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MagicJack: Is This Really the Next Netflix?

Back in February, hedge-fund manager Whitney Tilson made news when he called magicJack (NASDAQ: CALL  ) his next Netflix (NASDAQ: NFLX  ) . While the stock initially soared, and is higher by nearly 30% since the call, increased pressure from the likes of Facebook's (NASDAQ: FB  ) WhatsApp might kill much of this speculation.

Finding the next Netflix
If we look back at what made Netflix great, the company was ahead of a streaming curve that brought video to your smartphone and tablet, which consequently allowed consumers to enjoy content away from their TVs.

Whitney Tilson has been dead right regarding Netflix's success, and has enjoyed large returns as the company shook off its 2011 free fall to now have a combined 48.35 million subscribers and revenue growth of 24.5% in the first quarter.

In many ways, magicJack is similar, having changed the landscape of wireline phone use with unbeatable prices. Not to mention, after losing more than half its valuation from September 2012 until Tilson's 164,000 share stake was disclosed, it's easy to see why the stock reminded Tilson of his famed Netflix trade.

With that said, the big question is whether a rapid declining wireline industry, which currently consists of 70 million households, can make magicJack the next Netflix amid the growing use of smartphones as primary home-phone devices.

Tilson believes that consumers will find magicJack's $2.50 per month service unbeatable, and that a change in management will create a new identity and end corny marketing gimmicks. Therefore, with Tilson's large bet in place, and many investors following his lead, the fundamentals must now carry the company.

The fundamentals sing a different tune
In the fourth quarter of 2013, magicJack saw its subscribers fall by 100,000 over the previous quarter to 3.2 million. Many investors overlooked this fall, citing a transition with management and new direction. But the stock is currently trading lower by 10% following first quarter earnings, as subscribers fell another 100k to 3.1 million. Hence, magicJack, the next Netflix, is losing subs by the quarter -- and fast!

Moreover, the company's total activations and gross margin also declined, while spending increased a rather steep 53% year over year. Given these results, it doesn't appear that new marketing initiatives are working, and therefore it's hard to imagine magicJack as the next Netflix.

The one bright spot is also challenged
With all things considered, some magicJack investors acknowledge that its core business might not succeed due to smartphones replacing wireline services. But these investors point to a successful voice-over-IP, VoIP, business called Free Calls, which is an application that uses 4G or WiFi to make free calls to the U.S. or Canada.

In the fourth quarter, Free Calls had 6.9 million users and saw a 23% increase over the third quarter. But in the first quarter that growth decelerated to 21% over the fourth quarter to 8.4 million users. Therefore, while this segment is growing fast, and is believed to be a powerful advertising tool in the future, its performance significantly lags that of its peers.

Specifically, Skype has over 300 million users; Viber has 200 million; WeChat has 355 million; and Facebook's WhatsApp has an industry-best 500 million users. Essentially, Free Calls added 1.5 million users in three months, but Facebook's WhatsApp is adding about one million users per day. Thus, WhatsApp's market share grows larger while Free Call's growth might not be at the same rate of the industry as a whole.

In talking about WhatsApp, many questioned Facebook's decision to pay up to $19 billion for an application that had 450 million users and created just $20 million in the year prior. But in seeing how WhatsApp continues to grow, and given the news of WhatsApp expanding beyond free messaging and into free calls, this is a disruptive service that magicJack's Free Call will be competing against head to head, which should worry magicJack investors.

Final thoughts
In looking at magicJack's last two quarters, it's really hard to identify it as the next Netflix. The company operates in two key segments, and its core continues to decline while its growth unit is miles behind the industry's largest companies.

Therefore, with a $300 million market cap, magicJack is not necessarily expensive, but rather priced accordingly based on a declining core business and a fast-growing mobile-calling unit. Yet as an investor, the most significant concern must be when WhatsApp rolls out its free calling app, because if Free Calls sees a decline, magicJack's stock loss could accelerate from its two-year rate.

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Read/Post Comments (7) | Recommend This Article (1)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On May 14, 2014, at 3:13 PM, WakeUpInvestor wrote:

    It was better for the article to include Q1 results.

    In Q1 the company's total monthly active unique app users increased to 3.5 million, up from 3.3 million in Q4 2013.

  • Report this Comment On May 14, 2014, at 3:18 PM, WakeUpInvestor wrote:

    The earnings call transcript describes also a lot of positive news. I think the current stock price is a nice entry point if you have in management capabilities to grow their business.

  • Report this Comment On May 14, 2014, at 3:25 PM, WakeUpInvestor wrote:

    Have a look on the call transcript on Seeking Alpha, you see that the company has also a lot of positive things going on.

    If management can successfully execute their business plans you will see a higher stock price going forward.

  • Report this Comment On May 14, 2014, at 6:31 PM, Kevin2 wrote:

    No offense BUT you do not understand the inherent MAJOR difference between magicjack and EVERYONE else. All others are peer to peer, meaning that both caller and the person called or texted MUST have their app. magicjack users can call anyone, including a landline. ALSO, magicjack users can get a real area code+seven digit phone number. Landlines may be declining but the inherent need, want and desire for a landline or traditional phone line remain for households, small businesses, and even larger businesses. Funny, almost every doctor's office I know uses a magicjack for some reason, as do many small businesses. Comparing WHATSAPP to MJ is not valid whatsoever. ALSO, downloads versus usage are two different metrics. Heck, it is like gym memberships versus gym users. I have SKYPE but never use it. I know no one in US who uses WHATSAPP. ALSO, look at the revenues of teh companies you noted versus magicjack. Seemes like only magicjack is monetizing telecom. Sorry but I do not buy your logic.

  • Report this Comment On May 15, 2014, at 12:34 AM, BrianNichols wrote:

    WakeUpInvestor, I don't doubt that positive things are going on at magicJack, which is why I was rather positive in my initial coverage. However, the core business is declining and its Free Call app is not growing at near the rate of similar services. If Free Calls is to become a legitimate player in this space, it needs 100M+ users, and I don't see it happening anytime soon.

  • Report this Comment On May 15, 2014, at 12:35 AM, BrianNichols wrote:

    Kevin, I think your downloads to useage is interesting, which is often criticized against Twitter. But, even if only 20% of downloads are users of Skype, it is still many times larger than Free Call. At this point, no one is using the app

  • Report this Comment On May 18, 2014, at 9:51 PM, dmac1234 wrote:


    Good work. One piece that is easily missed by outside investors is their undisclosed liabilities. They have yet to disclose two material lawsuits to their shareholders. One being a $200 million dollar patent infringement lawsuit (netTALK v Magicjack Vocaltec et. al). They obviously need to keep this under wraps as it is a potential large claim against their only revenue producing hardware, but even as a foreign filer, this is a material event. Any plaintiff lawyer would have a field day gathering shareholders who bought at $X not knowing about a potential payout or upcoming trial.

    They have also not disclosed another lawsuit, Borislow and Technochat v Magicjack Vocaltec LTD for various allegations for $20+ million dollars. This one is a good read!

    What is interesting and odd is they do disclose a lower value lawsuit in their filings (less than $6M and a Cadillac Escalade, lol).

    Here are the two undisclosed lawsuits:

    netTALK v Magicjack:

    Borislow and Technochat v Magicjack:

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Brian Nichols

Brian Nichols is the author of "5 Simple Steps to Find the Next Top-Performing Stock: How to Identify Investments that Can Double Quickly for Personal Success (2014)" and "Taking Charge With Value Investing (McGraw-Hill, 2013)". Brian is a value investor, but emphasizes psychology in his analysis. Brian studied psychology in undergrad, and uses his experience to find illogical value in the market. Brian covers technology and consumer goods for Motley Fool. Brian also updates all of his new and current positions in his Motley Fool CAPs page. Follow Brian on Twitter and like his page on Facebook for investment conversations and recent stories.

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