Rosetta Stone (RST) has had its share of problems over the years. As the Internet grows, there are more free or low-cost language learning courses available online. That has resulted in more competition and put pressure on the product pricing. Until recently, the company was missing out on the opportunity to sell an online learning product to consumers.
The stock has attracted vocal activist investors, including hedge fund manager John Lewis of Osmium Partners, whose firm recently bought 2.1 million shares, or 10% of the company, and David Nierenberg of Nierenberg Investment Management, which owns 7.9% of Rosetta Stone’s stock, and has been actively making recommendations to management.
Things started to change for the better at Rosetta Stone in mid-2012, including its strategy to sell its language education software directly to schools, colleges, companies and non-profits. Additionally, the company made four strategic acquisitions to boost its product offerings and expand its online offerings.
Rosetta is now two years into its transformation. In June, management confirmed its 2014 financial guidance of $315–$325 million in sales (far above consensus analyst estimates). The company expects EBITDA–a measure of cash earnings–to be in the range of $18-$22 million.
If you believe that Rosetta Stone can deliver on its guidance, then the stock trades at a very reasonable 7x EBITDA. Rosetta Stone is a great value opportunity for patient investors seeking lots of upside. I think the stock could realistically double in the next year, and is worth more than $20 per share.
Rosetta’s balance sheet is clean, with $46 million in cash and no debt. That translates into $2 of cash per share of stock. And that means that the enterprise value per share is just $7.
Despite the poor financial performance, Rosetta Stone had sales of $264.6 million last year. Even after a difficult first half of 2014, the three analysts following the stock expect revenues of $275 million. That translates into a price-to-sales ratio of just 0.7.
The company has ambitious growth goals of $380–$400 million in sales in 2016. And management is targeting EBITDA of $38–$48 million. Even if the company hits the low end of those goals, it’s easy to see that the stock would be worth several times the current value.
One sign of their commitment to shareholders was a $25 million share buyback program announced last year. Thus far, the company has purchased 1 million shares at an average price of $11.40. That’s already reduced the number of shares outstanding by ~5%.
In early June, the CEO told investors that he thinks the stock is worth $20–$35 per share. And at the Value Investing Congress, John Lewis told the audience that he thinks the stock is worth nearly $23 today. If Lewis is correct, that would translate to a 155% increase for the stock from its current price.
My view is that the company is the best-positioned language education company in the world, offering 30 different languages. It’s has clearly faced many challenges, and made some mistakes along the way. The depressed stock price and mere $192 million valuation certainly reflect that poor performance.
Ian Wyatt, Ian Wyatt’s Million Dollar Portfolio, www.100kportfolio.com, 866-447-8625, September 17, 2014
