Hedge fund manager Whitney Tilson believes magicJack VocalTec (CALL) “… is the kind of growth story that investors could really fall in love with.”
CALL is the Israeli company that invented VOIP (voice over internet protocol), and Tilson sees rapid subscriber growth leading to significant stock appreciation. His observations to clients Feb. 10 has pushed CALL stock up 28% over the past four days of trading.
Tilson thinks CALL stock could be the next NFLX. Is he right? Yes, although the reasons may not be readily apparent. Read on to find out why.
History of CALL Stock
This is no overnight sensation. In fact, it has taken 25 years to get to where CALL stock sits today: A company with a product that has been around awhile but could be ready for prime time. Starting out in 1989 as a developer of speech recognition technology, Vocaltec went on to create the first internet phone software in 1995. The software compressed voice signals into digital packets so they could be sent over the internet and thus the acronym VOIP was born.
The company was so successful it went public in February 1996, not under the CALL stock symbol investors know today, but rather as VOCL, an obvious truncation of its corporate name. It then saved itself from a sure death in 2005 by undertaking a reverse merger with Tdsoft Ltd., a provider of VOIP gateways.
Although the merged entity would operate under the Vocaltec name and stock symbol, Tdsoft shareholders, which included Cisco Systems (CSCO), took control of 75% of the company.
The last piece of the puzzle came to fruition in 2010 when Vocaltec did another reverse merger with YMAX Communications, the creator of the magicJack. Dan Borislow created YMAX in 2006 to take advantage of the obvious growth in VOIP. After the merger, YMAX shareholders owned 90% of CALL stock with Vocaltec getting the remaining 10%.
That’s where we stand today. But how is that similar to NFLX? Believe it or not, both companies were actually slow starters before growth took off.
Netflix, although it feels like an overnight sensation, has been around since April 1998. First, renting and selling DVDs online; it didn’t introduce streaming video until the beginning of 2007. Even then its business didn’t really take off until it started producing its own original content with shows like House of Cards and Orange is the New Black.
Throw in a surprise profit in Q4 2012 and NFLX stock was off to the races. In the words of Lou Mannheim, the veteran broker in Wall Street, “good things, sometimes, take time.”
First Impressions of CALL Stock
CALL released its Q3 earnings November 12 and the first thing you’ll notice is that revenues declined 13% year-over-year. That’s not the way to get me excited about a stock. However, farther down the income statement things get far more hospitable with operating income growing by 13% YOY to $12.7 million.
Operating margins increased 830 basis points in the quarter. Over the first nine months, they increased by more than 12 percentage points. Often it’s quality over quantity that counts.
But before you run out and buy CALL stock, you should wait for clarity around the reasons for the margin increase. Specifically, why did the company reduce advertising by 40% in Q3 and 56% in the first nine months of the year? The answer will either tell us there’s a big red flag present or we’re in the early stages of ratcheting up future profits. Without a clear understanding of the reasons for this, all bets are temporarily off.
Last June, the company introduced a new version of the MagicJack Plus with enhanced voice, power and memory features. The new product is thought to be much better than the previous version, and initial sales numbers would seem to support this thesis.
In CALL’s Q3 conference call CEO Gerry Vento indicated that its “… marketing and packaging has become a bit stale. We are undergoing change to both of those areas and our partners are encouraged by our new direction.” In advance of introducing its new packaging and marketing initiatives, it has pulled back its quarterly ad spend because the dollars are better spent once it has a fresh face to go along with the fresh product. Think of this as reloading.
Netflix did a little reloading of its own in 2011 when it announced that it was splitting its two services into two separate operations with the DVD division being rebranded as Qwikster with a totally separate pricing scheme. NFLX stock took a beating, which eventually forced it to reverse its decision. Since that reversal, NFLX stock is up almost 300%, proving mistakes aren’t always fatal.
Why Tilson Likes CALL Stock
I see five simple reasons why he’s excited.
1. CALL has a quality product that will fly off retailer shelves once it brings a coordinated marketing effort and refreshed packaging to the game. In November, it was in about 9,000 stores. It plans to be in 30,000 stores very soon.
2. Its gross margins continue to improve up 600 basis points in Q3. Once it delivers scale from its marketing effort the net result will be to push more dollars to the bottom line.
3. Approximately 49% of its active subscribers use the original Magic Jack created in 2007. With superior sound quality, the new Magic Jack Plus will be purchased by many of its already satisfied customers. Not to mention the acceptance of VOIP is much higher today than it was back in 2007.
4. CALL activated 273,534 Magic Jack subscribers in Q3, an increase of 21% over the second quarter. It now has 3.3 million active Magic Jack subscribers. In addition, it increased access rights renewal revenues (the right to access its servers beyond the original term) in the third quarter by 34%. The healthy state of both these numbers is a key to its future success.
5. With no debt, $34 million in cash and investments, and operating cash flows expected to increase substantially in the next few quarters, its long-term future has never been brighter.
Bottom Line on CALL Stock
Whitney Tilson, like every investor, has good and bad calls. Comparing CALL to NFLX might seem like a stretch but the two companies’ products and services definitely provide significant value to consumers.
For this reason I think his investment thesis is right on the money. CALL stock is worth owning and could very well be the next NFLX. Now if they could only drop the Vocaltec from its name we’d be off to the races.
As of this writing, Will Ashworth did not own a position in any of the aforementioned securities.