MagicJack: What The Market Is Missing

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Jim Maguire
8 Followers

Summary

  • New management is incentivized to sell the company.
  • New ventures are finally in the works.
  • The company is operating within an expedited timeframe to unlock shareholder value.

Over the past year, few companies have been through as much as MagicJack (NASDAQ:NASDAQ:CALL) has. From seemingly endless M&A chatter to multiple proxy wars, the company's share price has gone through unusual turbulence ranging from $6.50 to $8.90 per share on consistently low volume. Fortunately, there is a light at the end of the tunnel.

The Business

MagicJack's revenue is distributed into three main components:

  • Core Consumer: This is MagicJack's most profitable division as it accounts for 88% of their revenue during Q1 of 2017. Included in this segment are any sale of MagicJack devices to a wholesaler or directly to consumers, access rights fees, and prepaid minutes.
  • Enterprise: This division represents Broadsmart. Broadsmart specializes in Unified Communication as a Service (UCaaS) and produced 2.7 million in revenue last quarter, or 11% of Q1 revenue. On the past conference call, CEO Don Bell announced that they would be writing off the majority of Broadsmart ($31.5 million of the $40 million acquisition) mainly because one, potentially two, of their customers were not renewing their contracts. In an effort to salvage what's left, management appointed Kerrin Parker to be the CEO of the Broadsmart division, who has hired an entire new sales team to revamp the business as a whole.
  • SMB: The SMB division focuses on the sale of phone services and equipment. It began in March last year, and produces <1% of revenue for each quarter.

Q1 2017 Earnings

  • Total revenues for the quarter were $23.2 million, with access rights renewals accounting for 58% of total revenues. The sale of MagicJack devices was $2.8 million, Broadsmart contributed $2.7 million, the sale of prepaid minutes accounted for $1.2 million, wholesale charges were 1.1 million, and various smaller sources of revenue accounted for $1.9 million.
  • The company operated at a loss of $34.5 million, mainly because of the Broadsmart write down ($31.5 million) and fees from the proxy fights along with departing senior management compensation ($5.2 million).
  • Churn came in a bit high at 2.5%, compared to last quarter's 2.4%.
  • MagicJack's subscriber base increased by 92,000 to a total of 2.08 million active subscribers.
  • Cash: MagicJack has $48.3 million in cash with no debt. In FY16 the company added $14.7 million in free cash flow and plans on spending 3 to 5 million on incremental investments, specifically within its SMB division.

Overall, this quarter was uniquely difficult for MagicJack because of the writing-off of Broadsmart, proxy fight fees, and exiting management compensation. Broadsmart was an ill-advised venture that never came close to living up to expectations, and is one of the final mistakes from the past management team that Bell was left to fix. None of the other fees noted should be recurring, and with the user subscriber base still growing along with new products in the pipeline, the rest of the year should shape up to be more inline with previous years while this quarter is an outlier.

Proxy Wars (NASDAQ:CALL)

Over the past 11 months, MagicJack has been working to find a buyer for the company. It began in July 2016, when MagicJack received two "indications of interest" from two separate companies, one known as Carnegie Technologies and the other kept confidential, with the company referring to them as "Bidder A." Bidder A's bid was within the range of $7.50 to $8.00 per share, while Carnegie's bid was within the range of $8.00 to $10.00 per share. MagicJack told both parties that neither offer was good enough, and that they will each have to substantially increase their offer for the company to consider it.

Keep in mind, all of this is occurring behind closed doors, and to the common public (and shareholders) all that is seen is the share price down nearly 50% from only eight months prior. Enter David Kanen of Kanen Wealth Management - holder of 5.6% of all outstanding shares - who submits a letter to the Board of Directors essentially demanding they take action to save the crumbling share price. In addition, Kanen nominated its own slate of directors for the upcoming annual meeting.

By the time September rolls around, Carnegie and Bidder A have both raised their offers. Bidder A is offering to buy the company for around $9.20 per share, while Carnegie is offering $8.50 per share. After more negotiations between MagicJack and each party, Carnegie wouldn't budge from their original price while Bidder A moved forward in their due diligence. By the end of December, MagicJack reached a settlement with Kanen, although the Board backed out last-minute. The Board made the decision to move forward with the nomination of both Kanen's and their own directors for the upcoming meeting. Along with that, the Board also announced that the then-current CEO Gerald Vento would be stepping down, and that Don Bell III would be taking his place. (An interesting note is Don Bell was a main contributor in the sale of IPC Systems to SilverLake Partners in addition to the sale of NTS Communications to Tower Three Partners, so he has experience in working through buyout processes.)

As the new year begins, Carnegie went public with their offer of $8.50 a share and nominated their own slate of directors for the Board. They state they are basically fed up with management, and their lack of an ability to reach a conclusive settlement offer with Kanen reflects their general incompetency. About a week later, a third bidder comes into play (known as "Bidder B") who offers to buy the company at a price apparently greater than what Carnegie is offering.

On January 30th, Kanen entered into an official settlement agreement with MagicJack, agreeing to withdraw all of his nominations for the Board of directors. What Kanen got in return, if anything, to my knowledge, is undisclosed. Within one week of the settlement, negotiations with Bidder B progressed to the point where Bidder B signed an NDA and began doing its own due diligence on the company.

Over the next two months, Carnegie and MagicJack go back and forth over numerous legality issues until, on March 30th, Carnegie agreed to withdraw their nominations for the Board of Directors. They claimed that they've been happy with the way the new management has run things (under Don Bell III) and sees no need to continue the proxy fight.

Since then, there has been no word from Kanen or Carnegie, aside from David Kanen appearing on quarterly conference calls to ask questions.

Active Management

After the proxy wars ended, management made it a priority to follow their new dual track process:

  • Execution of new business strategy: Management unveiled their new idea, UnJacked, in March. UnJacked is MagicJack's response to the growing trend of SOHO networks within the United States by making their services easier to access through the cloud. Essentially, the idea is that because of their already vertical operations, if they make their services easier to access (cloud-based retrievals are much more handy than having to go through configuration processes) they have the ability to competitively lower their prices while remaining profitable. This is the company moving forward a "mobile-first" initiative and making their services more accessible online. UnJacked will file under the SMB component of revenue. Management plans to send UnJacked to trial in Q3 and release it later this year.
  • Sell the company: The Board put together a special committee consisting of three people (Don Bell, Izhak Gross, and Thomas Fuller) whose main goal is to sell the company. According to the March conference call, they were still in talks with multiple bidders for prices in excess of Carnegie's $8.50 per share.

Currently, UnJacked is on track to go to trial as planned, and the process of selling the company under the new management is well underway. On Monday, Axios.com reported that YipTV is willing to buy MagicJack for $9.50 per share. They reportedly have $95 million in committed financing from Goldman Sachs as well as an equity sponsor.

Another important piece to the puzzle is an 8k filed by the company on May 10th, which states that if management sells the company within a year's time, Don Bell and Thomas Fuller will roughly make a combined $3.2 million in bonuses ($2.5 million for Bell and $700,000 for Fuller). In addition, Bell and Fuller are both entitled to options that could go through accelerated vesting if they sell the company after a year's time. So essentially, this is what management is looking at:

  • Sell the company within before the one year anniversary of the date of the grant and make $3.2 million.

Or...

  • Sell the company after the one year anniversary of the date of the grant and cash in on the options. (In order for the options to me more profitable than the bonuses, management would have to sell the company for around $11 per share.)

It's unlikely that MagicJack will sell for as high as $11 per share, so I see management shooting for the former. Needless to say, this provides an enormous incentive for management to deliver and sell the company. Keep in mind, if any bidder (such as YipTV) doesn't want to negotiate with management further for whatever reason, they always have the option of taking their takeover directly to the shareholders to vote. Considering YipTV hasn't made that move, it is likely they are still in the negotiation stages with management.

Concerns

Even with the likelihood of a buyout here, the rising churn is still somewhat concerning with how management outlined in its annual conference call making it being a priority to retain its subscribers. Along with that, the consistent reliance on the core consumer division (specifically access rights renewals) needs to be successfully diversified. We saw the last management team try to do so and fail with Broadsmart, so it is more relieving that this time around the company isn't trying to force unrealistic synergies between their services and outside companies through acquisitions. With any future revenues from what's left of Broadsmart being largely an unknown, it's important that UnJacked is a success for the SMB unit. Either way, I do not see this being a major factor in the sale of the company - although a new, successful product certainly wouldn't hurt.

With $48.3 million in the bank with no debt, the company's financial situation remains in good shape. All of the one-time obligations have been taken care of, and the main subscriber base is still growing. Competition is something to keep in mind because of the company's shift in focus to its SMB unit, with one of their long-time competitors Vonage (NYSE:VG) already having more exposure. Even with that, though, as Don Bell noted in the annual conference call, there are over 26 million SMB units within the United States. If UnJacked lives up to expectations, the company should have no problem breaking into the field.

Miscellaneous

Some other factors I found worth noting:

  • The company's new Chairman of the Board, Izhak Gross, is also one of the three people on the special committee to sell the company.
  • Thomas Fuller, also on the committee to sell the company and newly appointed CFO, worked alongside Don Bell during the sale of IPC systems.
  • Michael Tribolet, CEO of YipTV, was once MagicJack's Chief Business Officer.

Conclusion

To summarize, the company has been very open about not wanting to accept an offer for $8.50 per share because they had better options on the table, and I think YipTV is just one. Bell mentioned another potential bidder on the annual conference call back in March, so we're unsure if this is the most attractive offer they've received. If management wasn't making any true forward progress on selling the company, I see no reason why Kanen and Carnegie would end the proxy wars within one month of each other. Carnegie was not a majority shareholder and thus I'm unable to tell if they have kept their shares or not, but Kanen Wealth Management has held their shares since their settlement back in February.

The driving value in MagicJack is the pending sale of company, and given YipTv's takeover price represents a 26% premium from where the stock traded on June 14th, I see MagicJack as a buy. The current management team (unlike the last one) is incentivized to sell the company, has positive experience selling companies within the sector, and is operating within an expedited timeframe. Given the company has $3.22 per share in cash with roughly $0.92 per share in free cash flow annually with no debt (a decent price floor), a management team active in pursuing a sale of the company, and new, positive ventures on the horizon, MagicJack presents a refreshing opportunity for shareholders.

This article was written by

Jim Maguire profile picture
8 Followers
University of florida
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Disclosure: I am/we are 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.

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