This article is part of our Rising Star portfolios series.
I love getting a growth story at a value price.
Unfortunately, that's a very hard thing to find.
There are value prices here and there. I've recently highlighted value opportunities in flagging bricks-and-mortar retailers RadioShack (NYSE: RSH ) and Best Buy (NYSE: BBY ) (here) and health care behemoth-cum-serial recaller Johnson & Johnson (NYSE: JNJ ) (here). But none of the three holds the promise of tremendous growth. Just keeping up with inflation makes any of the three a reasonable opportunity from here.
On the other side, Amazon.com (Nasdaq: AMZN ) and Netflix (Nasdaq: NFLX ) bulls believe in the tremendous future growth prospects of their businesses, but each sells for more than 70 times earnings.
Today, I want to present a company that is going through some tough times, but is selling for the value prices of RadioShack, Best Buy, and J&J with growth possibilities closer to Amazon.com and Netflix.
That company is self-study foreign language software maker Rosetta Stone (NYSE: RST ) .
Squeezing water from a Stone
In April 2009, during the darkest days of the stock market, Rosetta Stone IPO'd to a surprisingly warm reception. Its shares were priced at $18 (already above estimates) and went up from there, topping $30 a share.
But while the rest of the market has rallied mightily, Rosetta Stone has dipped below its IPO price and sits below $14 a share.
Why? Because growth expectations have evaporated as its fourth-quarter sales dropped 5% year over year because of a struggling U.S. consumer business (its bread-and-butter market). The outlook for this quarter is even worse, with management forecasting a sales drop of 8%-14% and a net loss of $0.34 to $0.48 a share. That's spurred by a "25%-30% decline in sales to U.S. consumers."
I don't know how you define growth, but that ain't growth.
How Rosetta plans to grow
For the full year, though, management expects to grow sales despite these lagging U.S. consumer sales. Rosetta's mum on whether it'll turn a profit, but it expects to be cash flow positive (an easier feat because of its deferred sales, i.e., cash is received before sales are recognized).
Rosetta plans on making up for its U.S. consumer problems by doubling down on its international opportunities "including the opening of offices in new non-U.S. locations, the launch of Version 4 TOTALe outside the U.S., and the introduction of a conversational English solution for Asian users."
This is a result of internal studies from which Rosetta Stone concluded "consumers outside the United States spend more on language-learning than their U.S. counterparts."
It's also going to focus on boosting institutional sales.
In contrast, for the U.S. consumer operations, they're using words such as "reposition," "realigning," and "re-invigorate."
Why I'm still interested
Flagging domestic operations with the promise of international expansion sounds like a pie-in-the-sky story. The thing is, Rosetta Stone has proven to be an adept baker.
Although a loss is expected when it reports Q1 earnings in a couple of weeks, Rosetta has made some good profits in the past. It's also debt-free and sitting on a pile of cash. This gives it time to work out its problems without fearing the reaper.
When you back out its cash, Rosetta Stone is trading at 12 times earnings and less than seven times free cash flows. Not bad for a possible growth story.
The takeaway
Rosetta Stone isn't doing so great operationally these days, but at current prices, I'm willing to bet on its growth dreams coming to fruition. Rosetta Stone is building a brand and holds the promise of riding the trends toward globalization and personalized, go-at-your-own-pace education. And as Fool co-founder David Gardner (who has recommended Rosetta Stone in Motley Fool Stock Advisor) has said, "I can't find the Pepsi to Rosetta Stone's Coke. There's no comparable competitor."
I'm going to dip my toes in and buy a small position in the real-money portfolio I manage for The Motley Fool. If its share price falls from here (and I wouldn't be shocked if it did), I'll consider buying more.
We'll see if Rosetta Stone goes beyond German and Farsi and translates into growth and returns as well.
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