Should you buy Zedge (ZDGE)?

Zedge (ZDGE) has recently separated via spin-off from the IDT Corporation. The company’s main activity is operating a simple application (ZEDGE Ringtones & Wallpapers) that enables smartphone users to install wallpapers, ring tones, notification sounds, screensavers and icons out of a huge variety of pictures and music files. This is one of the most popular apps in the field, with over 200 million installations and 33 million monthly active users. About 40% of the app’s users are from North America, 30% from Europe and the rest are from the rest of the world.

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These impressive statistics place the app as one of the 25 most desirable free apps in the Google Play store in the US during the past six years, and is also among the 10 most desirable entertainment apps at Apple’s iTunes. The fact that the growth of customer base was done in a completely organic way, without any advertising expenses, indicates that the built-in app is easy to use, with a multitude of contents so that it is meets the needs of many users.

Over 90% of the company’s revenue come from advertisements that appear in the app. Despite the fact that ads are annoying, the company managed to increase its customer base, which resulted a 38.6% revenue growth in 2015 compared to 2014. In the last quarter (the third of 2016, which ended at the end of April) the customer base continued to grow at 18% compared to the same quarter last year. The company has maintained a similar revenue per active user per month so that revenues grew at a similar rate (17%). In fact, the growth would have been greater if the app had not been temporarily removed from the iTunes Store (why? The best reason I’ve found, is that the option of installing ringtones through the app violate the Apple’s tough limitations…). Now, after breaking from the shackles of its parent company, Zedge can invest more resources at growth and expansion of the range of services it provides (e.g. the new service it provides, Snakk, which allows sending messages in chats and social networks).

How much is the stock worth?

Zedge managed to maintain a lean operating structure and implement the latest technologies, so that the operating profit margin has improved in the last 9 months to 22.4% compared to 15.1% in the same period last year. Unlike its competitors, it is already producing a positive net income (22 cents per share in the first 9 months of 2016). However, we must remember that becoming a public company will add about 750 to 900 thousand dollars annually for regulation expenses and obtaining a number of services from IDT, the parent company, so the adjusted operating income of 2016 (that is, when taking into account other additional expenses) will be approximately 1.8 million dollars. Assuming the company will grow by 20% in 2017, and its profitability will improve by at least 1%, it will generate an operating profit of approximately 2.4 million dollars in 2017. In other words, ZDGE trades at an EV/EBIT of 16.7 for the profits of 2016, and a future EV/EBIT  of 12.2 for the profits of 2017. These are relatively low multiples for a company with growth potential of more than 20% in the coming years.

The main question is for how many more years will this growth continue?

The main risk is, of course, the risk that the company will not be able to maintain its competitive edge. In a world where there is an increase of similar applications, many of them are excellent, which also offer a variety of wallpapers and ringtones, no one can guarantee that Zedge will continue to lead. Moreover, many of the other apps do not have annoying ads thus may sway users to other apps. On the other hand, people who download apps usually choose those in the top 10, which increases the likelihood of the success of Zedge to continue for at least another couple of years until (maybe) will begin to decline. In addition, history shows that apps that do not have ads are finding it difficult to survive for a long time, so it is likely that the leading competing apps which are ads-free, will begin to show them in the foreseeable future.

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So… to buy or not?

If this had been a growing company from a different field, with less competition and a higher admission standard, I would buy the stock even at $4. The picture is different in this case. There are plenty of popular competitors, some have a better app than that of Zedge. Therefore, I would prefer to wait for a better price (something under 3 or 3.5 dollars). I’m not sure the stock will get that low, but I prefer to be conservative in this case and miss a possible stock rally, rather than invest in a company that may, in two years, disappear from the world.

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