Description

WorldQuest Networks, Inc. (WQNI, 1.88) is an international Internet telephony company, and no, this isn’t a short recommendation! Peter Lynch has bought ten percent of this busted IPO, it’s chairman owns another forty percent, the company is authorized to buy back another eight percent, and it is trading enormously below cash and its logical burn rate.

Worldquest has an enterprise value of a negative $1.35, which may seem logical for a company that has had an annual burn rate since its IPO of -0.16, -0.41, and through three quarters of this year, another -0.40. However, not only did the last quarter’s results show a solid improvement, but the results also accurately reflected some important improvements in the company’s business model and product mix.

From the second to the third quarter, earnings improved from -0.15 to -0.08, and gross margins increased to 29 percent, up from 18 percent both on the quarter and on the year-previous quarter. Excluding non-cash charges consisting of depreciation and amortization, WorldQuest’s net loss for the quarter narrowed to -0.02.

Also in the third quarter, WQNI increased its customer base by 39 percent to the year-ago quarter, and 6 percent sequentially. In addition, its fledgling money-transfer business increased remittance by 41 percent from the second quarter.

Most of the change in performance, and the reduction of the burn rate can be attributed to WQNI’s new management team shifting the company’s focus toward increasing retail revenues and gross-profit margins while de-emphasizing wholesale revenues. This can be seen by comparing the first three quarters of 2002 vs. 2001. Wholesale traffic revenues are just 13% of last year’s, while retail prepaid calling card revenue is 18% higher than last year’s.

So although revenue looks fairly static, the mix of revenue is leading to vastly improved margins. As retail revenues continue to climb, the company will turn profitable much sooner than that implied by the negative enterprise value.

Additionally, the board has authorized the company to repurchase up to $1,000,000 in shares over the next year, which at the current price, would be approximately 8% of the company.

What is driving these revenues, and is it sustainable? Well, this is about as simple as it gets. WQNI sells phone cards, and people make phone calls to a toll-free number that then completes the international phone call via the internet. All of the calls are made from phone-to-phone over their networks. The voice quality of these Internet carried calls is virtually the same as an international telephone call carried over a traditional telephone line.


This week’s technology column in the NY Times mentions the general phenomenon of international phone calls via the internet (see http://www.nytimes.com/2002/12/16/technology/16TELE.html). The most important part of the article is:

“Internet-based calls account for more than 10 percent of all international calling traffic today, up from almost nothing five years ago, as they reached about 18 billion minutes worldwide, up from 9.9 billion at the end of 2001, according to TeleGeography, a research firm. Most of these calls originated or terminated in poor countries.

Wholesale carriers carve out a business for themselves by taking advantage of differences in fees charged by local telephone companies to complete calls and the actual, often cheaper rates of transporting voice calls over the Internet.”


Let’s get back to the operational aspects of WQNI. A customer visits their website and buys a card online by providing a credit card number which is verified in seconds. They are issued a PIN as well as a toll-free number to call. They call this number from anywhere in the United States and enter the PIN to place a call. WQNI verifies the virtual card account balance and routes and completes the call. Calls are transferred through the company’s IP networks and internet gateways in other countries. These networks and gateways allow the call to be completed at the same cost as a local call for the country where the gateway is located. WQNI leases international telephone lines to complete calls to places in which they do not operate an internet gateway. A large portion of the company’s business is between India and the US. In addition, the company operates a money-transfer business from the U.S. to India.

A substantial portion of WQNI’s revenues is derived from customers calling from the U.S. to India. According to their website, the fees to India range from 12.9 cents/minute to 24.9 cents/minute, depending on the type of card. The cards vary from no fees, to cards with weekly service fees and connection fees. This range of parameters on plans is fairly typical from what I’ve seen looking across the internet at international rate plans. However, WQNI seems to be very solid on price.

A friend of mine has extensive family in India, and the rates were significantly better than what he currently was spending—significant enough to be interested in switching. Likewise, when I lived in Europe, I used calling cards and programmed the couple dozen digits and pauses into my phone, in order to save a lot on international phone calls. It’s really not a hassle, and I think that WQNI is in a very legitimate and growing business, with a real price and distribution edge. Their growing revenues and margins are evidence enough for the progress they are making.

Valuation: at a rate of losing eight cents per quarter, this company has seventeen quarters of cash left. If the company grows retail card revenues at six percent per quarter, shows no improvement in margins, and we assume gross profit (before operating expenses) matches the six percent growth, then then my rough estimate is that it will take approximately eight quarters to grow the current 880k in gross profit high enough to cover the 520k in current net loss. That simplistic math may be a bit rough, but there’s an awful lot of room here, we don’t need much spreadsheet power. If the company gets it together faster, and I think they will, so much the better.

Catalyst

Catalyst: Trading well below cash, company stock repurchase, ownership in strong hands, and working business model. Quarter-on-quarter pace of improvement, particularly given their more attractive product mix, will lead to a substantial reevaluation of their burn rate.