magicJack (NASDAQ:CALL) is a voice over internet protocol service. Basically you buy a $60 device and pay about $3 per month instead of paying about $30 per month for a landline. The device plugs into a router or computer and it allows users to make calls. The reason why I believe this stock is a buy is that the company's management put into place a turnaround strategy in the first quarter. The stock has recently declined for two reasons. The first reason is that the short squeeze that Whitney Tilson caused by recommending the stock abated.
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The second reason is that the some investors may have viewed the second quarter's results as disappointing since the company missed the street's revenue estimates and lowered guidance for the third quarter as some of its new initiatives will be delayed. The stock is currently trading at about $12 per share and the company has $4 per share on the balance sheet. In my opinion, last quarter's revenue metrics aren't important because the firm's new product the magicJackGo was in the process of being released. What matters to the company's stock in the long term is that the new initiatives are completed effectively. If these initiatives get properly executed, then the company will be able to increase its revenues in the future.
I'd be remiss if I didn't mention the huge short interest in the stock. As of August 11th the stock had 46% of the float sold short. The shorts believe that the magicJack service is outdated because people no longer use landlines. I believe that this is a flawed thesis. Millions of Americans are cutting the cords on their landlines because they use them less than cell phones making the high price not worth the usage amount. According to the AT&T website the company is charging $24 per month for a landline. If consumers are rarely using the product the cost benefit of having the service doesn't work out. The magicJack isn't a landline that will be declining along with service from AT&T because it is actually part of the cord cutting phenomena. This is how the company is marketing its product. Consumers obviously still make phone calls to each other - it's just a matter of how much they feel they should pay for those calls. With the magicJack the dynamic of not wanting to pay for a service that is only used occasionally is switched. At about $3 per month the value proposition is substantial for users who don't want to go over their allotted cell phone minutes or those who want a separate line for a small business. This situation is similar to the phenomena of cord cutting for services such as Netflix (NASDAQ:NFLX), Hulu, and YouTube. Consumers still want to be entertained - they just feel that the value proposition of having a monthly TV bill is not worth the benefit of the entertainment they are receiving.
Adding onto this thesis, it is important to recognize that the magicJack service only has 2.95 million active subscribers. With this base being so small compared to the 115 million households in America, this company can go against the tide of consumers speaking on the phone less. The company has had declining subscriber growth since the first quarter of 2012 because of poor management. If this turnaround strategy works, the company will be able to once again have subscriber growth. By adding new features the company can increase the already great value proposition that it offers to consumers.
The new initiatives that the company is putting into place affect every part of its business. Therefore, it is not surprising that the company is experiencing minor delays in putting these changes into practice. The most important change that the company made is the release of the magicJackGo. The product has the added feature of being able to do conference calls. This fits in with the message of having the product being marketed to small businesses. The magicJackGo now offers a free year of service with the purchase of the product compared to 6 months with the previous product which was called the magicJack Plus. While the product has only been in stores starting in June and July for different retailers, the company stated that they are seeing positive weekly sales growth that is greater than when the company released the magicJack Plus. This is a positive initial sign.
The company increased the options of renewal plans to include a one-month and a six-month option. In store cash renewal cards began being offered at Wal-Mart (NYSE:WMT). The company stated that the focus on renewal rates in the middle of this quarter was the first time it had done so. Clearly it has been effective as it has helped the company increase renewal rates by 5% and lower churn from 3.3% to 3.1%. The monthly churn rate in Q1 decreased from 3.5% to 3.3%. This is clearly a positive trend. When looking at the monthly churn number, I believe that it has much room for improvement. I know that this is not an apples to apples comparison, but I will compare it to AOL (NYSE:AOL) to put its churn into context. AOL has a legacy subscription service that used to provide users access to the internet back in the early 2000s. This is a service that consumers no longer need. AOL lost 9% of its subscribers last year and still only had a churn of 1.6% in Q2 2014. If the churn of an outdated service is that low, it is reasonable to assume that magicJack will be able to get its churn below 3% by the end of the year.
The other aspect which the company is looking to improve upon is marketing. This is being done by changing the website to make it more simple and modern, by changing the commercials which were previously annoying to consumers, and by changing the in-store displays. Best Buy (NYSE:BBY) will have a dedicated magicJackGo display and Fry's will be introducing a 4x6 foot display in its stores. This website has some of the older magicJack commercials along with some newer "Do the Math" ones. In Whitney Tilson's piece he shows examples of how the company has changed its website. These changes are part of the company's strategy to reposition the product.
The company has $72 million in cash - these initiatives will be where magicJack is investing some of this money. The other measures the company is trying to execute is improving customer care and improving quality of the product. If you look at any reviews online you can see that consumers are upset with the level of customer service and some are experiencing echoing or dropped calls. The product is the most important part of these initiatives. It showed great prudence for the company to delay other actions such as app monetization until it put through these important changes. The company is using its development teams in Russia and Israel and a switching team in America to work on improving the voice quality.
Another important initiative that the company is making pertains to its mobile application. Currently the company has 3.4 million monthly active unique app users. The app was recently updated to make everyone using the app register with magicJack. This lowered the usage base slightly, but it was an important step to make sure 100% of users were registered. The update also included a social feature. The app currently has 4 out of 5 stars on the Google Play Store (119,000 reviews) and 3 out of 4 stars on the Apple App Store (290 reviews). The main goal of that the firm has for the app is monetization. The company will be adding prepaid integrated voice and text offerings and international calling. It may also limit the amount of minutes that users can use for free with the app. It is important to mention that users with the magicJack product can download the app and have it ring simultaneously with the home phone when the user is connect to Wi-Fi.
The final initiative that the company is undertaking is the launch of sales into 14 Latin American countries. It is partnering with Telefónica (NYSE:TEF). The companies were initially going to do a pilot trial, but now aren't going to because of positive market research. The first country that magicJack is entering is Mexico. The research stated that there is substantial demand for the ability to make calls into America with an American phone number at a low price point. Telefónica will be purchasing the magicJackGo to sell in 4,000 proprietary Movistar mobile retail stores. It will also be acting as a third party distribution partner, selling the magicJackGo in stores such as Wal-Mart and Copal.
I believe that this stock is a buy as the market is not pricing in the success of these initiatives. The company has the cash on hand necessary to make this transition. The one analyst covering the stock is estimating that the company earns $1.02 per share which would give the company an 11.9 price to earnings multiple which I believe is too low based on the growth potential that these initiatives bring to the company.
The main risk that the company faces is execution risk. These ideas are clearly smart, but if the company botches the improvement of call quality then the turnaround will fail. I believe that the marketing results and early sales results are a positive indicator of future success, but this success is not a guarantee. The stock is trading at such a low valuation that I doubt it could fall much further even if this occurred. The company has faced regulatory issues in the past as you can read about here. As you can see from hindsight the article's claim that magicJack could be put out of business by the FCC ruling against them has been proved to be false. Therefore, I think the company will likely have low regulatory risk going forward.
Disclosure: The author is long CALL. The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.