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J2 Global Communications (JCOM) is my single largest holding and I am still very bullish on their prospects.

Background

JCOM is an online communications company best known for their flagship product Efax. Efax is the largest provider of web-based faxing (fax-to-email, computer-to-fax). As of the end of Q1 2005, JCOM had 600k subscribed phone lines paying $17 a month. In addition, JCOM has 8.5 million free fax users. Since turning profitable in Q1 2002 JCOM has rapidly grown its earnings. JCOM produced $0.40 a share in Q1 2005.

Valuation

At $36 a share, JCOM trades forward P/E ratios of 20.6 for 2005 and 16.2 for 2006 earnings estimates. Given that the company has consistently outperformed guidance nearly every quarter for 3 years, the true ratios are likely even lower. The company is estimated to grow at earnings 40%+ this year and next. If you look at the enterprise value (back out cash) divided by run-rate earnings (current quarter earnings * 4), they are trading at one of the lowest valuations since turning profitable (less than 21 run rate earnings). If they hit their guidance when they report on 7/25/05 (which they indicated they would 3 times in June) then that ratio drops to about 18.5. Outside of the huge run up in late 2003, JCOM has mainly traded between 20 and 26 x run rate earnings and their expected growth rate has remained extremely high (40%+). JCOM an enterprise value of about $750 million and a free cash flow run rate of $40 million. Simple math: if you assume that JCOM can get to 3 to 6 million paying subscribers globally, they could be earning 5 to 10 times what they are now.

Positive Business Characteristics

• Telecom is a large market and efax’s millions of free subs indicate people want online faxing
• Consistent and predictable growth
• High margins
• Low customer acquisition costs
• Sticky product (fax number on business card) means low churn - currently close to mobile phone churn rates of sub 3% per month
• International growth prospects (Europe, Japan, China, India, etc.)
• Patent portfolio seems to be preventing large players from challenging JCOM’s position
• Low stock option dilution

Potential Catalysts - Short Term (1-2 months)

• Could announce stock buyback now that they have over $100 mil in cash
• Raise 2005 guidance on Q2 call
◦ Company has raised guidance mid-year in both the past two years
◦ International should begin to pick up
• Outperform Q2 guidance
◦ Regularly outperforms guidance
◦ Just recently started bounty marketing online – which has been hugely successful for other subscription businesses
◦ Q2 is generally strongest quarter

Potential Catalysts - Medium Term (3-6 months)

• Investors acknowledge how undervalued JCOM is
◦ EPS growth – still going at 40-50% a year!
◦ Run-rate PE is close to lowest points since profitability
• Potential for short squeeze
• Major investment banking coverage / magazine coverage

Potential Catalysts - Long Term (6-18 months)

• January 2006: Set 2006 guidance well above the $2.25 expected (my guess is $2.50 or above)
• Announce a patent licensing deal with a telco or VoIP player
• Larger telco / internet company buys them
• Create a new pricing model to convert free customers (e.g. $20 a year)
• International growth: Launch of a bunch new languages / markets (e.g. Japanese, Chinese)

Risks – I don’t expect these will happen quickly or abruptly

• Competition
◦ Large telcos could bundle product
◦ Price war by another player
• Advent of online digital signatures
• Gradual decline of fax machines in favor of emails

Full disclosure: I am (very) long JCOM at the time of writing.

Source: J2 Global Communications: Stealth Global Telecom? (JCOM)