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Friday, February 19, 2010

j2 Global Remains Money Making (Cash) Machine; Outlook for Growth Improves

As we've pointed out previously, j2 Global Communications (JCOM, $21.13) has been a large opportunity cost for us over the past year. Last spring, we considered using our position as a source of funds to acquire more shares of then extremely depressed REITs. Unfortunately, we didn't make the move and now these same REITs are 3-4x where they were while JCOM is virtually flat. Truthfully (full disclosure), we still may use a portion of our position as a source of funds to purchase out of favor names where we see potential for more long-term upside.

That said, like last year, we have a hard time parting with any of our shares because there simply aren't many (any?) companies that have the margin/return (ROE/ROIC) profile of j2. Please let us know if you're aware of similar companies. The company's incredibly high margins (gross > 80%, operating > 40%) and stable, consistent revenue base enable gigantic excess cash generation. Plus, we trust management and expect them to responsibly deploy excess cash to maintain high returns on capital.

Nonetheless, as indicated by a trailing twelve month P/E of 11x and a TTM FCF multiple of 9x (7x on EV basis excluding interest income), we think j2 Global gets little respect by the Market because of growth concerns. While the company still grew last year -- through the recession -- growth of 2% Y/Y (and 9% in 2008) are well below historic levels as the digital fax market matures and some businesses simply scan/email documents instead of using fax. To us, using scan/email versus fax for sensitive personal data still gives us the heebie jeebies. As a result, we still use plain old fax service (and have a free eFax account for inbound faxes).

The Market doesn't know if the the slower growth is cyclical or secular (e.g. is fax going away) and, therefore, seemingly views JCOM as a value trap. We think the company's digital fax business is somewhat impacted by both factors, yet still see a long life for digital fax services (enterprise and international are growing) that will generate mountains of cash for j2. Meanwhile, j2 will continue to expand into other digital communications markets such as voice and email, where the company is making strides.

Thus, we continue to believe j2 Global is not akin to Earthlink (ELNK), which is trading at an EV/EBITDA of 2x as dial-up revenue erodes but cash keeps building on the company's balance sheet. We could also look at Deluxe Corp. (DLX) which is managing a decline in its cash cow check printing business (fewer and fewer checks used these days) by diversifying into business services and digital solutions. Total revenue is expected to decline another 2% in 2010 before stabilizing in 2011. Deluxe's stock actually tripled over the past year but still trades at only a TTM P/E of 10x and offers current buyers a secure 5.5% dividend yield. j2 Global's margin and growth profile are also different from that of Deluxe, but risk exists that JCOM continues to trade at a low multiple and/or even sees further multiple compression if growth does not accelerate.

For the importance of growth and corresponding Market perception, look no further than the performance of Priceline (PCLN), VistaPrint (VPRT), and Google (GOOG) over the past year. Of course, there are plenty of low growth companies that garner high multiples -- see PF Chang's China Bistro Inc. (PFCB) trading at 18x forward earnings (27 TTM) and Iron Mountain Inc. (IRM) trading at 22x forward earnings (30x TTM). The latter company is a favorite of Warren Buffett/Berkshire Hathaway (BRK-A, BRK-B) and certain other value investors such as Davis Selected Advisers. Berkshire Hathaway apparently bought more IRM shares during the December quarter (please see this media report). Iron Mountain provides a necessary service that will always be around (arguably supporting a higher than average valuation), yet is a somewhat capital intensive business (~11% of revenue) with low historic returns on equity/capital (sub 10%).

The good news is that j2 Global reported 4Q09 results yesterday afternoon and guided to 2010 revenue growth of +3-7% Y/Y with a target of 5% Y/Y. The bottom-line is expected to remain similar to 2009 results as the company steps up marketing efforts to drive growth and build voice/email brands. Management believes the economy turned the corner and expects higher marketing expense to bear fruit going forward relative to uncertainty that plagued 2009 and brought j2 to reign in spending. Summary 2009 results from j2's 4Q earnings presentation:

After record free cash generation of $101.6 million in 2009, the company's cash balance stands at $244 million or 26% of j2's market capitalization. We thought we might hear news of a new share buyback program or even a first time dividend (please see prior post here), yet management indicated that potential M&A transactions remain priority number one with numerous deals in the pipeline. Recent deals and pipeline commentary:

Accordingly, for now, the company has no board authorization for other uses of excess capital. We look for more news on this front later this year. If high return uses for cash fail to materialize in the near-term, we expect to see at least a buyback authorization. A dividend would also be nice, although a repurchase is arguably more sensible if the company can buy in shares at current levels (i.e. FCF yield of 10% or more). Again, with no debt and annual free cash generation of approximately $100 million, j2 Global will have bulging pockets of cash.

Below, we include a slide showing historical development from j2's presentation (click to enlarge):

How many companies have this profile?

Happy investing,

Jeffrey Walkenhorst
CommonStock$ense

Disclosure: long JCOM, BRK-B.

© 2010 Jeffrey Walkenhorst
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5 comments:

  1. Personally, I thought the companies comment about the lack of buyback last quarter (something about liking it at $18) because they didn't have an authorization was cheesy at best - I mean, how difficult is it to call board members and get permission? At the least, having an authorization in hand would be logical.

    Maybe they will do a 200m purchase, but with the new cash flow coming by the month I still don't get what this company is thinking.

    Regardless, a small comment - I really think the company's acquisition activity, at about 18m on average for the past 4 years, should be considered a normal part of CapEx. After all, it is next to impossible to determine whether prices paid for these transactions is appropriate and how the base business is doing.

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  2. Unless they have a huge acquisition on the horizon, why won't these guys do a special dividend. Take a look at SAPE this week. They announced a one time special dividend of .35 payable on march 15th. They have nothing close to the FCF of JCOM, they are growing 20%+, and they have about the same amount of cash that JCOM has.

    I don't follow JCOM closely, but do the insiders own such a small amount of stock that they are not even thinking of this?

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  3. Hello Anonymous - if I recall correctly, management originally said the BoD would decide what to do with all of the cash in early 2010 with full knowledge of financials at 12/31/09 and strategic opportunities. However, I hear you - if a share buyback is possibly on the table, why not act quickly to take advantage of weakness in the share price last DEC and in JAN? That said, without knowing what they have up their sleeve on M&A front, it's impossible for outsiders to know what potential use might be best. Clearly, j2 has an aversion to debt (okay by me) and wants to keep the growing cash pile for potential M&A. If we don't see activity soon, I'm fairly certain they'll announce a buyback and/or potentially a dividend (I think BOTH make sense).

    You've an interesting idea to consider acquisitions as normal capex as I agree it's hard to separate core business from value/performance of acquired companies. Yet, j2 spent only $12.5 million on M&A in 2009, down from $42.8 million in 2008 and we know j2 likes to pay no more than 2-3x sales for businesses (implying a revenue contribution from 2008 acquisitions of perhaps $15-20 million depending upon growth). In my view, the best measure to monitor use of shareholder capital remains ROIC and I think management understands this. IF ROIC (and margins) compress following acquisitions, we can surmise that they might be poorly allocating capital. But, we've not seen this.

    Jim,

    Per 2008's proxy, management and the BoD owned 9.8% of the company:

    http://www.sec.gov/Archives/edgar/data/1084048/000107261309000662/proxy_16390.htm

    So, they own a NOT insignificant piece of the company and, no doubt, care about how capital is allocated. I would prefer a regular dividend rather than a one time special dividend but can understand from a corporate finance perspective why j2 might lean toward buying in shares at a 10%+ FCF yield (if still available) to shrink shares outstanding and increase EPS (hopefully pushing shares higher).

    JW

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  4. I'll admit to not calculating ROIC as an investment measure (sorry, not sophisticated enough), but also think that with the chaos in the economy the last few years it is difficult to separate normalized performance and the variations of sales outside of the company's control. Thus, I'm not sure that ROIC measures, at least over the short term, or margins would be a true indicator that acquisition activity is appropriate. Even price to sales don't measure how well a business does after being brought into the fold. In short, I think a simple but logical approach is use some sort of averaging on all acquisition activity, especially one that is as steady as this one. As you note, only 12.5m in M&A in 2009 but 2010 sounds like it will be far more active. Just one choice.

    On the buyback, the obvious thing to do is to have one open-ended on hand. The fact that this management team didn't have one, at the same time they bemoaned the stock price at 18, is simply idiotic (my real feeling - cheesy was a polite word). Who are they kidding?

    Regardless, you run a truly superb blog. Your thoughts are greatly appreciated.

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  5. Hello Anonymous,
    Indeed, the last couple of years have been abnormal for nearly all companies. Fortunately, j2 managed to grow including a few acquisitions that seemingly offset modest declines in the core efax segment. Right - 2010 should see larger M&A activity. If j2 can truly create market leading positions in the voice and email categories (like position in digital fax) that accelerate future growth while maintaining ROIC/margins, then we'll know management succeeded in deploying excess cash.

    Let's see what happens in the next 3-6 months. I will be disappointed if we see no M&A and no new buyback/dividend. While it's hard to know how a dividend might impact valuation, I suspect JCOM's multiple would expand and am inclined to see JCOM not as a DLX but more like a PETS (launched dividend last year) and WWE (extremely high dividend given large cash balance). Both PETS and WWE garner higher multiples, although growth profiles may be higher than that of j2 at present.

    Thanks for your kind words re: the blog.

    JW

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