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Deep Value Investing With magicJack

- By Holmes Osborne, CFA

A classic example of deep value investing is magicJack (CALL). The company is rich in cash and has a high free cash flow but is losing sales year after year.

The company has 15.86 million shares, the stock trades for $7.09, and the market cap is $112 million. The company has $51.5 million in cash and no debt. This equates to $3.25 per share. Free cash flow is an outstanding $18.6 million over the last three quarters. That's a free cash flow yield of 16.5%.

But here's the problem with magicJack - sales dropped from $143.5 million in 2013 to $116.3 million in 2014 and reached $100.9 million in 2015. Like many tech companies, magicJack had a hot product, but new entrants stole market shares.

The problem with magicJack is there are too many complaints online. I mean hundreds, maybe thousands. If it were just a few, I'd say that it's not statistically significant. A few years ago, I got a Vonage line. I'm willing to pay up for it and don't want a cheap landline. Users of magicJack complain about service and connectability. Read these 195 comments online. It looks like on Amazon (AMZN) that the company is always slashing prices for its products.

Back in August, a small investment adviser, Kanen Wealth Management in Parkland, Florida, filed a 13D form with the SEC. This form must be filed when an owner plans to take an active role with a company. Kanen's clients own 637,032 shares which is about 4% of the company. Kanen wants to add two new board members. Management of magicJack postponed its October Annual Meeting. Often, when there is a proxy fight, management will move the annual meeting to make it more difficult to change board membership.

Kanen also wants to reduce "churn" to below 1.8%. This is the number of customers that the company has been losing. Kanen also wants to buy back $50 million in shares. Here is a link to a good article on Seeking Alpha.

The company is going to relocate its corporate headquarters from Israel to Atlanta. Some think this will boost the price as American money managers that cannot invest internationally will be able to then buy shares. This was to be voted upon at the annual meeting which has been postponed. I was not able to see if the meeting was rescheduled.

The CEO, Gerald Vento, makes $1.2 million in compensation. That's about 1% of revenues. The compensation package is way out of line. Vento should be making considerably less than this, even if magicJack was performing well.

Earlier this year, magicJack purchased Broadsmart for $40 million; $38 million was cash and $2 million were magicJack shares. Broadsmart specializes in what I'll call Internet phones for businesses. In the most recent quarter, Broadsmart contributed $2.8 million out of $24.6 million in total revenues.

The tough thing about investing in a company like this is that cash can evaporate rather quickly. One day, you wake up and management has spent all the cash on a huge acquisition. Having stated this, a small investor can eke out a few bucks trading a stock like this inside their IRA.

Disclosure: We do not own shares.

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This article first appeared on GuruFocus.