Hedge Fund Sticks to Losing Bet on MagicJack Shares

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Kase’s Tilson Sticks to Losing Bet on MagicJack
Kase Capital Management. New York Managing Partner Whitney Tilson. Sales at MagicJack fell 27 percent to $25.8 million in the third quarter, steeper than the 23 percent drop forecast by analysts surveyed by Bloomberg. Photographer: Peter Foley/Bloomberg

When hedge fund manager Whitney Tilson touted MagicJack VocalTec Ltd. in February, he said it was a beaten-down stock with great management and fixable problems. The shares have fallen another 36 percent since.

Tilson is undeterred.

“Obviously it’s been a disappointing investment so far, but I think it’s pretty cheap right now,” Tilson, who oversees $83 million at Kase Capital Management in New York, said by phone Nov. 13. “There’s a decent chance that we saw the bottom in the third quarter, and that things will stabilize and start to turn up.”

Shares of the company, whose main product is a device that connects to a computer or router to enable voice calls over the Internet, sank 12 percent last week, compared with an 0.9 percent drop on the Bloomberg Israel-US Equity index, after reporting a seventh consecutive quarter of declining sales.

Investors are growing increasingly skeptical of MagicJack’s plan to transform itself from a voice-over-IP company to a provider of free mobile communication services, with shares now trading near a four-year low at $8.80, below the level when Chief Executive Officer Gerald Vento took over in January 2013. Tilson argues the turnaround plan will halt a slide in subscriptions, and a new agreement with Spain’s Telefonica SA to sell the device in Mexico looks promising.

Sales at MagicJack fell 27 percent to $25.8 million in the third quarter, steeper than the 23 percent drop forecast by analysts surveyed by Bloomberg.

Buffett’s Principles

Tilson has compared his MagicJack bet to an investment in Netflix Inc., which he says earned him an eightfold return. He says he bought shares of MagicJack about a year ago, and took some profits as the stock rallied 78 percent in the first three months of the year. That rally has been wiped out by sliding revenue and analyst downgrades, triggering a 26 percent rout in the stock this year. Tilson added more shares to his MagicJack position last week, he said.

While his assets under management may be dwarfed by larger funds, Tilson has become a well-known figure in the industry by publishing a newsletter and co-founding the Value Investing Congress, a biannual conference devoted to the investment principles of billionaire Warren Buffett and his mentor, Columbia University professor Benjamin Graham.

MagicJack, which has headquarters in Netanya, Israel and West Palm Beach, Florida, markets itself as a cheap alternative to landline and mobile phone plans, charging fees ranging from $5 a month to $120 a year to make calls with the device to the U.S. and Canada. The company is trying to attract more paying subscribers to the device through its mobile application, which had 3.4 million monthly active users in the third quarter, according to a Nov. 10 earnings call.

Telefonica Deal

Management plans to begin marketing a new version of the mobile app in the U.S. in the next two to three months that will have text messaging as well as international calling features, said Chief Financial Officer Jose Gordo.

The company finalized an agreement with Telefonica last week to market the MagicJack device and app to the Spanish carrier’s 20 million Mexican mobile subscribers, with the potential to expand to other Latin American countries.

“We have a plan to take the company in a whole new direction than it’s ever had,” Gordo said by phone from West Palm Beach, Florida on Nov. 14. “At under $10 a share, we think we’re significantly undervalued.”

MagicJack trades at 11 times current-year earnings, the lowest valuation among 16 similar companies, data compiled by Bloomberg show. Gordo points to a six percent uptick in device activations in the third quarter from the prior three months and 84,000 devices sold in October, the most since April 2013, as signs that MagicJack’s core U.S. business is stabilizing.

Still, the company’s turnaround may take longer than expected to produce results, according to Greg Miller, an analyst at Canaccord Genuity Inc. in New York who has a neutral rating on MagicJack shares.

“I have not given up on the company,” Tilson said. “If they get traction in Mexico, the stock could be off to the races.”

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