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Actionable news in CALL: magicJack VocalTec Ltd,

magicJack: The Market Has Gotten Too Pessimistic, Valuation Remains Compelling

Despite declining device sales, access right renewals will have a long tail and keep providing ample cash flow.

The overall VOIP market remains strong, and the company is likely to bounce back as management diversifies its offerings.

The stock is so cheap at 2x EBITDA, no home runs are needed. A mere single by management will cause the stock to pop significantly.

Our cash flow analysis shows the company could have upside of 70% or more to fair value even with pessimistic growth prospects.

magicJack VocalTec Communications Ltd (NASDAQ:CALL) is a company and stock that has seen more than its fair share of ups and downs. Take, for starters, the period after 2009, when the stock bounced from near zero all the way up to the high $20s three years later. Unfortunately, we missed the chance to get rich on this one, as most readers probably did as well. A mere 100-share investment in November 2008 for a grand total of $38 was worth about $2400 in August 2012. This great rise was due in part to the market bounceback, but mostly attributed to the company's great success in ramping up sales of its magicJack devices after they first debuted in 2007.

However, as we fast-forward about four years later to today in 2016, the company has taken the roller coaster down fast and furious, with the stock now in the $6 range and hovering near 52-week lows. The bear case here and the reason for the drop is quite simple: despite ridiculous profit margins, the market has continued to seriously doubt the future of the company due to alternative VOIP options via smartphones, which have caused magicJack device sales to decline significantly. Due to the continued high rate of service renewal fees from devices sold previously, profits and free cash flow margins have actually soared as the sales mix has changed and operating expenses have been cut, but many view this as temporary, since renewals in the future will logically drop if there are fewer devices being sold today, and the company cannot logically ramp up device sales without more aggressive marketing. So, for these reasons, the market has not been willing to pay much of anything for the company, as the stock is trading for EBITDA multiples in the low single digits.

Due to this dynamic and expected long-term decline of the technology, many view magicJack today as a value trap. We, however, respectfully disagree with this notion and believe the market has turned so negative on the stock that the ridiculously cheap EBITDA multiple the company is now trading for is not justified. In this analysis, we'll detail our case for going long the stock.

magicJack - Company Overview and Recent Results

magicJack is a technology company that is known for a small device that give users access to a VOIP service that allows them a much cheaper alternative to traditional landline phone service.

The company began selling devices in 2007 and became very successful in the mid-2000s as device sales soared. These devices allow users to have unlimited long distance calling during the length of their subscription. They can be plugged into a computer or also a modem, and then into a traditional handheld cordless phone. Plans are significantly cheaper than traditional services - the best value being the 5-year plan which costs $99.75, equating to a few bucks a month. Another advantage of VOIP devices like magicJack are that they are portable. For example, a businessman or woman who frequently travels internationally could take his/her device with them and still be reachable on a US-based phone number without paying international roaming fees. Users can also transition to the service and keep their current phone number if desired, but they will pay a small fee for porting the number over. International pre-paid minutes can also be purchased, and the rates here are also cheap and comparable to services like Skype, with rates often as low as 2-3 cents per minute.

The company has always had two primary revenue streams from the sale of its devices - one being the sales of new devices themselves (which typically come with 3-12 month access plans, depending on which model is purchased), and the second revenue stream being access right renewals. Devices themselves cost between $39.95 and $59.95, with the initial access period included. They can also be found cheaper on platforms like Amazon (NASDAQ:AMZN). Renewal contracts can be purchased in increments as small as 1 month and for as long as 5 years. As of the most recent quarter, management stated that 55% of the $62 million in annual access right renewal revenues were due to 5-year contracts, which has ensured some stability.

In 2011, magicJack came out with its first smartphone app. The app can be downloaded for iOS and Android devices and provides similar features as the traditional device. For $9.99 a year, users can upgrade to the premium edition and get a U.S. phone number. Management recently announced that free voice calling will be phased out, as the company is launching a new app called magicJack Connect. Users will still pay the same annual fee for having a local phone number in up to 60 countries. As of the most recent quarter, the company had 55,000 paying mobile app subscribers, 90% of which were on annual plans. As device sales decline, magicJack would obviously need to significantly ramp up premium app customers in order to replace the business.

Competitive Analysis

The reason for magicJack's big decline has been its inability to keep up device sales, especially in the face of increasing competition and the myriad of options that users have for VOIP services. There are many similar offerings and smartphone apps which can achieve similar services: Skype, Vonage, Ooma, and WhatsApp, to name a few. The company was first successful in the consumer space, after it had a good run in the infomercial space which helped it get a leg up as an early mover and it become a well-known brand in the consumer VOIP market. However, in recent years, there has been an increase in competition, and this, combined with the loss of the early-mover effect ensured the core business has struggled. One look at Google Trends, and we can see how the popularity has waned:

One contributor to this is likely the rise of the iPhone and the subsequent smartphone revolution, which has made the need for separate devices not really necessary in many use cases. For example with services such as Skype or WhatsApp, users are able to make free, unlimited calls to anyone else who has the same app worldwide, as long as both users have a working data connection on their phones. Since downloading of the apps themselves is free, and smartphones are becoming more and more ubiquitous and high-GB data plans getting cheaper, it becomes less useful to have a service like magicJack. Especially as many Millennials don't even have landline phone service, so there is no incentive, as they don't have a landline phone number they want to maintain and be reachable at.

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