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J2 Global Communications
Some Things to Think On

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By yttire
March 30, 2005

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Here you are, holding your breath, holding your pants because you have to go and you have to read to the bottom of this note before you go, and you are not sure you are going to be able to wait that long, because, well, there is a lot to read, but you know if you make it to the bottom you will be rich, wildly rich, if not monetarily than in ideas, and in that my friend, you are correct.

But lets hope for the monetary aspect as well, shall we?

The problem with stock picking is that we are not picking stocks, we are picking businesses, and unless you are buying businesses you are buying hot air. However as we are all seeing here in small cap world the business itself changes perception fast, and your job is to root through the wreckage and find the sorry losers who have been jettisoned for no good reason. Basically, it is like hunting in the trash for that piece of pizza you threw out last night and you are hoping that the yogurt did not spill on it because the mac and cheese in your fridge has hair. So you are looking for a stock that is on hard times.

And it appears there are a lot of them as of late.

However, I am going to focus on one, not simply because I am biased, but also because some of the many great opportunities coming to you this one has an exceptional record.

My pick is JCOM. It got nailed yesterday after the 10k came out and they warned about possible FCC regulations increasing costs.

They have a historical revenue growth rate of 66% a year. That is correct. It is like the Challenger rocket flying up into space. Bad analogy. They have an unbelievable record of making money- and they do it by selling fax services. Primarily, receiving faxes in an email box. Strangely, there are others that do it better, and cheaper, but eFax takes home the prize for revenue growth. Just like other companies we know and love to hate, they win while we suck our thumbs and moan in our beer and wonder why we didn't invest in them earlier. They are partnered with evil powers, which gives them a marketing edge. No kidding.

Will they sustain this revenue growth? No way. But we don't need a huge amount of growth to support this business where it is priced now. It's current P/E is around 29, and its forward P/E is around 16. They are forecasting high growth (40%) for this year.

Now we have to ask ourselves- how is this a business model? They have competitors with no moat to entry. They have a product you can switch easily and the revenue will all wash away. And they have a price multiple.

The answer is the above paragraph is wrong on all counts. They have competitors, but no competitors with their 8 million subscribers. That is to say- JCOM offers a free service to 8 million businesses, and has only converted 500 thousand of them. There is simply a high barrier to entry for someone attempting to get those 8 million businesses. And that 8 million number is up from 5 million a year ago. The world is converting to eFax like a communist plot.

You can not switch to another product easily. You can switch to another product expensively. Even if the other product is cheaper on a month-by-month basis- you have to pay for that.

Why? Because JCOM owns the numbers with which those businesses do business. Those small companies hand out business cards, spend hours talking up clients, phone, fax, make web pages and do everything in their power to get business- which contains JCOM's proprietary ownership of the fax number. JCOM owns the fax number, and it is extremely risky and expensive for a small business to switch out a fax number. Their old clients will send faxes, which will vanish into la la land. It is not insurmountable- but it makes an expensive switching cost. You lose not only on past investments in advertising, but also in potential lost business. Therefore- JCOM has a business model which is solid enough to stand on. To invest in.

However, there are certainly risks here. If the FCC does raise charges on phone line connections than JCOM runs some real risks- it will not lose much existing business, they already raised rates and experienced no loss in customers- but it will make it less profitable (or negatively profitable) to run the free eFax business, which is the core of their recruitment effort for new customers. This would mean their growth would slow like a car entering DC at rush hour. How much? It would depend on the hike. If they dropped all free services, they would get a huge influx of customers hanging onto phone numbers and then a sudden and dramatic slowdown to the rate other offerings provide.

JCOM does lose 3% of its customer base each year, so there is definite attrition, however it is difficult to assess how much of this is due to businesses closing down shop (some 70% do in the first few years so it is expected they should show loss of subscribers) vs dissatisfaction with the service.

There are also a slew of other risks if you look through the 10k, but the primary ones seem to be federal government regulations (either of costs, of the ability to secure phone lines, or the ability to have access to certain area codes which are preferable for their clients).

Also, there is the risk of another technology coming along and replacing them. This comes to the second part of why JCOM is a good business. I mean, faxes are old. They are outdated. They date back to the Stone Age, or at least back to when they had not spotted planets outside our solar system. In fact- this is true, and it is their rock. Because paper documents trace back to the stone age, our government sees fit to demand paperwork to back up contracts- buying houses- buying cars- making any sort of contract- the entire foundation of our mercantile system- is based on paperwork. It is doubtful this will change anytime soon. It is too easy to forge electronic documents. Therefore, as long as our mercantile system is contract based, there will be a paper component, and there will be those who wish to send this paperwork to someone else who wants to store it. Enter JCOM (or its ilk). Perhaps paperwork will all go away, but it seems unlikely. I personally have paperwork stacked in piles for only one purpose- in case I need to flash it in front of some government official. The IRS. The claims adjustor. The guy who protects my house when squatters come and move into my living room and eat all of my mac and cheese in the fridge.

Anyway, I think JCOM is now attractively priced with some risk. I think there may well be better entry points in the upcoming months until the next 10Q comes out- look for them, and be ready to pounce. This is a better business than many that have come through GEM land, and although there are real risks you have to have some courage or else get out of Dixie.


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