The Two Problems With magicJack's Quarter

The Two Problems With magicJack's Quarter

You have to hand it to Whitney Tilson -- he published a report on Feb. 7, saying that magicJack VocalTec could be the next Netflix. Looking at the stock price and recent earnings upside, Tilson may be right. At $20.85 in the post-market, the stock is up 54% in just over a month. There's more to the story, though, and you need to look behind the headlines before purchasing the stock. There were a couple of ugly things about the quarter.

Financial results blew away expectations
After the close on March 12, magicJack reported revenue and earnings that blew the Street away. Revenue of $38.2 million and EPS of $0.69 smoked estimates of $35.9 million and $0.41 cents. That's a $0.28 beat on earnings. Unfortunately, the earnings beat came mostly from an income tax benefit of $35.4 million, which was four times the amount of net income the company generated. Ignoring the details, which is what the market will do, the earnings beat is huge.

Two obvious problems with the quarter
One other thing that worries me about the results is the fact that active magicJack subscribers were actually down from the prior quarter at 3.2 million. The prior quarter was down from 3.3 million, as subscribers seemed to roll off the paid service and onto the free service. This is a big concern, but even with these two significant problems, the positives outweigh the negatives.

MagicJack is a very cheap subscription at only $30 per year, so making international calls into the U.S. pays for the service with one call per month. It seems as if the company just needs to ramp up marketing to increase the size of the subscriber base. And that's just what management is doing.

Increasing distribution is just what the company needed
The company brought on several new channel partners that will double its physical presence, adding 10,000 new locations that will sell the device. These are urban sites that focus on prepaid relationships and should substantially increase the opportunity for distribution in the U.S.

High-margin subscription revenue is more of the mix
The revenue mix is favorable as well. Service renewals have increase to 40% of revenue, up from 28% in 2012, which is higher margin and more stable since the likelihood of renewing multiple times is greater in the out years.

Why use magicJack?
Telecom services are much cheaper than they have been in prior years, and Skype is free, so what does magicJack do for consumers? The value proposition seems to focus on two groups of people. The first group is people trying to call into the U.S. from international locations. MagicJack can save them substantial amounts of money, and the product will quickly pay for itself, if not on the very first call. The second group of people is those in the U.S. who need a home phone, but are looking to save money with unlimited calling and/or who want their home phone to ring on a mobile device.

MagicJack is launching a refurbished product and branding campaign in about 100 days, near the end of the second quarter. If this campaign begins to show traction, with accelerating product sales, the stock can move quickly.

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