j2 Global (JCOM) #1/X - Delaying the Inevitable

The formula ‘two plus two equals five’ is not without its attractions.
— Fyodor Dostoyevski
“You are a modern day pyramid scheme, built on acquisitions of cloud subscriptions. So keep stacking!”
— glassdoor j2 Global Dublin Review

 

Couldn't have said it better myself. This is a multi-part series taking a closer look at j2 Global ("JCOM or "j2"), which I first read about a few years ago from a now-defunct blog called Stableboy Selections.

Background

j2 Global (“JCOM” or “j2”) has been a short seller’s nightmare the last few years, consistently beating revenue and earnings estimates while acquiring hundreds of companies. Their high-margin fax business' negative organic growth is hidden through serial acquisitions, while aggressive and misleading non-GAAP/accounting presentation masks the true economic realities of the company. Acquisition-fueled growth is an appealing strategy for management as organic growth starts to slow, stutter, and decline – and j2 has gone all-in on the roll-up strategy.

History

j2 Global was founded in December 1995 as JFax and went public in 1999. In 2012, the company acquired digital publisher Ziff Davis Inc. for $167M in cash and most recently, in December 2016, acquired health and wellness digital media company Everyday Health for $465M in their largest acquisition to date. They currently operate their business through 2 segments: 1) Business Cloud Services, which includes Cloud Connect (Fax), Cloud Backup, and E-Mail Security/Marketing, and 2) Digital Media, which includes Ziff Davis Inc. and now Everyday Health. Historically, their fax business has been the most significant portion of revenue and EBITDA margin, from a height of 83.2% of consolidated revenue in 2011 to 35% in 2016, dropping to an estimated in 27% in FY2017. They separate their fax solutions into two basic groups: number-based (DID) and non-number based (non-DID), the former of which is the “sticky” and highly profitable portion of their business, with >50% EBITDA margins. In 2012 Cloud Connect (fax/voice) EBITDA was ~96% of total EBITDA and it is currently ~51% of EBITDA despite being only 35% of revenues. They also have a small IP licensing division (<1% revenue) with a typical run-rate revenue of ~$4M/yr. Ziff Davis, the company’s digital media segment, had revenues of $307M in 2016 and Net Income of $15.45M. Based on my estimates, Cloud Services NI was around ~30M, so despite j2’s best efforts the declining fax business (Cloud Connect) was over 70% of net income for the company in 2016.

In order to continue to grow the eFax business, j2 has had to consistently acquire and/or sue smaller competitors. After acquiring these companies, j2 reduces the headcount, jacks up prices, or completely shutters the acquired company, all the while being notoriously hard to cancel. A cursory glance of eFax reviews on Consumer Affairs  or quick Google search will tell you all you need to know about the eFax business – hard to cancel, lots of complaints, bad customer service, etc. That being said, the fax business is their cash cow – without it, j2 doesn’t make any money.

Goodwill, Intangible Assets, Accounts Receivable Growth – Delaying the Inevitable

JCOM’s goodwill and intangible assets such as patents, trademarks, and customer relationships to total assets has grown from 58% in 2011 to 79% today. Similarly, the Intangible Turnover Ratio has consistently declined from 88% in 2011 to 53% in 2016. It is my opinion that the company has an artificially increased balance sheet and is not generating any recurring growth from the majority of its acquisitions. Some of the more infamous roll-ups like Tyco, WorldCom, and more recently, Valeant, produced revenue and earnings growth by taking advantage of the loophole in acquisition accounting rules, boosting operating results with inflated CFFO and earnings. Buying declining and/or limited cash flow businesses and using accounting conventions to cover it up, works until, well, it doesn’t. Tyco, at its peak in 2001, had a Goodwill and Intangible Asset/Total Asset Ratio (Goodwill Intensity) of 32% and in 2002, after it blew up, it stood at 48.62%. In 2001, AOL Time Warner's Goodwill Intensity ratio stood at 61.5%, before its massive 2002 goodwill write-down disaster. That puts j2's Goodwill Intensity in some prime company, and given the types of companies it purchases, its own doomsday goodwill write-down is inevitable.

Although I could not find the total number of acquisitions the company has done since inception we can calculate it with information given to us from management and press releases. Management states in Q1 of 2015 that they had done 109 transactions and spent $1.1B since 2000. In 2015, they did 24 acquisitions, spending $314M and in 2016, they did 22 acquisitions for a total of $591.1M ($493.7M of which was Everyday Health). They have also done 5 more in Q1 of 2017 for an undisclosed amount, so we have a total of 160 acquisitions since 2000, spending $2B in the process. Since the start of their true acquisition spree in 2012, management has spent $1.56B in acquisitions while EBIT only increased $81M, from $162M to $243M, and management’s favorite metric, “adjusted EBITDA,” has grown from $194M to $396M.

Growth in accounts receivable and Days Sales Outstanding has also been persistent. A/R turnover, calculated with both average yearly receivables and year end receivables has grown every single year from 2010. Similarly, DSO has grown from 19 days in 2010 to a current 54 days using the average method, and from 21 to 83 days using the year end method. Receivables have grown much faster than sales, with sales CAGR of 21.5% since 2010 and receivables growth of ~60%.

j2 is either overinflating the value of their receivables or not writing off uncollectible accounts.