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J2 Global Communications (NASDAQ:JCOM) is a ~$1.1B market cap company that provides cloud-based communication services to business customers. The company helps corporations digitize various business communications (fax, phone, and online voice messaging) and deliver on-line service infrastructure to reduce corporate capital spending.

In my opinion, JCOM stock is undervalued and represents a great buying opportunity in a value investment that offers the popular cloud computing theme. In this article, I will run you through the firm's historical financial performance and my DCF valuation, as well as provide you the recent corporate development to support my view on the stock.

Historical Financial Performance

(click to enlarge images)

Comments: JCOM has experienced healthy revenue growth since 2007. The firm is very profitable as reflected by its ~80% gross profit margin and ~40% operating income margin. It is also a cash generator as free cash flow margin has grown steadily from ~35% in 2007 to ~42% in 2011. Stable ROE trend reaffirms the company's high profitability and the current ratio metric suggests JCOM is financially safe in terms of liquidity.

DCF Valuation

Comments: Baseline assumptions give a stock value of $35.55, which is ~44% above the current stock price of ~$24.

Comments: The highlighted assumptions are changed to reflect a stress case, and they yield a stock value of $24.53 - in line with the current stock price. It appears that the market price has factored in those very pessimistic assumptions, which I believe are extremely unrealistic given JCOM's healthy fundamentals.

Valuation Comparison

Comments: JCOM's price multiples indicate that the stock is much cheaper compared to the industry average despite the company's higher profitability and earnings growth.

Recent Development

  • In Q1 2012, JCOM delivered an estimate-beating quarter. Its revenue went up by 18.1% and EPS jumped by 6.7%. The operating margin expanded to 43.4% while churn rate achieved a record low of 2.4%;
  • 22,000 DIDs (direct inward-dial numbers) were added in the quarter versus 9,000 in Q1 2011;
  • JCOM continued its momentum in free cash flow generation in the quarter and it increased the quarterly dividend by 2.4%; and
  • By the end of Q1 2012, JCOM has $193M in cash and short-term investments versus the total assets of $638M and has no debt.

Additional Facts

  • JCOM is a market leader in providing the cloud-based digital fax services. It is currently undergoing a revenue mix diversification by expanding its digital voice business through small tuck-in acquisitions;
  • JCOM paid its first dividend in 2011, and current dividend yield is 3.6%;
  • The stock returned ~-12% YTD primarily due to the firm's exposure to the European market; and
  • The ratio of shares shorted as % of float is standing at ~34%, implying potential buying support in the near term due to short covering.

Note 1: Charts and exhibits are created by the author.

Note 2: Financial data is sourced from company 10-Q, 10-K, press release, Yahoo Finance, YCharts, Wall Street Journal, and Morningstar.

Disclosure: I have no positions in any stocks mentioned, but may initiate a long position in JCOM over the next 72 hours.

Source: A Quality Value Play: J2 Global Communications