Rosetta Stone: Deciphering Value

10/06/2014 8:00 am EST

Focus: STOCKS

Ian Wyatt

Publisher & Chief Investment Strategist, Wyatt Investment Research

Ian Wyatt recently attended the hedge-fund oriented Value Investing Congress in New York City; here, the editor of Million Dollar Portfolio shares a new idea he uncovered at the hedge fund oriented event.

I'm going to warn you: at first glance, this stock doesn't look like a winner. But I suggest you read the full story before passing on this idea.

Two activist investors with a history of turning around troubled companies have recently placed big bets on this stock...and I think now is the time to get invested.

The recommendation is language education company Rosetta Stone (RST). Well-known for its language learning courses, the company has had its share of problems over the years.

Those challenges are reflected in the stock. Rosetta Stone's IPO priced at $18 and closed its first day of trading at $25. Since then, it's been all downhill.

The shares have lost 44% of their value in the last year. At current prices, the total market cap of the company is just $192 million.

Why has Rosetta Stone performed so poorly? The company has been slow to adapt to changing times. As the Internet grows, there are more free or low-cost language learning courses available online.

That has resulted in more competition for Rosetta Stone and put pressure on the product pricing.

With Rosetta Stone shares now at all-time lows, the stock has attracted some vocal activist investors. John Lewis of Osmium Partners discussed Rosetta at the Value Investing Congress. His firm recently bought 2.1 million shares, or 10% of the company, at an average price of $9.55. 

Osmium is a California hedge fund that focuses on small-cap Internet and media companies. Lewis is aligned with former Bain & Co. partner David Nierenberg of Nierenberg Investment Management.

Nierenberg's firm owns 7.9% of Rosetta Stone's stock and has been actively making recommendations to management.

Both Osmium and Nierenberg see considerable room for improvement at Rosetta Stone. The combination of sizable revenues, a well-known brand, poor financial performance, and a battered stock price make this stock attractive for a financial turnaround.

Rosetta is now two years into its transformation. A recent acquisition now puts the company's education software in 13,000 schools with one million students.

The company has also been tweaking its consumer product offerings. It now offers a robust online learning solution, with six-month subscriptions starting at $169 (less than the $249 for a full CD-ROM course).

I think that the financial results in the second half of this year could be a stark improvement. With very little expected of the company right now, Rosetta Stone should be able to exceed those low estimates when it reports Q3 results in early November.

The bottom line is that Rosetta Stone is a great value opportunity for patient investors seeking lots of upside. I think the stock could realistically double in the next year and is worth more than $20 per share.

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