Whitney Tilson: "MagicJack: My Next Netflix"

MagicJack: My Next Netflix

Whitney Tilson, February 7, 2014

What do Amazon, Costco, Netflix and Southwest Airlines have in common? They offer their customers big savings and great service. Are Americans smart enough to figure this out? Of course! These have been some of the most successful companies of all time, vastly outperforming their peers and delivering phenomenal returns to shareholders over long periods of time. Imagine investing in one of these stocks when they were small companies…

In fact, I did just that with Netflix 16 months ago when I pitched it at my Value Investing Congress when it was at $54.44 (click  hereto see the slides I presented that day) and have made almost eight times my money since then.

Not surprisingly, I’m always looking for my next Netflix: another stock with multi-bagger upside potential. Such stocks tend to have the following 10 characteristics:

1)      A tainted company with a beaten-down, heavily shorted stock;

2)      Great management;

3)      Fixable problems;

4)      An enormous, global market;

5)      Big, lumbering competitors that are resistant to change;

6)      A paradigm-shifting technology or way of doing business;

7)      A position of market leadership in the new arena;

8)      Attractive economic characteristics: high margins, low capital intensity, robust cash flows, a strong balance sheet, and customer acquisition cost far lower than the lifetime value of each incremental new customer; and

9)      A moat around the business to ensure that the company’s market leadership and attractive economic characteristics endure;

10)  An extraordinary value proposition to customers, combined with great service, resulting in intensely loyal customers who are “evangelists” for the company.

Netflix had every one of these characteristics 16 months ago and, I believe, magicJack has – or will soon have – all of them as well:

1)      A tainted company with a beaten-down, heavily shorted stock. MagicJack’s stock, at $13.75, is barely half its peak reached in September 2012, trades at a mere 5.6x trailing EPS and 3.3x EV to EBITDA, and 29% of the company’s shares (and 43% of the float) are sold short.

2)      Great management. I’ve met three times with the new management team (which has only been in place for a few months without interference from the founder and former CEO), and I’m extremely impressed with them and their track records.

3)      Fixable problems. MagicJack’s problems – spotty customer service, unsophisticated marketing, unprofessional web site, and the tendency to manipulate the stock – were all attributable to the former CEO, and are rapidly being fixed.

4)      An enormous, global market. In the U.S. alone, there are 70 million households with either plain old telephone service or a bundled “triple play” of TV, internet and phone service from their cable company. While the number of people “cutting the cord” and getting rid of their home