The search for attractive, quality investment ideas trading at discounts to intrinsic value has become harder and harder. Yet Rosetta Stone (RST) offers such an opportunity. Trading near $8 per share and sporting a market cap of $184 million, the stock is likely worth $16 per share, if not more, to a private buyer. And a few prominent investors and large shareholders are involved, ensuring that gap between market price and intrinsic value is narrowed.
Most investors are familiar with Rosetta Stone; it's the preeminent language-learning company. Whether it's the commercials or kiosks at the airport, most of us have seen the bright yellow boxes. But the company is much more than the CD/DVD language-learning company, and that is what makes it worth much more than it is today.
Two investment groups, Osmium Partners and Roumell Asset Management, who own 9.7% and 5% of RST, respectively, are happy with either a sale of the company or the business strategy that current management has in place. That's a rare combination. In fact, in a recent letter to management (which if you are interested in RST, you should read), Osmium Partners notes that unless the company can be sold for $16 a share, RST should stay independent, and current management should continue with its business plan. Roumell, in its letter, effectively says the same thing.
The thesis for Rosetta Stone is simple: The market continues to view the company as a dying CD business while overlooking the growing Software as a Solution (SaaS) enterprise and education (E&E) business. Over the past five years, E&E revenue has grown to more than $100 million from $40 million. Gross margins for the E&E business are approximately 70%, implying more than $72 million in gross profit for the E&E business alone in 2014. The "dying" legacy language business is still one that has tremendous appeal, even though it may be shrinking; its current revenue run rate is nearly $200 million.
Rosetta has $3 million in debt on the balance sheet and $45 million in cash, or an enterprise value of $136 million. For that price, investors get a growing educational business generating more than $100 million in revenues at 70% gross margins and a legacy business generating $188 million in revenue. Operating losses the last three years are a result of sales, marketing and R&D costs that I believe enable RST to generate tremendous cash flow in the coming years, as the company shifts from a hardware model to a software model.
Rosetta is a gem that is currently misunderstood and, as a result, is misevaluated by the market.