In 2012, j2 Global (NASDAQ:JCOM) acquired Ziff Davis, creating a match that married its cloud services business to Ziff Davis' digital media business.  More than seven years later, management continues to suggest that the combined company is doing well.  

But is it really? A closer look reveals that the company may not be delivering the results to shareholders that it should. Is it time for a breakup? 

A bride and groom cake topper facing away from each other.

Image source: Getty Images.

Seven-year itch

Before the acquisition, j2 Global was solely a cloud services company. Today, that part of the business provides fax, virtual phone, data backup, email, email marketing, and customer relationship management services to a range of business customers. As a cloud services company, j2 Global survived two market crashes, and during the financial crisis, it cruised through barely missing a step. While reporting constant revenue growth throughout the crisis, however, it did suffer a mild 8% decline in net income in 2009 and then rebounded big in 2010 with a 24% gain.

Things changed in 2012 with the Ziff Davis acquisition, whose diverse digital media segment includes websites PCMag.com, IGN.com, Speedtest.net, and Everydayhealth.com.

In recent earnings calls, management has highlighted revenue, adjusted EBITDA, and free cash flow as three metrics for investors to get excited about. The first three quarters of 2019 saw revenue and adjusted EBITDA grow by about 12% from the same period in 2018. Free cash flow, meanwhile, grew by about 9% year over year. Management also points to j2 Global's repurchase of about $20 million in stock and around 10 new acquisitions, of which the company appears to be particularly excited about two: BabyCenter and Spiceworks. And then there's the increase in full-year guidance for revenue, adjusted EBITDA, and non-GAAP EPS to reflect a year-over-year growth rate of about 10%.

But these highlights don't reflect the full picture. Both divisions are seeing growth for digital media that now exceeds cloud services, but revenue isn't translating to shareholder profit. While cloud services' operating income has increased, digital media's income and operating margins for both have been declining. In turn, net income has been rather flat, having grown only about 6% since 2012. It hasn't helped that interest expense has grown to over $60 million following the accumulation of about $1.25 billion of long-term debt since 2012, though a reduction in the company's effective tax rate has provided support to net income in the past couple of years.

In terms of free cash flow, j2 Global uses a traditional measure of operating cash flow minus purchases of property and equipment.  However, I don't believe that approach gives us a fully representative view of j2 Global's actual free cash flow, because it ignores the significant cash costs (i.e., outflows) related to its acquisitions of businesses. These costs should be included, since they reflect purchases of capital assets used for operations and depreciated or amortized in operating cash flow, just like the assets that are acquired through the purchases of property and equipment line items. 

Since 2012, the company has spent over $3 billion on acquisitions. For reference, net income has totaled just over $1 billion and operating cash flows has been about $2.1 billion during that time. When acquisitions are included, free cash flow is never above $50 million in a year and is actually often negative.

Then there was the suspension of the dividend in 2019. Management said that it took that step to direct resources to more acquisitions. But where are the benefits from the previous ones?

Maybe it's time to call it quits?

This union has rewarded investors with stagnant net income, poor free cash flow, and a suspension of the dividend, while all available funds are directed to acquisitions that don't appear to be adding to the bottom line.

At least on the surface, an independent cloud services company could provide investors with a slow-growing but reliable business with a substantial dividend, whereas digital media seems to be getting worse despite the continuous investment that cloud services net income provides.

While a breakup of j2 Global isn't the only solution, I think it's a fair point to consider. Breaking up the company would allow investors to evaluate each business on its own merits. Maybe cloud services needs these acquisitions just as much as digital media to sustain its performance. Maybe digital media's situation isn't as bad as it looks. As it stands, investors simply don't know, since the current structure obfuscates the real situation. However, as separate companies, the true health of each would be seen for what it is, and the company's owners could decide for themselves what to keep and what to cut.