Electronic fax is so yesterday that when I think about it I also think of dial-up internet, I am working in the Australian Treasury, I had an American girlfriend with a PhD in economics and the Spice Girls are the hottest band in the world. (And my girlfriend objected to the Spice Girls which did not seem sporting...)
Actually electronic fax does not figure very much in my life at all. I have sent only one or two faxes in the last decade and I have received none. The closest I get to faxing is scanning a document and emailing that.
So it was a great surprise to come by J2Global.com (JCOM:NASDAQ). You see J2Global is an electronic fax company - it is the old e-fax. It is the only brand in electronic fax I remembered.
And I could not imagine that it possibly had about 300 million revenue and a market cap of almost $1.5 billion.
Like really? Like who are you kidding?
And note this was a price to sales ratio of five - a number consistent with the most profitable or highest growth companies in the world. I mean there are not many companies in established businesses with a price to sales ratio of five.
And very few businesses that should be in such obvious decline as electronic fax would ever deserve such a ratio.
But there it was, listed, with a big cap, fairly transparent looking accounts and a stock that slowly levitated over the decade in much the way that bricks don't.
This was so unexpected a find that I really did double-take.
There was a bull-story relentlessly promoted of course - which was that J2Global was a "cloud company" in the sense that internet-fax was one of the first applications out there "in the cloud" but it was a cloud company a little less sophisticated than Hotmail or the AOL "walled garden".
I had to find a customer
I was wondering whether my experience with fax machines (they have rapidly become irrelevant) was the universal one. I could not imagine being a subscriber (at $16.95 a month no less) to efax and wondered why anyone else was.
I rang our foundation client - an industrialist about 15 years older than me who is on the road quite a bit. I thought he might be a subscriber - but he can't imagine wanting to join. He wondered where I found companies like this.
So I kept asking people whether they would subscribe to an electronic fax person - and I found one - a fund manager who thought he paid $3 a month and it was before MyFax purchased his supplier (MyFax is owned by Protus - more about them below). My friend now pays $6 a month even though the cheapest price on the MyFax website is $10 and has been for some time.
The price differential was so large ($3 a month versus $16.95 per month) that I wondered why anyone would pay it. It is fairly easy to find suppliers at $8-9 a month. Faxage.com and others have prices for very light users down to $3.50 per month. And lets face it - most people who use faxes are very light users...
The first explanation for the continuation of the business was inertia (which is the same reason why some people still use dial-up internet).
Inertia or ripping off your customers?
YouTube is a valuable resource - you can usually find someone complaining about or proselytizing for a product.
In this case it was complaining. You see it is very hard to cease being a efax client. The video below shows you how when you dial up they tell you that you should cancel your account on the net. On the net it gives you a number to dial up (with a long wait). That gives you another number (with a long wait) and that tells you to cancel on the net.
You get the idea: phone center hell.
I wondered whether this was typical: whether the modus-operandi of this business was to keep ripping people off even when they wanted to cancel.
Alas there is strong evidence that it is. One of my colleagues found that the Better Business Bureau gave the company an F rating (on an A+ to F scale). The Better Business Bureau had closed 419 complaints against the company in the last year. Here is a summary:
Most complainants allege billing disputes or difficulty canceling accounts. Many customers complain of excessive hold times, anywhere between 10 minutes and up to several hours, when attempting to speak to a customer service representative. Other complainants allege the fax service does not work or fax numbers are reassigned without notice or justification. A few complaints allege the company does not disclose the fact that the number of faxes you can send is limited or that there is a per page charge for every outgoing fax. The company responds to some complaints by canceling accounts, issuing refunds, and apologizing for the interruption of service. In a few cases, the company retrieves and reactivates fax numbers or verifies the service is operational. The company further responds by claiming customers have more than one account or that they have no evidence of cancellation.You see these guys are appear a little sharp (at least in the view of the Better Business Bureau). You cancel an account and they will keep billing you claiming no evidence of cancellation or that you have more than one account (as if anyone would have more than one electronic fax number).
This sort of business behavior is harder to pull off outside the US. The US seems to have a culture that accepts consumer rip-offs (predatory lending for example). Other cultures think of unconscionable conduct. This is unconscionable. In the US I guess it works until they get a class-action lawsuit.
Anyway it is worse than just relying on inertia. The company raises rates regularly and rely on inertia not to object to or shop higher rates. Here is a blog post which complaints about their rate raising:
eFax today announced that they are raising their already gouging rates from $12.95 a month to $16.95 a month, unless you want to “lock in” the $12.95 a month rate by paying it annually (i.e. pay the $12.95 x 12 up front to the tune of more than $150.00 a year).
I call it “gouging” because eFax originally started out with this model: you could either pay to get a fax number that was local to you, or get a free fax number which could have an area code in any part of the U.S. except local to you.
At that time it cost a mere $4.95 to have the local number, which was part of a service called “eFaxPlus”. So eFax Plus was only $4.95 a month, and that was as recently as the year 2000.
However, once they got you hooked (and having distributed your fax number far and wide) they boosted their fees to $12.95 a month - more than double what you’d signed up for - and you were stuck, unless you were willing to lose the fax number you’d given out to everyone. Still, it was month-to-month so you could make a decision each month as to whether it was worth it.
But now they are doing it again, saying either pay that $12.95 a month up front for a full year (a total of $155.40 a year), or pay the exhorbitant rate of $16.95 a month. And, if this prompts you to decide to cancel the service, let me tell you up front that there is no easy way to cancel your account [the blog post purports later - not quoted - to tell you how to cancel the account].
Here is the relevant portion of the email that I myself received today:
“The monthly subscription fee for all eFax Plus numbers on your account will be changing.
Starting on your next billing date, the monthly fee for each of your eFax number(s) will be $16.95.
You will also receive an enhanced level of eFax service.
Receive up to 130 fax pages and send up to 30 fax pages free each month. Store faxes up to one year with your eFax Message Center. Get 24/7 live phone support.
To lock in the old $12.95 rate for the next year, switch to annual billing by clicking here.
Please respond by October 01, 2006.” ...
But here is the nub of it. They raised the rates to $16.95 per month in 2006. They have not raised them since... there is a limit to how much you can gouge - even if you make it so hard to exit that people have to stay in a phone center queue for three hours or take you to the Better Business Bureau just to exercise their rights...
And nobody would rationally sign up - as the same blog post makes clear this service is at least twice as expensive as the competition. If you do a simple internet search you would find that efax is poorly rated, and actively disliked by consumer groups. This is a dumb product to sign up to.
But the revenue is still growing. Why? Why the hell would anyone want to sign up to this?
My first thought was that the accounts were a lie.
Falsifying the fraud theory
I see a lot of stock fraud - and I immediately thought that they were just making the rising revenue up. After all I could not see why revenue from electronic fax should be rising. It just seemed so unlikely.
And they really are (at least in the words of their complaining customers) nasty. Customers just say the company is a scam. Just the sort of people who would fake accounts - or so I incorrectly thought.
Bolstering my theory that they were faking their accounts was their less-than-mainstream auditor. They use Singer Lewak LLP. The SEC database allows us to see all the other companies audited by them. It is not a list of known frauds - but it is hardly inspiring.
So I tried to puzzle how they did it. The company generates lots of cash but pays no dividend which makes it hard to confirm the cash is real. But if the cash is real the profits are real. And if the cash is not real the profits are not real.
So I tried to work out whether the cash was real. Here is the balance sheet:
j2 GLOBAL COMMUNICATIONS, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
December 31, 2010 and 2009
(In thousands, except share amounts)
Cash and cash equivalents
Accounts receivable, net of allowances of $2,588 and $3,077, respectively
Prepaid expenses and other current assets
Deferred income taxes
Total current assets
Property and equipment, net
|Patent and patent licenses, net||18,102||14,955|
|Customer relationships, net||36,674||7,743|
Other purchased intangibles, net
Deferred income taxes
LIABILITIES AND STOCKHOLDERS’ EQUITY
Accounts payable and accrued expenses
Income taxes payable
Liability for uncertain tax positions
Deferred income taxes
Total current liabilities
Liability for uncertain tax positions
Deferred income taxes
Other long-term liabilities
Commitments and contingencies (Note 8)
Preferred stock, $0.01 par value. Authorized 1,000,000 and none issued
Common stock, $0.01 par value. Authorized 95,000,000 at December 31, 2010 and 2009; total issued 53,700,629 and 52,907,691 shares at December 31, 2010 and 2009, respectively, and total outstanding 45,020,061 and 44,227,123 shares at December 31, 2010 and 2009, respectively
Additional paid-in capital
Treasury stock, at cost (8,680,568 shares at December 31, 2010 and 2009, respectively)
Accumulated other comprehensive loss
Total stockholders’ equity
Total liabilities and stockholders’ equity
During 2010 cash dropped from 197 to 65 million - the difference been spent on acquisitions. Goodwill went from 81 million to 282 million and the cash flow statement reveals that they spent $249 million on acquisitions - that $249 million being cash generated over the business over time.
If that $249 million was real then the business is real - and there is no wholesale fakery in the accounts. If they bought real assets from real, unrelated people then I would conclude the accounts were probably more or less OK. If they purchased assets from parties I could not identify then they could be from fake parties or related parties. The only assets you can buy with fake cash are fake assets and you tend to have to buy fake assets from fake parties or related parties. So I went looking for the assets purchased and who they purchased them from. This was my test of fakery. [Lots of people have asked how I do this. This is as good an explanation as any though there are more than a few tricks in the Bronte arsenal...]
So I went looking for what the acquisitions were. Here is the key text from the 10K:
During 2010, j2 Global acquired eight businesses: (1) the voice assets of Reality Telecom Ltd, (2) the fax assets of Comodo Communications, Inc, (3) the unified messaging and communications assets of mBox Pty, Ltd, (4) the assets associated with the email hosting and email marketing businesses of FuseMail, LLC, (5) the assets of Alban Telecom Limited, a UK enhanced voice services provider, (6) Venali, Inc., a Miami-based provider of enterprise Internet fax messaging solutions, (7) keepITsafe Data Solutions Ltd., an Ireland-based provider of online backup services, and (8) Protus IP Solutions, Inc., a Canadian provider of Software-as-a-Service (SaaS) communication services and solutions to the business market.Now I had a work program. I wanted to find out what I could about the acquisitions. If the acquisitions were real companies from reputable parties and over $200 million was paid I could confirm that the business was substantially real. If they were acquisitions from dodgy-brother-related-parties then I would be ringing the Longtop-type-fraud bell.
I had to work out where they spent that $200 million. Being a methodical type I did the acquisitions in order.
This press release covers (1) Reality Communications, (2) Comodo and (3) and something called Quexion which is not on the list of acquisitons. The total consideration is not material.
Mbox (3 above) is a small Australian supplier. It is hardly the use of $200 million. Nor was it Fusemail (number 4 above) as that had only 6000 subscribers and the price was not disclosed. Alban telecom (number 5) was also specifically described as not material.
Venali inc (number 6 above) was the first with a material purchase price ($17 million). It also had $10 million of revenue and the purchase involved the settlement of some patent disputes.
By this time I was getting excited. Nothing here came close to being a real purchase using over $200 million in cash. For number 7 on the list (KeepItSafe.com) I went to the Irish companies office and pulled the balance sheet. This was a trivial purchase:
KeepItSafe.com is a remote-drive business a bit like Amazon Cloud Drive but with much higher and opaque pricing. They do not tell you their pricing on the website but I wrote to them for a quote:
50G - $75 per month
100GB - $100 per month
Additional GB is .80cent per month
This is approximately 12 times the pricing of Amazon leaving me wondering what this business does at all. (If you wanted to protect your data would you sign up for this company or Amazon with the better balance sheet and only one twelfth of the subscription price?)
I further looked up the directors and they are not key contributors to the tech world.
Whatever - it is, the pricing (opaque and outrageously expensive) and its lack of transparency or even an obvious competitive offer made me fairly sure this was a nonsense business. (It may have a product - but whatever - you can get it elsewhere cheaper...)
Now I am getting really excited. I have checked the first seven out of eight acquisitions and with one exception (Venali Inc) they are either not material or nonsense acquisitions.
I think I have my next Longtop Financial Technology. I was actually dancing around the office. (It happens - and you do not want to see it...) We already had a small short on this stock but I was going to make it a huge put-option position and see what I could do to make it pay. That sort of money-making opportunity gives me goosebumps in excitement - not quite like a 15 year old boy going on a date - but it is up there... (It is also a very large proportion of Bronte's cumulative returns.)
But I am a thorough guy and so I checked the last one - Protus IP Solutions. And my "its a Longtop" thesis collapsed. Simply collapsed. You see they purchased Protus for $213 million. If that $213 million were paid to dodgy parties or related parties I could hazard a guess that the $213 million and the purchase was a fiction. But the vendors were highly reputable venture capital funds: Bank of Montreal Capital Corporation, Edgestone Capital Venture Fund, L.P., B.E.S.T. Discoveries Fund Inc. and New Millennium Venture Fund Inc. And the number was reported in the Canadian press.
So we can conclude the $213 million was real.
And that $213 million had to come from somewhere - and the company did not raise it in the market. So we know the company actually generated that money. Protus is billed as a "software as a service" offering but it is in fact another electronic fax company. MyFax - the service my friend subscribes to - is a Protus product.
What you are seeing here is my thesis (that this was a Longtop style fraud) collapsing around me. I danced around the office prematurely - and the huge option position I was considering: well we never put it on.
I went home thinking I had done a decent two days work and achieved not very much. This is - of course - the lot of a fund manager. (Most days we achieve very little...)
But I am still left pondering the business.
So what J2Global really is
Much to my chagrin we now know that J2Global really is a fax company. And it really generates a lot of cash which means that there really are suckers (ahem customers) who pay $16.95 per month for a fax line from a company that it is very hard to unsubscribe from.
But over time the company builds up cash and then buys something - another fax company.
We also know that it puts up the rates. My friend above who had the fax at MyFax.com originally had it at another provider (and he remembers it as $3 per month). That company was acquired. Now $6 a month. Now it is inside J2Global the price will push up and up - and may eventually reach $16.95 - a price where J2 seems to stop.
And this really is a business about yesterday: he sends less and less faxes each year and so does everyone else. But J2 Global will raise his rates bleeding him for as much cash as they can before he gives up (analog) fax as an antiquity like dial-up internet.
Protus says they had revenue at about $72 million per annum. The other significant acquisition (Venali) had $10 million revenue per annum. Acquisitions thus added revenue of about $80 million per annum or $20 million per quarter. The other acquisitions had to be a few million more.
I looked at the first quarter of this year (the first full quarter with those acquisitions which can be compared to a PCP without those acquisitions). Revenue goes from $60 million to $73 million. That is a nice rise - but not quite enough to account for the acquisitions. There is a pretty sharp underlying decline.
The next quarter they seem to have put some prices up (which is what they do) and revenue growth resumes. But you have to imagine that the clients are kicking back - slowly fading away even if it does take 3 hours on hold to cancel your account.
So what we have here is actually pretty straight forward. It is a business in decline - but it is dressed up as a cloud computing company which I guess makes people happy. It can't be much of a cloud computing company because property, plant and equipment is only $13 million and is not growing and cloud computing is capital intensive.
Because it is (at least from an equity-marketing perspective) a cloud computing company it sports a respectable PE multiple and a reasonable stock price. But revenue growth comes from two places (a) buying the competitors and (b) raising prices - and that is offset by the general decline of the electronic fax industry.
They slow that decline by making sure that customers have a really hard time unsubscribing.
Sure it generates cash - but it spends the bulk of that cash over time on acquisitions - necessary to actually get revenue growth.
The management behave as if the stock is expensive. They are selling their shares at a pretty good clip. The management at Salesforce.Com are also selling shares at a pretty good clip and that seems not to hurt them. I have sometimes purchased shares from management and done well.
And I could be wrong in the core thesis. Electronic Fax may really have a future. Maybe they can crank the rates to $30 a month and the customers will continue to love them. It seems unlikely to me - but no more unlikely that some hip 18 year old could do a Spice Girls cover on YouTube and get millions of views.
And that happened. And to complete the homage they repeated the Spice Girls trick of doing the video in one continuous take.
PS. Disclosure: I still have my small short on. It will stay small - technical obsolescence is something we generally short. Hyping old industries with fashionable words (like "cloud" and "software as a service") is also something we generally short. But my excitement: that was misplaced.