May Idea of the Month: “Busted Growth Revival Story”

As I typically do after attending the Value Investing Congress, I’m selecting one of my favorite ideas from the conference to share with you as our next “Idea of the Month.” The selection process was a little tough this time, because there were several picks that I found pretty compelling — a couple specialty insurance companies (First American (FAF) for title insurance and Atlas Financial (AFH) for commercial niche auto insurance), a couple natural gas-weighted stocks like WPX Energy (WPX), and some stocks that I’ve already got an eye on for “hidden” assets and improving balance sheets, like Dole (DOLE).

But today I’m more interested in looking for some growth stocks that aren’t the valuations that they might deserve based on their prospects, and on that front the two that jumped out at me were Spark Networks (LOV) and Rosetta Stone (RST). LOV is an intriguing story that Whitney Tilson called a possible “next Netflix” in their potential to grow dramatically from here — he says they’re fairly valued based on the excellent cash stream from their mature JDate service, but that the potential of their newer ChristianMingle service, which could become dramatically larger, is not reflected in the shares at all. But LOV has run up quite a bit in the last few weeks (partly as a result of the Congress), and I’m not comfortable enough with the potential for this dating site operator just yet — so I’m going to focus on what I think is the more interesting transformation story at Rosetta Stone (RST).

Rosetta Stone is an immersive conversational language learning tool that’s technology-based — they essentially use a series of images and phrases to teach introductory students in an interactive and audiovisual format. From all I’ve seen and read, it has its limitations but is at least a good first step for a great many people in the process of learning and becoming conversant in a new language.

The company has a powerful brand, one that you’re probably quite familiar with even if you haven’t used the product. Their large advertising presence over the past decade, including a huge investment in spreading their kiosks and yellow boxes around pretty much every mall and airport in the country, has build up a large amount of name recognition and a pretty big base of existing users — but it was also extremely expensive. They ...

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