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Thursday, January 14, 2010

j2 Global Communications (JCOM): Is it a Value Trap?

We're still long j2 Global Communications (JCOM), but noted that our stake represented a sizable opportunity cost during 2009. Further, let's say this up front: although we're typically long-term holders of our companies (*we've owned JCOM for almost two years), we are not opposed to reducing a position in favor of opportunities where we see greater upside.

In this regard, a fellow investor recently posited to us that JCOM might be a value trap because of uncertainty around what the company looks like in five to ten years. In addition, partial logic behind such a view might also be that, "well, since the share price has gone nowhere, it must be a dud!"

We acknowledged these concerns in our initial j2 post last July and appreciate the related question of whether it's better to own a business that will, with 100% certainty, be around in a decade doing exactly the same thing it does today (e.g. consumer packaged goods, beverages/food, railroad and/or hazardous waste companies we previously discussed).

In many sectors, such certainty does not exist -- from technology, communications, and Internet, to media/publishing/newspapers and even manufacturing. Things change. Thus, we must always consider risk factors that may turn a seemingly great business today into a defunct business tomorrow. Preferably, we own franchise type businesses with durable competitive advantages.

We remind ourselves that the market price for any stock is often not a reflection of a company's intrinsic value (although efficient market theorists would state otherwise). Notably, underlying fundamentals and results suggest that j2 Global is NOT a value trap: the company's eFax business remains stable while voice/email segments continue to grow. Moreover, j2 delivers steady Q/Q improvements in book value per share through increased retained earnings. In fact, retained earnings were up 32% Y/Y through 9/30/09 -- how many companies delivered this type of performance through a recession? We suspect not many.

Meanwhile, excess cash keeps accumulating on j2's balance sheet and now stands at 25% of the company's market capitalization. Further, unlike many cyclical companies throwing off huge free cash flow through inventory liquidation, j2's free cash flow is largely derived from net income because of the company's high margin business model (j2 has NO inventory, which we like!).

Finally, we met one-on-one with Scott Turicchi, President of j2 Global, last fall. Our meeting reconfirmed the following:
  • Competent, motivated, shareholder friendly management team that knows what they're doing and where they're headed (one significant caveat and risk factor they're aware of: the growth dynamic and adoption curve for voice/email services are different than those for digital fax services)
  • Despite negative secular trends, the fax business (~80% of revenue) can still grow as more businesses keep fax capabilities and look to outsourced IP fax offerings. Some businesses will keep fax service for daily use, others for "insurance" purposes in case necessary to communicate with customers.
  • Voice (~12% of revenue) and email (~3% of revenue) segments are growing and should become a larger piece of the pie over the medium- to long-term.
  • Large, consistent free cash flow generation (>$90 million per year) should continue with growth hinging on the economy and take-up of new products.
  • Priorities for excess cash ($220 million as of 9/30/09) remain (1) M&A and (2) share repurchase (although we suggested why not also pay a dividend). In both areas, management acts as value investors and always seeks a low price.
We'll come back in another post with brief discussion of how j2 might allocate excess cash.

Happy investing,

Jeffrey Walkenhorst
CommonStock$ense

Disclosure: long JCOM.

© 2010 Jeffrey Walkenhorst
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