MagicJack's Detractors Have It Wrong

| About: magicJack VocalTec (CALL)


CALL offers its services to consumers at a deep discount to its competition.

Despite lowering advertising spending previously CALL has almost all its subscribers and increased its app users, and has recently begun increasing advertising.

CALL allows users and subscribers to call any number in the USA, Canada, or magicJack user for no additional cost, making it unique among its peers.

CALL is preparing to advance its business into the next stage, particularly with its app, and this will provide tremendous value to shareholders.

CALL in a solid fundamental position to continue bringing value to shareholders with ample cash, no debt, and being profitable.

There has been a lot of buzz surrounding magicJack VocalTec Ltd. (NASDAQ:CALL). It had a significant beat on earnings with both revenue and earnings per share, and has had Whitney Tilson proclaiming the company could follow the disruptive path set by Netflix (NASDAQ:NFLX). His analysis of magicJack is thorough and in lieu of covering the same ground I recommend you read it for yourself. I want to focus on the bigger story.

The story seems to be that there are supporters of magicJack that seem to claim its technology still has a lot of value to give, and detractors that magicJack belongs in the tech graveyard with the other obsolete technologies like Betamax. I think the detractors miss the benefits of the existing technology, but more importantly ignore the ability of magicJack to quickly rise to the challenge of its competitors. Taking the long view, it is not hard to see that the detractors will be proved wrong this year.

Offering Consumers Value Succeeds, Period

This point bears repeating as the number one reason magicJack remains a prime contender in the field of Internet communication with the likes of Skype, Viber, and others. The subscription is $3 a month. The device costs $50 and comes with a 6 month subscription. There is a discount for subscribing for longer terms. A five year plan is only $100 and for people in the United States or Canada with family in another country it seems like a fantastic proposition. The same is true for people who travel extensively abroad.

The subscriptions are for the ability to use any phone to make the calls. This can be with or without a computer depending on whether Internet access is wired or wireless. The app you can get on your smart phone is free. It requires no subscription to make calls out to numbers in the United States, Canada, or another magicJack number. The low cost of the service should explain why magicJack is managing to grow its users despite spending less on advertising recently. Only now is it ramping up spending on advertising.

User growth was driven by the free app, but critically the number of active device users only slipped slightly. Small fluctuations can be forgiven, and this does not raise any red flags for me. Renewals represent 40% of magicJack's revenue, and that is up from 28% in 2012. That is an amazing increase, and carries a lot of weight going forward as the subscriber base grows. A loyal subscriber base would produce a lot of value for magicJack and subsequently its shareholders.

Solid Base to Grow Into the Future

It is rare to find a company that has its fundamentals improve while it is undergoing a major transition. The new management at magicJack is trying to reinvent the image of the company. It might not be as significant of a reinvention as trying to turnaround a failing business model, but cutting advertising is a significant step.

Keeping advertising spending while changing the nature of advertising would be the kind of hybrid approach expected. Rather than prudence, it would signal to me that management lacked resolve. In the case of such a major overhaul of a company's image, bold steps are required. The course management has taken tells me that they have vision and commitment, which bodes very well for the future.

On a separate note, cutting advertising spending and continuing to grow is a very strong sign of future growth. Word of mouth is the greatest form of advertising, and only comes about by offering services and value that consumers like enough to evangelize.

Benefits and Potential of the Technology

Right now magicJack only allows free calls to Canada and the USA. I can immediately see additional service plans that include other countries, though there is cheap calling to other countries. It might not be a unique concept, but with the consumer value that magicJack brings to the table it could be a solid way to expand subscriptions. The adherence to keeping things low cost for consumers means that magicJack does not need to add country plans for the sake of product variety.

Detractors of the company like to focus on how the device seems very old-fashioned compared to the software-based solutions of some competitors. I think the focus on landlines is a strength, because it makes the product attractive to people who might not be as tech savvy as others. You just require someone to set up the device with the wireless routers and the phone, and it is simple to use. I could set it up for a family member and that would be it. Setting Skype up in the same way would be more expensive, and maybe more complicated.

Simplicity of installing magicJack

The Single Most Important Feature

Users of magicJack can call any number, not individuals using the magicJack app. It does this for a fraction of the cost of its competitors. Other competitors do not even offer that feature. I might be overstating its importance, but this simple feature makes me like magicJack the most.

Any other company that offers a similar feature costs far more. I was out of the country a few months ago, and used Skype credits. To my subsequent regret, I realized I could have saved money with magicJack. It is such a simple but important feature, and it makes me confident that magicJack is attractive enough to grow its subscriber base.

I do not like to focus on buyouts for investment theses, but calling out to any number is the one feature for that price that really sets magicJack apart from all other competitors. A lot of the chatter around magicJack has turned toward the possibility of a buyout. The acquisition of WhatsApp for $19 billion, Viber for $900 million, and Skype for $8.5 billion creates much anticipation and expectation that magicJack might meet the same fate. At its current valuation there is a lot of room for an acquisition that is cheap and yet rewards shareholders.

The Current App is Just the Beginning

It would be so easy to dismiss the magicJack app as nothing important since it can be used for free and does so very little for the company. I think it would be a mistake of the highest order to think that management's plans for the magicJack app begin and end with the current state of the app. For now it serves as a gateway for people to try out the service and then upgrade to a subscription. I seriously doubt that magicJack will only keep the app as a simple gateway.

The appointment of Anthony Russo to VP of Mobile dealing with the magicJack app makes me think that the company has some near-term plans for the app. With the reinvention of the company's image all but complete, it is not surprising that the company is going to work on the next evolution of its business.

Appointing someone to management that used to work for competitors is not a sign that the company is simply going to copy what the competition did, which would be the most cynical interpretation. Effective managers are versatile individuals that can also help craft something new with the experience that they garnered from their previous positions.

I think these plans will be unveiled soon, probably within the year. I think it will drastically help the share price. If the news itself does not drive the share price, then it will be reflected in earnings. MagicJack is not developing cutting edge hardware. I expect new products or product changes to be rolled out quickly and to have an almost immediate impact on earnings and guidance. Immediate does not mean massive, but we would have a sense of the future growth the company could see. I suspect the potential will be substantial and the stock will respond quickly.

Closing Points

The stock has moved quite a bit in recent history, but even at these levels it seems undervalued. I judge it more on its potential, and that is not potential based on its forward price-to-earnings ratio. My belief is based on the nature of its business, the quickness that new revenue and profit generating initiatives can be enacted, and the strength of its current operations.

The company just underwent an overhaul of its public perception, but it is not a stock in distress. Instead it has no debt and ample cash. I really cannot see anything but upside regarding the stock, especially with its short interest. The negative arguments do not sway me, because I do not think the facts bear them out.

The fundamental state of the company does not suggest what the negative lobby is claiming. If the technology and concept are as behind the curve as they claim, magicJack should be heading into oblivion and fighting a battle for survival. Even a moderately negative approach does not hold weight, because many big bets have been placed on the future of Internet communication recently.

MagicJack's present strength makes it a solid player in this bright future that so much money has been wagered on. At the very least magicJack is a buyout opportunity. Either of those two paths lead to a solid return for investors.

MagicJack is a company very much driven by its earnings. If you require a catalyst to time your investments then earnings should be the focal point. However, I do think that the company is working on the next evolution of its business, and an announcement would form just as much of a impetus for a rise in the share price. That means it is better to take a position sooner rather than later.

Note the risks involved in a play like this and size your investment properly. MagicJack is a small company, and despite it being fairly operationally mature, with profits and no debt, it is in a volatile business that has yet to discover its true value.

I personally am using options with various dates, and strikes ranging from $22.50 to $30 for April and May. I would look at strikes into the $40s with terms past the next earnings. I am not opposed to owning shares, and might do so at some point after April options expiry.

Disclosure: I am long CALL. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: Long via April call options. Formerly long with May call options. I might buy shares in the company at some point along with more call options, but only after April options expiry in about 2 weeks.Remember to do your own due diligence to verify any information, and to appreciate the very real risks.