magicJack Vocal Tec Might Attract A Cable Suitor

| About: magicJack VocalTec (CALL)
This article is now exclusive for PRO subscribers.

Shares of magicJack Vocal Tec (NASDAQ:CALL) were among the market’s leading gainers last Friday, on news of strong fourth quarter sales of the company’s latest Internet telephony device. The shares also got extra lift from a second simultaneous announcement, as the company canceled a dilutive share offering. The unexpected sales provided the needed operating capital in the offering’s stead. Shares of CALL were up 18% on the day, placing the company among the market’s leading gainers.

It appears the magic may in fact be back for magicJack. The company announced Friday that its latest product, the magicJack Plus, is basically selling like hotcakes (whatever that means), with approximately 365K units sold in the last 30 days. The original magicJack device needed to be plugged into a computer connected to the internet to make use of it, but the magicJack Plus connects directly into the internet line. Thus, you do not have to keep your computer on 24/7 to make or receive phone calls. It’s a major upgrade in technology and utility value, and the price is likewise higher, retailing at $69.95, versus the $39.95 price for the original magicJack.

Because of the strong sales, the company expects to have a cash store of approximately $50 million by next month. Thus, it was able to kill its planned share offering. Not only did it do so, but the company will renew its share repurchase program as well. It’s an interesting shift in capital management that I find telling about the management team’s forecasting prowess. That means that both upside and downside surprises are highly possible in the future as well. Such unreliability and uncertainty likely burdens the company’s valuation a bit.

Internet telephony has been an interesting market to follow. We saw Vonage (NYSE:VG) dive after its high profile IPO in the middle of the last decade. However, Vonage’s product price point probably was not or is not far enough off the major telecoms to stick, in my view. VG shares still rose in sympathy with CALL Friday, up 7.3%, to $2.36. Likewise, Skype, now owned by Microsoft (NASDAQ:MSFT), did well enough but never caught on with the broad populace. Perhaps it was just too early or maybe the tech savvy needed to use it was too much for an older demographic of American citizens. It’s clear, though, that with the evolution of technology usage, Internet telephony will be an easy learn. Meanwhile, magicJack just made it easy enough for even non-tech savvy seniors to use.

Eventually, the Verizon’s (NYSE:VZ), AT&T’s (NYSE:T) and Sprint Nextel’s (NYSE:S) of the world will feel threatened by internet telephony and magicJack, if they aren’t already. I’ve noted that the price difference between Verizon’s independent internet service and internet and telephone service bundle is marginal, leaving me to question whether “the jack” would really offer worthwhile savings given the convenience trade-off of the first model. I suspect Verizon and other internet providers have priced this way for this very reason. You can get cheaper internet service from the big boys of the industry, but you get less bandwidth in return. Now this second product model by magicJack presents a different story, and given that the ability to port your old number has finally arrived, the game may be on.

The important question to ask is what strategy will the telecom giants employ to crush this emerging competition. Well, the big box players are well positioned to do so, given that they control the internet. However, I could see the cable providers, who are also providers of bandwidth, like Time Warner Cable (TWC), Cablevision (NYSE:CVC) and Comcast (NASDAQ:CMCSA) having interest in acquiring a magicJack in order to provide a more competitive bundle package against the telecom players’ offerings. Thus, the new magicJack might be more than just a nifty product for a thrifty spender. Its shares and those of similar servicers might find broad appeal one way or another. Given that a recent census poll showed about half of America is poor, and given the number appears to be increasing, even the worst case scenario seems to present an expanding market opportunity.

There’s just one analyst following the company, based on Yahoo Finance data. His EPS estimate for 2012 appears to be $1.83, which puts its P/E ratio at 13.1X as of Friday. While EPS growth looks to approximate 71% in 2012, the long-term growth estimate is 17.5%, again based on Yahoo Finance and its data providers. Based on this thumbnail, the stock would appear undervalued. The question is, can Internet telephony, and more importantly, the MagicJack, really replace standard telephone service? It once seemed unlikely, but there certainly is a market of bargain seekers willing to try it out, and that market is expanding as economic difficulties continue. Meanwhile, the technology just got easier to operate.

I suspect there is untapped value in recurring revenue not currently being maximized. Today, you buy the magicJack and have telephone service all year long, and then are asked to pay the same amount the following year to continue using the service (though the company stretches that revenue across the year). I suspect that an acquirer would create value by raising the monthly charge tied to magicJack usage through the year. So, while lowering the revenue received currently through telephone service provision, they could also add value to the acquired service and position more competitively against the big three telecom providers. I see this as a clear opportunity for the cable industry, but bad news for the savvy consumer now benefiting from his "jack".

The stock’s chart seemed to show market disinterest until volume picked up in 2010. The cure for questions is earnings growth, and earnings visibility is a new development here. As earnings grow now, and with a P/E near single digits, there would be little stopping the share price following earnings per share higher. The company managed to sell 8 million of its original magicJacks® into a market of roughly 100 million households. This newest product is far superior and the economics more attractive. Its appeal can reach a broader span of Americans, in my view. So, I am a short to medium term fan of magicJack shares and recommend them for aggressive, emerging growth and small cap portfolios.

See my review of the old magicJack.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.