Rosetta Stone Trading Cheap and Set for Growth

Technology has, so far, failed to allow us to upload new languages into our brains. The closest we can get is by using the highly recognizable, kiosk mainstay Rosetta Stone . The computer-based language learning company had a rough few years on the market after a high-profile, richly valued IPO followed by skyrocketing marketing expenses and competition. Though the stock recovered, it just recently received a fresh haircut, courtesy of a lackluster earnings report. Is Rosetta Stone a value tech play for the opportunistic investor? Let's take a closer look.

Earnings recap
Rosetta Stone disappointed investors and analysts this week with both a top- and a bottom-line miss. Revenues came in at $63.9 million, about $1 million shy of analyst expectations and an 8% drop from the year-ago quarter. For net income, things went into the red as the company posted a loss of $0.22 per share. Last year, the company posted a $0.09 loss. The Street was expected a profit of $0.08 for this quarter.

There was some positive news, though, for the company. Gross margins improved 330 basis points (we'll touch on this in a moment), though both operating and net margins dropped 310 and 470 basis points, respectively.

What investors need to understand is that Rosetta Stone is in a product cycle transition. The days of airport and mall kiosks selling German language packs are pretty much over. Management is committed to investing in mobile platforms and social elements to keep the company relevant.

The plan
Rosetta Stone launched a mobile app for Android last month. With no marketing (very important given its tremendous marketing spend for traditional products), the app had 50,000 downloads within three weeks. Management believes that the app, which gives users some sample products and encourages them to visit the website, will help alleviate one of the company's biggest issues -- advertising and marketing spend. By generating leads via the low-cost app, the company will be less reliant on television and print ads.

The new plan for Rosetta Stone is online learning (with user count up by nearly triple digits year over year) and digital distribution with a mobile focus. This is a much leaner, more efficient machine than the bloated kiosk model that got the company in trouble to begin with.

Foolish bottom line
Rosetta Stone is steering back toward growth, investing heavily in R&D. Moreover, adjusted EBITDA is growing very quickly -- showing the first signs of a successful turnaround strategy. This quarter, the company brought in $2.4 million -- a 39% gain over the prior year's number.

The company has $140 million in cash with zero debt on the books. With today's market cap, that means the market value of the operating business is just $236 million. The company is expecting $16 million to $18 million in EBITDA for the full year and $280 million to $290 million in revenue. With the operating business trading at less than one time sales compared with enterprise value, the company still looks very cheap, regardless of the 25% run-up in stock price over the past 12 months.

For investors interested in a value tech pick, Rosetta Stone offers encouraging signs of a turnaround for a low price.

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Fool contributor Michael Lewis has no position in any stocks mentioned. The Motley Fool recommends and owns shares of Rosetta Stone. Try any of our Foolish newsletter services free for 30 days. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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