Building a Castle in the Cloud

06/01/2012 10:30 am EST

Focus: STOCKS

Taesik Yoon

Editor, Forbes Investor and Forbes Special Situation Survey

This Internet play has a number of revenue sources being mined well, and the trend is undeniable, writes Taesik Yoon of Forbes Investor.

j2 Global (JCOM) is a global provider of cloud services used by individuals, small- to mid-sized businesses, large enterprises, and government agencies.

Cloud services are services that are hosted on the Internet and delivered directly to PCs, telephones, cell phones, and other computing devices. JCOM’s cloud offerings include:

  • online fax services that enable users to receive faxes as e-mails and to send faxes via the Internet
  • virtual phone systems with enhanced services
  • e-mail, archival, and perimeter protection solutions
  • enhanced e-mail marketing solutions
  • secure online data backup services
  • customer relationship management (CRM) solutions designed to increase sales and efficiency for customers

These services are marketed under the eFax, eVoice, Fuse-mail, Campaigner, KeepItSafe, Landslide and Onebox brand names. Revenues are derived primarily from customer subscription and usage fees.

Total paying telephone numbers at the end of 2011 stood at 2.0 million, up from 1.9 million the prior year. JCOM also generates revenues from licensing patents and from a share of sales, advertising, and revenues from premium-rate telephone number customers.

Cloud-based services offer several advantages over similar services run locally (i.e. directly from a device). They are generally less resource-intensive. Additionally, because voicemails, e-mails, and other important data are stored online, they can be retrieved from multiple devices.

These and other benefits help JCOM’s customers reduce or eliminate costs, increase sales, and enhance productivity, mobility, business continuity, and security. As such, more businesses have been purchasing cloud services to meet their communication, messaging, data backup, and CRM needs.

Fourth-quarter revenues rose 19.8% year-over-year to $85.1 million. A 5% climb in total paying telephone numbers helped subscriber revenues grow 19.7% to $84.2 million.

The adjusted operating margin, which excludes gains on investments, acquisition-related costs, and other special items, improved 103 basis points to 47.32%. This helped minimize the negative impact of a materially higher tax rate. Adjusted net income climbed 10.2% to $30.6 million, or 64 cents per share. This was a penny ahead of the consensus estimate.

We expect demand for cloud services to help drive JCOM’s top line over the foreseeable future. This is consistent with the company’s own 2012 guidance for total revenue growth of 4.5% to 10.5%. However, adjusted earnings are expected to be flat year-over-year. This implies operating margins will shrink in 2012, which may be turning investors off from the stock.

Yet JCOM’s guidance does not include any favorable impact from repurchases under its stock buyback authorization, which allows for the repurchase of up to 5 million shares. It also does not factor in contributions from any meaningful acquisitions. Given the company’s exceptionally strong balance sheet—with $221 million in cash and investments at the end of 2011 and no debt—and prior acquisition history, we would not rule out either possibility.

More importantly, we are not too concerned by the lack of earnings growth in the current year, since it is the result of higher expected expense levels stemming from increased investments designed to support new services the company has acquired over the past year-and-a-half.

The increased spending is also expected to support geographic expansion and improve upon the company’s initial success with cross-selling efforts launched in 2011. For example, JCOM recently augmented its portfolio of cloud services with the acquisitions of Australian-based cloud voice service provider Zintel Communications and UK-based Zimo Communications.

Zimo owns Numberstore, a cloud-based provider of phone numbers and associated value-added services in the UK. Because the benefits from these investments will not be realized immediately, they will likely depress margins over the near term.

However, they should position JCOM to get the most out of the current trend towards cloud-computing, which has plenty of additional growth potential. As such, we think the temporary hit to margins is a small price to pay if the net benefit is increased and sustained growth over the next several years.

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