly on the rise.
As for value, most analysts I see are pointing to $60 as their target. Pretty appealing with shares taking a little dip under $50.
May 2014 – Announced Mar quarter results
Record first quarter revenues (up 18.0%)
Record first quarter EBITDA (up 18.9%)
Record first quarter adjusted earnings of 76 cents (up 13.4% from 67 cents)
Eleventh consecutive quarterly dividend increase to 27 cents. (They are small increases, from 26.25 cents sequentially and from 24 cents last year, but still, they are moving up).
Free cash flow was $38.4 million and reflects a $7.3 million payment for an acquisition-related obligation.
They ended the quarter with approximately $315 million in cash after deploying $52.4 million for acquisitions during the quarter and paying their regular quarterly dividend.
“The first quarter was very strong for j2, with Business Cloud Services revenues growing by 11.1% and Digital Media revenues growing by 45.7%, year-over-year. In addition, our Cloud Backup business has surpassed the $50 million annual revenue run-rate milestone faster than anticipated while making a significantly larger contribution to our EBITDA margins than anticipated.”
Business Outlook
j2 is reaffirming the following previously announced fiscal 2014 financial estimates: Revenues of between $580 and $600 million and Adjusted earnings between $3.23 and $3.47.
It is anticipated that the normalized tax rate for 2014 will be between 27% and 29%.
May 2014 – Seeking Alpha Pro Recommendation
Legacy fax business obscures growth potential of a strategically acquired portfolio of businesses.
Summary
The legacy cash-cow fax business obscures growth potential of J2’s other cloud services and media business.
JCOM has excellent management with a history of value creation and with ownership in the company.
Media acquisitions add value on their own but also contribute to a greater strategy.
The operating leverage in the Digital Media segment will double operating margins.
J2 Global Inc. (JCOM) was founded in 1995. The company began as a cheaper alternative to owning a fax machine. Today, incredibly this is still a cash cow, J2 still processes more than 1 billion faxes a year for lawyers, doctors and others who rely on delivery confirmation and phone records. The company is led by CEO Nehemia Zucker, who has established an impressive track record of value creation.
Last year the market got really upset when the company missed on earnings, and scared because the CEO moved away from acquisitions in the cloud space to acquiring assets in the media space.
The stock dropped from $55 to $45 after that earnings call. I subsequently discussed the company and since that time the stock held up reasonably well, but made a less pronounced dive after the most recent earnings call again, back to just $46 per share even though results were not at all bad:
Revenues were $134.1 million, a first quarter record, and up 18%.
— Business Cloud Services revenues were $108.8 million, up $10.1 million or 11%.
— Digital Media revenues were $33.3 million, up $10.5 million or 46%.
Both results exceeded our internal budgeted targets.
EBITDA increased 19% to a first quarter record of $57.3 million, up from $48.2 million.
Current Business
Right now, the company has three distinctly different sources of revenue.
- the Cloud businesses with the eFax and eVoice tools,
- the Media Business
- IP licensing revenues
Everybody says fax is not sexy, but it makes a ton of cash.
“Our non-fax business of total revenue back in 2011 was only 17%. So over 80% of our business in 2011 was fax. In 2014 fax is going to be a little bit less than 50% and non-fax is going to be bigger than 50%. It is very, very important to state that while our fax business is still growing, our other non-fax businesses are growing even faster.
What is especially interesting about this dynamic of having a legacy cash cow business complemented with a fast growing portfolio of businesses acquired at reasonable prices, is that the growth speed of the new business gets lost. This allows us, as investors, to acquire these fast growers at an attractive price.
IP licensing revenue is highly volatile and is very little compared to the company’s total revenue. For example, in Q4 it was $1.6 million. That’s why it is somewhat underestimated by investors. In reality this revenue falls almost completely to the bottom line. The volatility of this revenue stream, because it often involves litigation, can make the company’s valuation multiples look somewhat elevated at certain points in time.
Promising Media Business
Management has noted that the reason it has recently mostly been buying media companies is a matter of price. Although it is also interested in building out its cloud business, the asking price by sellers was too high.
In the Dec conference call there were a few especially intriguing bits when thinking about future growth:
“In our Media business, we’ve created a leading digital public share in tech, in games and in men’s lifestyle. All this was done during the period of one year, really amazing. We added in 2013 the brands of IGN, the business of AskMen, NetShelter and TechBargains. We continue to expand our geography footprint on the Media business and we expect to launch up to a dozen new version of IGN, PCMagazine and AskMen globally”.
The company wants to launch local versions of its magazines across the globe. The recent stock pullback also has them more optimistic about acquiring companies in the U.S. instead of looking across the globe in search of more attractively priced assets.
Getting incremental revenue will influence the ultimate EBITDA margin that is attainable in the Media segment. Management estimates they are somewhere in the low to mid-20s right now, but argues it’s realistic to attain margins in the 30s. The 4th quarter of 2013 was highly promising in this regard, because management indicates that this high revenue quarter saw almost all the additional revenue fall directly to EBITDA.
Obviously high growth in revenue combined with margin expansion will exponentially inflate the bottom line.
Management with history of value creation
J2 has historically been a serial acquirer. This is not the first time Zucker steered the company in a different direction. Fighting for its life, J2 acquired its main competitor, eFax, in late 2000 and raised prices. When Nasdaq threatened to delist J2, the company did a 4-for-1 reverse split of its shares in February 2001. Zucker also halved the $8 million+ ad budget, equivalent to 62% of revenue. This returned the company to profitability by 2002.
Zucker has bought 40 or so companies since he took over at the helm. He has taken J2 into document management, e-mail hosting, marketing services, conference calls and now media.
Through all these years he built up a track record of creating tremendous value for shareholders. Earnings per share have grown by an average of 24% per year over the past ten years. Returns on equity have been astounding.
A philosophy of careful capital allocation appears to be well ingrained in the entire management team as President Scott Turichi spelled it out in the latest earnings call:
Well our whole thesis is really about the return on invested capital. Whether that capital was invested in activity, that some people deem organic, or whether invest it in M&A activity, that’s the key driver of how we think about our businesses, doesn’t matter whether the intellectual property business, the cloud subscription business or the media business.
The chairman of the board is Richard S. Ressler who owns approximately 5.26% of the company and is the founder of Orchard Capital. Zucker owns 0.4% of outstanding shares with a market value of over $8 million, in May he, along with other insiders, has acquired some more shares. A majority of key insiders are properly incentivized to further the goals of minority stockholders.
Greater Strategy Behind Digital Content
As much as I dislike companies driving growth by acquisition, Zucker has the track record to back him up. His latest foray into digital content has a greater strategy beyond just prudently investing capital into cash generating businesses.
It is vital to understand this in order to judge the company’s prospects correctly. Paramount to this strategy is the acquisition of NetShelter. The company is using its advanced digital ad targeting platform and Ziff Davis B2B, a leading provider of research to enterprise buyers and leads to IT vendors, to expand its ad platform and data providing services to businesses.
Going forward, I expect management will seek to acquire more content platforms in the technology space to expand on the reach of its new ad network. By building a highly targeted network with enough reach, the company will have an attractive offering for large advertisers.
Increasing the number of advertisers will drive interest among publishers to sign up to the ad network. When 3rd party adoption of the advertising network can be accelerated, the segment can quickly grow revenue. Ads on third party websites will leverage the digital ad targeting platform asset and drive revenue with almost no incremental expense. In turn driving the bottom line very hard.
Another strategic benefit of the NetShelter engine is to allow the company to extract incremental value from investments into media companies. When management acquires enough niche websites or signs up 3rd party publishers, the company is effectively establishing a moat around its business.
When its ad network has both scale and is highly targeted, it will become very hard for other networks to match J2’s effectiveness per dollar spent on ads.
Both its historic track record and this ongoing strategic execution strengthen my confidence the company will achieve better returns on equity than the S&P 500 over the next few years.
Valuation
J2 is trading at a P/E of 19 with a forward PE of 13. Before, the fax business was dominating both on revenue and at the bottom line. This is a part of the business that is growing at a much lower pace. This means there now is upwards pressure on the company’s overall growth rate going forward.
This is much easier to see when I break out the numbers by division:
2013 Year-over-year ($x 1000)
Segment/company/division ------ revenue operating margin growth rate operating income growth rate sales
Business Cloud Services $390,104 51% 6.20% 7.90%
Digital Media $130,697 5% 133% 1245%
Fax $260,000 51% N/A 5.50%
J2 Global $521,000 34% 30% 40%
This will have a profound effect on the bottom line contribution coming from Digital Media. Currently Business Cloud Services operating income dwarfs Digital Media’s with $49 million vs $4.6 million. Last year Digital Media was still operating at a net loss.
Although the numbers currently available since the company moved into the Media segment are anything but stable, in conjunction with what we know about the operating leverage of the Digital Media segment and the greater strategy behind these acquisitions, they make sense:
Q1 2014 vs 2013
segment revenue operating margin ------ growth rate operating income growth rate sales
Business Cloud Services $100,830 45% 1% 11%
Digital Media $33,368 14% - 45%
Fax $68,000 45% N/A 4%
J2 Global $134,000 37.00% -8% 18%
The quarterly picture already shows a strong move in the right direction and Q1’s are known to be very weak quarters for Digital Media. Generally expected to represent a fifth of full year revenue without further acquisitions.
All segments have very capital light business models and the CAPEX required to maintain Free Cash Flow is negligible. Most of the company’s CAPEX goes towards acquisitions.
Conclusion
The CEO has a great track record of capital allocation. My analysis of the strategy behind the latest string of acquisitions shows the soundness of his current plans. This indicates Zucker has a good chance to keep batting his historic averages of creating tremendous value for shareholders.
The market is underestimating the company’s room to increase margins at the Media business and continue growing revenue at its historic pace. This creates an opportunity to buy J2 and wait for the market to recognize the company’s true worth when future earnings reports paint a clearer picture.