This week we revisit Isentia (ISD.ASX) which we first highlighted back in March this year. The stock has now gone from being a portfolio laggard to a star performer. Picking the right turnaround story can be very rewarding, and so far we feel like we are on track for one.
Isentia (ISD.ASX) provides media monitoring services to corporate and government agencies. The majority of revenues are subscription based (78% SaaS recurring revenue) and ISD has, both historically and today, generates strong cash flows and high margins.
A brief look at the past tells us that almost four years ago ISD was valued at a billion dollar market cap but a lot has changed since then. Up until recently the stock was down as much as 95% from that point due to several successive downgrades, a disastrous acquisition, and a loss of focus on their core business by previous management. This allowed new entrants (Meltwater and Streem) to disrupt and capture market share, thereby creating margin compression and customer churn for ISD.
So what has changed? In the last year a new CEO and CFO have been appointed and a return to basics mentality was outlined at the time. A well thought out strategy has been implemented to cut costs, increase automation within the business and focus on product development modules to retain and grow the customer base.
So far the strategy is taking shape nicely with 66 new product releases in FY19 which is already 3x more than the previous year. In addition, the new management team has taken out $5.2m of costs during the year. All this, and a refocused sales strategy, should lead to a reset earnings base in FY20 which from then on, if executed well, could deliver double digit earnings growth in FY21 and FY22.
It is important to understand that a key reason for ISD's loss of market share was a copyright fee agreement negotiated three years ago by previous management. This agreement created a high fixed cost for the business and did not reflect the current commercial reality. A favourable interim tribunal decision on this agreement was announced last year, which should deliver significant cost savings over time but more importantly, the ability for ISD to compete better against its rivals.
Strategically, ISD is still an attractive takeover target due to a significant market leading share in the APAC region, an improved balance sheet and an earnings base that is now on the cusp of growth. Suitors could be an industry giant such as Cision or Kantar (recently acquired by private equity for 8.2x EBITDA), or private equity (PE) firms who can acquire ISD at a depressed valuation now and serve it back to the market at a premium valuation in three years time (a classic PE play).
ISD FY19 results were in line with company guidance but way ahead of our forecasts in the NPATA and Cash flow generation. Revenue of $123m and EBITDA of $23m were down on last year but in line with guidance. Cash EPS came in at 4.7 cents and operating cash flows were quite strong, benefitting from some favourable balance date movements. Overall, at $28m net debt, the balance sheet now has the lowest amount of debt since 2015. The business is finally benefiting from lower negotiated copyright costs and a focused and incremental investment into the product suite.
Guidance for FY20 is for $20-$23m EBITDA and we estimate net debt to reduce further to approximately 1x earnings. This is a level that we believe will enable the board to consider reinstating dividends. Management believes from FY20 onwards both revenue and earnings will return to growth (10-20% growth) and we see FY21 Cash EPS of 5.5 cents as a realistic outcome (current share price 41 cents).
We first bought ISD at 30 cents earlier this year. At the time the market didn’t seem to care too much and we averaged down as the stock sold down to 18 cents. The stock then appreciated going into the August result and following a strong report we added further in the mid 30 cents range. Although the stock is up 50% in the last few months, we still see significant upside as investors regain confidence in what is a high-quality business and a now de-levered balance sheet.
Right now, we value the company at about 65 cents and believe it is highly likely that ISD will get taken over eventually. If we apply the same multiple Kantar was recently acquired on, we can easily see a takeover at $1.00 in time. ISD has become a conviction holding in the TAMIM All Cap IMA portfolios.
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TAMIM Asset Management provides general information to help you understand our investment approach. Any financial information we provide is not advice, has not considered your personal circumstances and may not be suitable for you.