J2 Global (JCOM) #3/X - The Big Question - What is JCOM's Organic Growth?

Reading the earning call transcripts through the years, the same question comes up every quarter in various fashions: “What percentage of growth in each segment (particularly their legacy eFax segment, Cloud Connect) is due to organic growth versus growth from acquisitions?”

Management has done a great job side-stepping with the typical answer: “a mix,” “mostly acquisitions,” “we don’t break that out.”

In 4Q16 we got a better answer as to an organic growth rate based on the CEO’s Answer.


Rishi Jaluria - JMP Securities LLC

Hey, guys, thanks for taking my questions. Appreciate the granular detail in your 2017 guidance. Couple of quick questions for you. So, first, just to be clear, on guidance, I want to make sure my understanding is correct. You're 2% to 3% on the Cloud Services side, that's purely organic, so assuming no M&A, is that a fair understanding?

Scott Turicchi - j2 Global, Inc.

No, it does include some M&As that we have in the pipeline. I think there's a couple of deals have closed already that are rather small.

Nehemia Zucker - j2 Global, Inc.

You're talking about like 1% or less in the business, small.

Scott Turicchi - j2 Global, Inc.

But it does include some M&A.

Rishi Jaluria - JMP Securities LLC

Okay. Got it. So, the entire Cloud Services, the bulk of that 2% to 3% is inclusive of M&A?

Scott Turicchi - j2 Global, Inc.

Yes.

- 4Q16 Earnings Call


Note: They are referring to “Business Cloud Services,” which includes “Cloud Connect” and “Cloud Services.”

Given the number and spread out nature of these acquisitions, it is almost impossible to calculate the true organic growth rates of each segment - but the company does give pro forma estimates of revenue and net income as if that year’s acquisitions were included from the beginning of the current and prior year. Using those numbers I conservatively calculated estimates of how much each year’s acquisitions boosted revenue and net income, and then calculated revenue and net income growth excluding acquisitions.

One thing to note is that the Pro Forma Combined Revenue includes revenue that the company already booked for the year’s acquisitions, so really that number is understated. For example, we know from j2’s EVDY Investor Call in December that EVDY had ~$243M in revenue TTM 2Q15 to 3Q16. When we back out the pro forma numbers from the 2016 10-K, we get a total of ~$228M of added revenues in 2016 due to acquisitions. Obviously that number is way too low but when we add official revenue contribution of ~$53M for 2016’s acquisitions (which includes the $20M revenue contribution from EVDY as well as ~$33M in other acquisitions), we get $288M. How do  know this is the more accurate number? Many of 2016’s acquisitions had publicly available revenue information, including SMTP, VaultLogix, Callstream Group Limited, and FrontSafe A/S. When we add up all the reported revenues (shown later) we get close to ~$290M, and that’s only including companies that had revenue information available either through public filings, management statements, or unofficial sources.

Long story short – to get the actual revenue acquired each year we add the pro forma combined revenue to the revenue from year’s acquisitions (which is already included in each year’s/quarter’s results.)

Note: Since the Pro Forma Financial Information for Everyday Health Acquisition shows that if the acquisition had occurred on January 1, 2015, 2016 Net Income for j2 would have been $103,541, which equates to a -$48,898 net loss for EVDY. Since EVDY was only in j2’s results for one month in 2016, I adjusted both revenue and net income to account for only the one month contribution (2016 in yellow).

As shown above, I estimate that j2 has acquired 98% of its revenue and 34% of its net income since 2008. Why the disparity between acquired top and bottom lines? J2 has relied on its fax business, with declining revenue and huge margins, to prop up the net income side, while acquiring the revenues (most businesses acquired are garbage- low or negative margins). What happens when they run out of fax companies to acquire? How many more acquisitions can really move the needle? They’re getting too big for their britches and this is a house of cards waiting to come crashing down.

A Look at Recent 2016 Acquisitions

Here’s a quick look at those 2016 acquisitions we have revenue numbers for:

Fonebox Australia, which j2 acquired in March of 2016 for $30M, had reported revenues of $9.4M in 2016. In June 2016, j2 acquired the SMTP relay and email delivery products and services business portion of the business for $15M. Revenue for that the SMTP e-mail relay business for the six months ended June 30, 2016 was ~$2.75M, so I assumed yearly revenue was ~$6M.

VaultLogix, which was acquired by InterCloud Systems in 2014 for $16M, was bought by j2 in February2016 for $24M. The Cloud Services segment of InterCloud was entirely comprised of VaultLogix, so a real good look into its operations as well. Referencing InterCloud's 10-K for FY15, VaultLogix had revenues of $9.9M, EBITDA of ~$3.2M, and EBIT of ~$0.4M (when the combined goodwill and intangible asset impairment is stripped out). From the InterCloud press release in October 2014, VaultLogix had generated approximately $12M in revenue and $4.3M in adjusted EBITDA for the 12 months prior to its acquisition by Intercloud. So we have a business that did $2M less in revenue and $1M less in EBITDA than the year prior and j2 paid $8M more for it than InterCloud did in 2014. The rest of the 2016 acquisitions we have numbers on were small – Callstream Group Limited had  revenue of 200,000 GBP (from 240,000 GBP in 2015), operating profit of 14,114, and a loss before taxes 214,368 GBP for the YE 2016 (Annual Report) Frontsafe A/S, based in Denmark, had FY16 operating profit of ~$428,000 USD on ~$3.16M of revenue, compared to ~$614,418 and ~$3.51M in 2015, respectively. MaxEmail was acquired in July of 2016, and the company said it “1% more on the Cloud Connect” business, so we can assume ~$3.5M in revenues.

Adding it all up, combined revenues of 8 of the 24 2016 acquisitions is right around ~$300M based on my estimates, with the vast majority of that coming from EVDY. On the Q4 call, management guided to revenues of $1.130 to $1.170 billion, so we’re looking at a $256M-$296M increase in revenue for this fiscal year. The official revenue contribution from 2016 acquisitions was $52.9M, so if we subtract that from our estimate of $300M in acquired revenues this year that’s $250M in revenue not accounted for, leaving us with $6-46M more in projected revenue. Let’s go with the best case scenario here and say that j2 generates that $6-46M in revenue from “organic growth” in their two segments. That’s a projected organic YoY growth of at worst, 0.7%, and at best, 5.2%. But here’s the kicker - this is assuming j2 does NO acquisitions that add to revenue in 2017 (they've already done 5 in Q1!) and these are based on management estimates! What’s the over/under on management acquiring at least $6-46M in revenues, implying negative organic growth? I’d go all-in on that bet.

Disclosure: I have no current positions in JCOM. In the past, I have had short positions in JCOM.