As we've pointed out previously, j2 Global Communications (JCOM) 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 (where we were making selective purchases).
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 last Thursday 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 rein 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 type of historic development and margin profile?