MagicJack Feeling the Short Sellers Now as Stock Plunges

When Tim McDonald, the chief operating officer of MagicJack VocalTec Ltd., talks about the challenge of transforming his voice-over-Internet technology company, he likes to compare himself to Nik Wallenda, the daredevil who crossed Niagara Falls on a tightrope.

“Every single day we’re focused on crossing that high wire to get to the other side,” McDonald said in a May 23 interview at Bloomberg headquarters in New York. “What we see on the other side is a growth market.”

Investors aren’t convinced. MagicJack’s shares sank 18 percent in May, the biggest drop in 16 months, while short interest in the stock is still more than five times the average of companies on the Nasdaq Composite Index. McDonald and chief executive officer Gerald Vento are betting a revamp of MagicJack’s mobile application will allow it to benefit from the same business model of free communication services offered by WhatsApp Inc., which Facebook Inc. bought for $19 billion.

“People think that their growth and margins are unsustainable even as management has rolled out new initiatives that have produced some fair results,” Yousef Abbasi, a market strategist at JonesTrading Institutional Services LLC in New York, said in an e-mail. “There’s high competition and innovation, and the management team has to keep up with that.”

MagicJack, with headquarters in Netanya, Israel and West Palm Beach, Florida, is changing its pricing and marketing strategy to more tightly link the use of its MagicJack device and mobile app. It’s also working with retailers including Wal-Mart Stores Inc. for a June push to unveil the changes. The goal, according to McDonald, is to market MagicJack as a provider of cheap mobile number and voice services, instead of a “gadget business.”

‘Value Proposition’

Revenue declined 4 percent in the first quarter to $35.3 million, while the number of device subscribers fell 2 percent from the prior quarter, the company said on a May 12 conference call with analysts.

The dip in sales helped drive last month’s stock rout, which was the worst on the Bloomberg index of the largest New York-traded Israeli companies. The company, which burned short-sellers with a 78 percent rally in the first three months of the year, has dropped 31 percent this quarter. Israel’s benchmark TA-25 index gained 0.3 percent in Tel Aviv today.

The company’s earnings results in the first half of the year won’t reflect the kind of growth MagicJack is aiming for with its strategy shift, according to McDonald.

“We’re changing the value proposition of the company, and that value proposition and that new offer is yet to be tested in the marketplace,” he said.

Business Model

While short sellers are paring back their positions, the amount of stock borrowed to profit from declines represents about 16 percent of shares outstanding, compared with an average of 3 percent on the Nasdaq Composite Index. That’s down from a record 22 percent of shares outstanding on May 16, according to Markit, a London-based provider of financial information.

McDonald likens his task of transforming MagicJack’s business model while contending with short-sellers to a high-wire walker getting hit by fire hoses.

“The guys with the fire hoses trying to spray Nik Wallenda off of the tightrope, they see the gadget business, and they say the gadget business is dying,” he said. “What we’re seeing on the other side is, no, we have a service business, which sells numbers and voice services, at home and on the go.”

App Users

MagicJack’s monthly active unique app users increased to 3.5 million in the first quarter, from 3.3 million at the end of 2013, according to the May 12 conference call with investors. The company expects to generate app-only revenue in the second half of 2014. McDonald stresses his app is different because it enables calls to any phone line, not just between users of the same app.

Even if management is successful in changing the business model, competition from other mobile apps like WhatsApp, Rakuten Inc.’s Viber Internet messaging system or Apple Inc.’s FaceTime video-chatting service still spur investor skepticism, Abbasi said.

“Investors see the business as a lot more commoditized,” he said. “Why not use Viber on your cell phone, or FaceTime for voice over the Internet? All of those are free.”

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