j2 Global (JCOM): Half Cloud, Half Digital Media and All About Acquisitions

Guest write-up by Jayden Preston

 

 

Introduction

 

j2 Global brands itself as an Internet service company. At its core, the company’s goal is to participate in the monetization of the shift from analog to digital. They do so in two business segments: 1) Business Cloud Services and 2) Digital Media.

 

Business Cloud Services (BCS)

 

The main business here is providing businesses of all sizes with cloud services that meet their communication, messaging, security, data backup, hosting, customer relationship management and other needs. At the moment, the biggest value drivers are their fax and voice products, including eFax, an online fax services that enable users to receive and send faxes over the Internet; and eVoice, which provides their customers a virtue phone system. These are the original businesses of the Company and are called number-based businesses.

 

In more recent years, j2 has also built up their non-number-based businesses within their BCS portfolio. This group includes KeepItSale, a cloud backup solution; FuseMail, which provides email encryption solutions; and CampaignerCRM, a customer relationship management tool.

 

The above group of service offerings all have a subscription business model, where the lion’s share of revenue is derived from “fixed” subscription fee from basic customer subscription, with the rest from “variable” usage fees generated from actual usage of services by customers.

 

j2 Global also generates revenue from licensing their intellectual properties to third parties. However, historically this revenue source has been minimal, around 1% to 2% of segment revenue from BCS. We will thus neglect this in our following discussion.

 

Digital Media (DM)

 

Their DM segment consists of the web properties and business operations of Ziff Davis, the physical-magazine-turned-digital publisher that j2 Global purchased in 2012 for $167 million. j2 Global bought the company from private equity firm, Great Hill Partners, with the intention of providing more capital so that Ziff Davis can continue to execute its business plan of building a multi-vertical online publisher that earns revenue from video ads affiliate links, demand generation and data licensing. This is exactly what happened in the subsequent 5 years.

 

Since the acquisition, Ziff Davis has gone on an acquisition spree, spending nearly $1 billion to expand their web property portfolio. Major properties now include PCMag.com, IGN.com, Speedtest.net, AskMen.com, Everyday Health and Mashable. Revenue of Ziff Davis increased from around $50 million in 2012 to $539 million in 2017, with revenue sources from advertising and sponsorships, subscription and usage fees, performance marketing and licensing fees.

 

During 2016, their DM web properties attracted 5 billion of visits and 18.1 billion page views, up from 345 million visits and 1.1 billion page views in 2012.

 

 

Durability

 

Business Cloud Services

 

Durability of the BCS segment mainly rests on whether eFax will still be needed in the future. In 2016, fax-to-email revenue constituted 35% of the Company’s consolidated revenue, or 54% of the Business Cloud segment.

 

The modern fax machine was introduced in the US in 1964. Since …

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U.S. Lime (USLM): A High Longevity Stock in a Low Competition Industry

This is the second article in my new approach to writing for Focused Compounding each week. I will give you a look into my initial thoughts on a stock that I may then research further. At the end of this article, I will tell you my interest level (0% means there’s no chance I will follow-up with additional research on this stock; 100% means it’s already at the top of my research pipeline). This is my first article on U.S. Lime & Minerals (USLM). So, the question I have to answer here is not “should I buy the stock”, “what is the stock worth”, etc. Right now, the question is simply: should I research USLM further.

Charlie Munger is a fan of flipping how you frame a problem by “inverting”. If everyone is looking at a problem the same way – maybe looking at it upside down will give you a different but equally correct way of seeing things. Today, I’m going to “invert” the problem of finding a company with a high return on capital. Actually, what matters for us investors is a company’s incremental return on capital while we own it. What the stock earned on its capital before we invested in it and what it earns after we sell the stock isn’t what we care about. We care about the return on money put to work while we own the stock.

That’s a more difficult question to answer, though. So, let’s just start by asking if we think U.S. Lime will can earn an adequate unleveraged return on equity for a long-time into the future. Here, I am focusing on the “long-time into the future” part.

First, a confession. I personally don’t think in terms of return on equity when making my own investing decisions. Instead, I always “invert” ROE. I think of capital not as something you earn a return on but something which is a bit of a “tax” on growth. The reason I wrote about a stock like NIC (EGOV) is that if it does grow – that growth will have a very low owner’s equity tax. Maybe the stock will grow and maybe it won’t. But, if it does grow, it isn’t going to need to retain earnings to do it.

With a commodity like lime, it’s possible that the “inflation” part of any growth won’t require much capital investment. If you already own plenty of lime deposits, then it shouldn’t cost you much more to produce the same tons of lime each year – and yet, if the dollar gets 3% less valuable each year, you may be able to charge 3% more for your same quantity of lime produced.

This is the aspect of a commodity producer that’s attractive. There are other less attractive aspects to commodity producers that often make me shy away from them. But, maybe we’ll learn lime doesn’t share those qualities.

My interest in U.S. Lime is a little odd. On the one hand – as …

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Babcock & Wilcox Enterprises (BW): A Risky Stock Getting Activist Attention

I’m trying something different this week. In an effort to share more ideas with members, I’ve decided I’ll write about whatever stock I’m looking at – even if I don’t like what I see. This will give you some insight into my stock selection process at the earliest stages. It will also let me give you more regular, stock-specific content. The downside, of course, is that it’s risky. I’m risking getting you interested in a stock you shouldn’t be interested in. So, I’ll rate the initial stock ideas I write up here with an interest level (from zero to ten) at the end of the article.

This week I’m writing about Babcock & Wilcox Enterprises (BW). I once owned this stock, because I bought the pre spin-off Babcock & Wilcox and kept my shares of BWX Technologies (BWXT) through to today. I sold my shares of Babcock & Wilcox Enterprises about 11 months ago at $15.48 a share.

Where is the stock today?

It’s at $5.80 a share.

Your first step in researching Babcock & Wilcox Enterprises should be to read the old report on Babcock & Wilcox in the “reports” section of this website. That report describes what would become BWXT and BW in great detail. I’m not going to spend time here discussing what it is that Babcock does, because you have a report available to you that describes that in greater detail than probably any public information on Babcock that’s out there.

However, that report describes what those businesses looked like as of about two and a half years ago.

Some things have changed since then with BW.

Let’s start with the recent news items that might get a value investor interested in the stock. The company has attracted two major investors.

One is Vintage Capital Management. It owns 14.9% of the company and now has two board seats. You can read Babcock’s announcement of the deal with Vintage here. You can also visit Vintage’s website for yourself and see what other companies are in their portfolio.

The second – and more recent – investor in Babcock is one you’re more likely to have heard of: Steel Partners.

The details I’m going to give you now come from Steel Partners’ 13D on Babcock filed February 5^th. Steel Partners owns 11.8% of Babcock & Wilcox shares. These shares were bought between January 26^th and February 5^th at prices between $5.99 and $6.58. The stock now trades at $5.80. So, you can get your shares a bit cheaper than Steel Partners got their shares. That’s one reason for writing this up obviously.

Another reason is that the stock trades at $5.80 a share and Steel Partners apparently wanted to buy all of Babcock for $6 a share. This quote is from the 13D:

“On December 15, 2017, Steel Holdings made a proposal to the Issuer to acquire all of the Shares not owned by Steel Holdings or its subsidiaries for $6.00 …

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NIC (EGOV): Loses Its Biggest Customer (Texas) – Stock Drops 20% Instantly

As I write this, NIC (EGOV) stock is down 20% for the day. For potential buyers of the stock, there have been two developments in the last 24 hours. One, EGOV announced it lost the Texas dot org portal. It is still in the running for payment processing on behalf of the state. Texas, as a whole, accounted for 20% of EGOV’s revenue. It may have accounted for even more than 20% of the company’s profits. Two, shares of EGOV are now down 20% in price. EGOV has no debt and has some net cash. So, a 20% decline in the stock price is equivalent to a 20% re-pricing of the entire business’s value. Right now, I can’t say that one of these events is clearly outsized versus the other. So, I can’t say that the news of the last day should make you much more or much less inclined to buy the stock. That’s because the loss of Texas is a big loss for the business. However, we already knew: 1) That any business EGOV has could be lost and 2) That any re-bid for something like Texas could be done at a lower level. So, the expected probability of losing Texas wasn’t 0% before yesterday. And yet the stock dropped by almost 20% when the company announced it has lost revenue of about 20% of the total company. You see how the similar scale of the two items – the loss of a profitable business and the reduction in the stock’s price – make it difficult to say whether the stock has become a lot more or a lot less attractive.

So, I would caution those who say this clearly is a buying opportunity or this clearly is the moment to bail out on the stock – right now, I don’t see this moment being either of those things.

What do I see?

There were some other points discussed in the earnings release and the earnings call transcript. You can read the full transcript at Seeking Alpha.

1. Same-state revenue growth in interactive government services continues to be excellent and management continues to expect it to keep being excellent. Interactive government services – these exclude driver history records – were up 11% for all of 2017. As discussed a little in the article I wrote on EGOV and even more in the comments to that article, a fast rate of growth in same-state interactive government services means EGOV will be less reliant on car related revenue and may even be able to grow its overall business even if it can’t win more state contracts and keeps losing some contracts.
2. The information (really “guidance”) provided on taxes was also excellent. In 2018, the company expects its tax rate – “before any discrete items” – to be in the range of 24% to 25%. Historically, EGOV’s tax rate had been in the high 30s. It was between 35% and 40% in something like 13 of the last 15 years. So,

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Carrols Restaurant Group (TAST): America’s Biggest Burger King Franchisee Comes with “Rights of First Refusal”

Guest write-up by Vetle Forsland

 

Overview

 

Carrols Restaurant Group (TAST) is the largest Burger King franchisee in the US. They are currently operating 753 Burger King restaurants on the east coast of North America, in 16 different states. That accounts for about 10.2 % of all Burger King locations in the USA.

 

Carrols was founded in 1960. At the time, they were operating an independent burger chain. In 1976, they started converting those stores to Burger King locations, and they became a franchisee. In the 1990s they were already one of the nation’s largest Burger King franchisees. Later, Carrols bought the Pollo Tropical and Taco Cabana brands, which accounted for about 50 % of the company’s revenue in the 2000s. In 2012, Carrols spun off the two latter businesses to Fiesta Restaurant Group, and Fiesta’s market cap is currently around $520 million vs Carrols’ $450 million. The spin-off took place shortly after 3G capital took control of Burger King’s owner, Restaurant Brands International (QSR). A part of 3G’s plan was to give more power to franchisees, as these businesses in the past were capped to a certain amount of Burger King locations, leaving BK restaurants fragmented and underperforming, as a result of little to no economies of scale.

 

Since the spin-off, Carrols has put significantly more focus on expanding their business and acquiring other Burger King locations. Most notably, they acquired 278 restaurants from QSR in 2012. Sales have increased 23 % annually on average since the spin-off, versus a 1 % decrease a year from 2000-2011. Additionally, the number of restaurants has increased around 24 % since 2012, compared to a 1.4 % decrease in locations in the 11-year period before the spin-off (Carrols had an IPO in 2004, so store counts before 2000 are non-existent/very difficult to find).

 

The 2012 acquisition of nearly 300 restaurants from QSR was financed through debt and preferred stock issued to QSR. So, Burger King’s owner basically bought a 21 % equity stake in Carrols. Executive officers and directors also own 5 % of the company, so 26 % of Carrols is owned by insiders. The 2012 deal included a preapproval by Burger King for Carrols to expand to 1,000 restaurants in “Rights of First Refusal” states, and the ability to expand beyond this region with Burger King’s approval. Carrols therefore has Rights of First Refusal in 20 states on the East Coast, paving the way for more acquisitions in the near future. 21 % of Carrols’ restaurants today are in North Carolina, 17 % of them are in New York, and 31 % are in Indiana, Ohio and Michigan. So, 69 % of their restaurants are in 5 states, diversifying their revenue but at the same time making the company vulnerable to potential economic downtrends on the east coast.

 

Durability

 

Restaurants have been around for hundreds of years, and serves as an important part of modern culture and our society today. There is no need to analyze …

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Dunkin’ Brands (DNKN): A 100% Franchised Business Built on a “Morning Ritual”

Guest Write-up by Jayden Preston

 

Overview

Dunkin’ Brands owns two well-known quick service restaurant (QSR) brands, i.e. Dunkin’ Donuts that sell coffee and baked goods, and Baskin Robbins, selling hard serve ice cream. Dunkin’ Brands is now purely a brand owner, as they currently employ a 100% franchised business model, with over 20,000 points of distribution in more than 60 countries worldwide.

 

They organize their business into four segments: Dunkin’ Donuts U.S. (DDUS), Dunkin’ Donuts International (DDI), Baskin-Robbins International (BRI) and Baskin-Robbins U.S. (BRUS)

 

Dunkin’ Donuts is the more important brand to the business. Despite the term “Donuts”, it has moved away from its root to become a major coffee beverage house in the US. It is a national QSR leader in serving coffee, selling more than 1.9 billion cups of hot and iced coffee and espresso-based beverages per year. For 11 straight years, Dunkin’ Donuts has been named the top brand for customer loyalty in the out-of-home coffee category in the US. In FY2016, systemwide sales of DDUS was $8.6 billion, with 58% coming from coffee and other beverages. The brand is even considering shortening its name to Dunkin’. For Dunkin’ Brands, their Dunkin’ Donuts segments generated revenues of $630.9 million, or 79% of total segment revenues in FY2016. Dunkin’ Donut’s brand equity is much stronger in the US, generating $608.0 million in revenue, while the international segment only had $22.9 million in revenue.

 

The situation reverses for Baskin-Robbins. Its international segment generated revenues of $119.0 million, while the US segment produced $47.5 million. The brand develops and sells a range of frozen ice cream treats such as cones, cakes, sundaes, and frozen beverages. The brand is highly recognizable in the US, where it enjoys 89% aided brand awareness in the US and internationally in South Korea, Japan and the Middle East.

 

As of December 31, 2016, there were 12,258 Dunkin’ Donuts points of distribution, of which 8,828 were in the U.S. and 3,430 were international, and 7,822 Baskin-Robbins points of distribution, of which 5,284 were international and 2,538 were in the U.S.

 

 

Franchising Agreements

 

Let’s talk first about their franchising agreements.

 

A franchisor usually has several means to make their franchisees “captive”: 1) Royalties as a percentage of gross sales, 2) Rental payments on properties, 3) Required purchases from a company-owned supply chain and 4) Marketing fund pay-ins.

 

As with many franchisors, the majority of the Dunkin’ Brand’s revenue comes from royalty income, usually set as a percentage of gross sales made by franchisees, and other franchisee fees, including initial franchisee fee in the US. This is an upfront payment for the right to operate one or more franchised brands from Dunkin’ Brands.

 

The effective royalty rates for the different segments are 5.5% (DDUS), 4.8% (BRUS), 2.4% (DDI) and 0.5% (BRI). The much lower royalty rates for BRI reflects a difference in business model for that segment. Dunkin’ Brands derives revenue from the sale of ice cream …

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NIC (EGOV): A Far Above Average Business at an Utterly Average Price

NIC (EGOV) is a company that’s – as the ticker suggests – focused on eGovernment. In particular, NIC is focused on providing internet based interactions with state governments in the United States.

This is not a truly huge market. EGOV is by far the market leader and yet it only has $331 million in revenue, $78 million in pre-tax profit, and $59 million in after-tax free cash flow. The company is valued at $1 billion (the market cap is greater, but the company has net cash). To put this in perspective, EGOV has about half the addressable market for state government portals in the U.S. So, the stock market is saying that the entire potential state government portal industry – for all 50 states – is worth no more than $2 billion.

To me, that sounds a lot like a niche. And that’s what got me interested in EGOV. Actually, my co-founder, Andrew, got me interested in EGOV. But, I think my interest in the stock quickly outstripped his own.

In the U.S., government clients can be broken down into: 1) school districts, 2) cities / towns / municipalities, 3) counties, 4) states, and 5) the federal government (including military branches and various agencies). The biggest available government contracts are at the federal level. And the greatest number of available contracts are at the local level.  For example, a Department of Defense contract would be a deal serving just one client, but the client would be very big. The Department of Defense has an annual budget of $534 billion. Meanwhile, the largest state government in the U.S. (California) only has an annual budget of $183 billion. Keep in mind, the median U.S. state by population (Louisiana) is about one-eighth the size of California. So, the average state’s budget might be 5% of the Department of Defense’s budget.

The biggest state with which NIC does business is Texas. It is the second most populous state in the U.S. (behind California) and yet we know that the revenues from providing eGovernment services through the Texas.org portal are only about $64 million a year (EGOV’s 10-K tells us that Texas is 20% of NIC’s total revenues and NIC’s total revenues were $318 million last year).

It may seem like I’m throwing a lot of numbers about market size at you here for no reason. But, I think there’s a very important reason that goes to the core of whether you should or shouldn’t invest in EGOV.

How niche is this business?

How competitive is this “industry” now?

And how competitive is it likely to get?

My guess – as long as EGOV stays in its niche of providing individual online portals for the 50 U.S. states – is that isn’t not very competitive now and it’s not likely to get much more competitive in the future. However, if EGOV strays from operating “dot gov” sites for the states into trying to win business with federal agencies, city governments, etc. (which it is already …

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Cars.com (CARS): A Cheap Enough Stock with a Clear Catalyst and Tons of Rivals

About a week ago, Starboard Value disclosed a 9.9% position in Cars.com (CARS). Starboard Value is an activist hedge fund. It is probably best known for its 294-page presentation on Darden Restaurants (DRI) back in 2014. You can read that presentation here (PDF). Cars.com is a 2017 spin-off from Tegna (TGNA). Tegna is the rump of the old Gannett. It consists mostly of local TV stations. The public company now called Gannett (GCI) was spun-off from Tegna (then known as Gannett) in 2016. It consists mostly of USA Today (a national newspaper in the U.S.) and about 100 local newspapers.

So, in a sense, the public company Cars.com was formed as a break-up of a break-up.

Cars.com is a research website for car shoppers. Publicly traded competitors include CarGurus (CARG) and TrueCar (TRUE). TrueCar went public in 2015. You can read its IPO prospectus here. CarGurus went public in October of this year. You can read its IPO prospectus here. Because Cars.com was a spin-off instead of an IPO, the SEC document it filed is different. You can read Cars.com’s 2017 spinoff document (its S-1) here. The company has yet to file a 10-K. You can read the most recent 10-Q here.

I’m not going to describe what Cars.com does, because you can visit the website or download the app (today, most people use the app) and play the role of customer for yourself. No description I can give you will explain the company better than having you just give the website a whirl.

So, I’m not going to explain Cars.com’s business. What am I going to do?

I’m going to explain why I’m writing to you about the stock.

I’m writing to you about Cars.com stock for 3 reasons:

1. An activist hedge fund, Starboard Value, now owns just under 10% of the company
2. The stock’s history is that Cars.com was bought by Gannett (then a TV and newspaper company) in 2014 and then Gannett broke into two parts in 2016 (Cars.com went with the TV part) and finally Cars.com was broken off of an already broken-off company. So, there are no long-time owners/analysts/etc. of Cars.com stock and many of the investors who have held the company’s – or its predecessor’s – shares were not originally interested in owning a website.
3. Some competitors of Cars.com trade at much higher multiples of sales, earnings, etc. than Cars.com does.

In other words: this is a Joel Greenblatt “You Can Be a Stock Market Genius” type situation. The company is the end result of a fairly recent (2014) acquisition and two very recent (2016 and 2017) spin-offs. Most importantly, the stock appears to be a relative value.

Is it a good business?

 

Quality

The business model is theoretically a good one. And the company’s current financial results are very solid. A website like this has economics similar to a local TV station. For full-year 2017, management is guiding for an adjusted …

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