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Robert Abbott
Robert Abbott
Articles (881)  | Author's Website |

J2 Global: Value Investors and Institutional Investors

It is a Buffett-Munger Screener stock, but should value investors buy it like the big money managers?

June 09, 2020 | About:

The famed mutual fund manager Peter Lynch didn’t like to buy stocks that had a high level of institutional investment, even though he was an institutional investor himself. The reason? Their prices would be too slow-moving to give him the types of huge returns he chased (often successfully).

What, then, are we to think of J2 Global Inc. (NASDAQ:JCOM), a tech company with 91% institutional ownership, not to mention another 3.55% of insider ownership.

Despite the heavy institutional ownership, J2 shares have risen nearly five-fold over the past 10 years:

GuruFocus J2 stock price chart

J2 is also a Buffett-Munger Screener stock, one of just 18 on the list, as of June 9. These are considered high-quality stocks at fair value or undervalued prices.

The company began as an online faxing service in 1995, but has since expanded its list of internet services and changed its name to J2 Global. It has two main lines of business, according to its 10-K for 2019:

  • Cloud Services, which provides “cloud-based subscription services to consumers and businesses and license our intellectual property ('IP') to third parties. In addition, the Cloud Services business includes fax, security, privacy, data backup, email marketing and voice products.”
  • Digital Media, which “specializes in the technology, gaming, broadband, business to business, healthcare, and international markets, offering content, tools and services to consumers and businesses.”

Revenue from Cloud Services is relatively stable, while revenue from Digital Media is growing. Those dynamics have pushed down its operating margins.

The company cites two causes: First, Digital Media is growing faster than Cloud Services, but its operating margins are narrower, meaning that consolidated operating margins will continue to shrink.

Second, and as J2 reported in its 10-K, “the trend in advertising spend is shifting to mobile devices and other newer advertising formats which generally experience lower margins than those from desktop computers and tablets. We expect this trend to continue to put pressure on our margins.”

Despite the shrinkage, margins remain respectable, for now at least:

  • Operating margin: 20.04%
  • Net margin: 12.81%

Analysis

As we’ve noted, J2 is a Buffett-Munger Screener stock, and we can analyze the stock using the screener’s four criteria: a high predictability score, a competitive advantage, little or no debt and an undervalued PEG ratio.

Predictability

J2 has a five out of five rating, the top for predictability, for consistently growing its revenue and its earnings. Here is its history over the past 10 years:

GuruFocus J2 revenue and earnings per share chart

Competitive advantage

One of its competitive advantages, or moats, is its proprietary technology and intellectual property. In addition, it has developed or acquired a large stable of brand names, including these shown in an investor presentation from last month:

J2 brands

Quantitatively, a median return of at least 15% per year over the past decade, on return on capital and return on tangible equity, is the competitive advantage hurdle in the Macpherson model:

  • ROC: In the early part of the past decade, J2 had an outstanding ROC record, as high as 50%. But as the decade progressed, ROC declined to the high single digits before rebounding slightly. In 2019, the return on capital was 11.21%.
  • ROTE: Like several of its competitors, including RingCentral (NYSE:RNG), it has no meaningful return on tangible equity data.

Debt

The following 10-year chart shows how J2 piled on the debt—and grew its earnings per share proportionately:

GuruFocus J2 long term debt and earnings per share

Although the earnings per share numbers have increased, the company cannot be comfortable with this level of debt. Consider a couple of metrics in the financial strength table:

GuruFocus J2 financial strength

Interest coverage is less that 5, the level Benjamin Graham set as his minimum for companies with debt.

The Altman Z-Score is bordering on the Distress area and turning to the spread between the return on invested capital and the weighted average cost of capital, the difference is just 5%. Combine that with shrinking margins, and it is not an encouraging sign.

Valuation

The PEG ratio, the main valuation tool for Buffett-Munger Screener stocks, is high, but not as high as it has been in recent years:

GuruFocus J2 PEG ratio

At 1.56, the PEG ratio is high; a ratio of less than 1.0 is considered undervalued, while anything above 1.0 is considered overvalued.

Looking at other measures of valuation, the price-earnings ratio is 22.52, down from the low-to-mid 30s, and comparable with its peers.

From the discounted cash flow calculator, we get a fair or intrinsic value of $44.90, considerably lower than the current price of $81.08. That means the company has a negative margin of safety.

Reviewing all four criteria, there is little that is compelling in J2’s profile. Yes, it has provided predictable results, but at the same time, it has a narrow moat, a debt load and a PEG ratio that is relatively high. Its only claim to valuation strength is that the pandemic and economic crises have reduced its share price below recent highs. But there may be an important piece of its strategy we should also consider.

Acquisitions

J2 has acquired more than 100 companies since adopting a strategy of growth by acquisitions in 2000.

However, it has a strategy within a strategy. It pursues “programmatic acquisitions,” which should provide an outsized boost in returns. This slide from the investor presentation shows the degree of outperformance:

GuruFocus J2 aquisistions

Programmatic acquisitions? A McKinsey & Co. article explained: “Nearly a decade ago, we set out to answer a critical management question: What type of M&A strategy creates the most value for large corporations? We crunched the numbers, and the answer was clear: pursue many small deals that accrue to a meaningful amount of market capitalization over multiple years instead of relying on episodic, 'big-bang' transactions.”

Acquisitions could brighten the future, but at the same time it’s important to recognize that new streams of revenue and earnings may be necessary just to make up for shrinking margins.

Conclusion

J2 Global is a Buffett-Munger Screener company, but not a particularly strong one from a value investor’s perspective.

It has more than what I would call “no or little debt” and the share price, though lower than it has been in the recent past, provides no margin of safety. Still, for some investors, including those looking for a solid company to buy and hold for five years or more, J2 has the potential to provide satisfactory results.

As for institutional investors, I suspect most of them would fall into the latter category. For them, slow and steady beats the Lynch approach of pursuing multi-bagger wins.

Disclosure: I do not own shares in any companies named in this article and do not expect to buy any in the next 72 hours.

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About the author:

Robert Abbott
Robert F. Abbott has been investing his family’s accounts since 1995 and in 2010 added options -- mainly covered calls and collars with long stocks.

He is a freelance writer, and his projects include a website that provides information for new and intermediate-level mutual fund investors (whatisamutualfund.com).

As a writer and publisher, Abbott also explores how the middle class has come to own big business through pension funds and mutual funds, what management guru Peter Drucker called the "unseen revolution."

Visit Robert Abbott's Website


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Comments

Thomas Macpherson
Thomas Macpherson premium member - 7 months ago

Hi Bob. This is a name I haven't seen in a while! I have a general rule where I don't grade or reply to articles where I've been mentioned, but I thought I'd break that rule on just this occaision since our involvement was over a decade ago. We owned JCOM in the Nintai Investment portfolio (the Nintai Partner's corporate investment portfolio) for about 5-6 years in the period 2006(?) - 2011(?). At the time, the company had no debt and a yield of roughly 4%. It was a little cash machine at the time. We sold it after talking to management and hearing about their "tuck-in" acquisition strategy, seeing the ROIC and ROE drop (which it continued for the next decade), the company plan to take on significant debt, and starting the use of stock-based compensation. We lost out on quite a run (as you so painfully point out), but overall I'm glad we maintained our sell criteria. For us, it was a prime example of do you stick with your model or adapt it to your holding. Thanks for a great article. Best - Tom.

Robert Abbott
Robert Abbott premium member - 7 months ago

Hi Tom

Thanks for your thoughts!

I would suggest you made the right decision based on the opportunity costs. What would you have forgone if you had held the name until now?

Best wishes, Bob

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