iSentia, putting the story back together.

Background

Isentia Group Limited (ASX: ISD) is a media intelligence software-as-a-service provider positioned to service a range of corporate and government clients. Established in 1982 as a traditional press-clippings business, iSentia today holds a dominant position in the ANZ media monitoring market.

iSentia has its traditional standard media monitoring offerings as well as value added services (VAS) which includes social media monitoring and analysis/insight reports and other services.

Mainstream media monitoring comprises the bulk of the firm’s revenues (circa two thirds) and is generally paid for via subscription (some legacy clients pay via the volume of articles read, however this is being phased out).

For clients, media monitoring services start out with a basic ‘mainstream media alerts’ service that sends out relevant notifications via email/text once every 24 hours for a recurring fee. Customers can upgrade to online news notifications for an additional recurring fee and to the Media Portal platform (which provides live updates and is also the platform for media analysis) for another recurring fee. A range of other premiumised services is layered on top.

Analysis

Buyer beware

Do you know who weaves a great story? Roadshow bankers. Now take those bankers, have them pushed by private equity firms, and they will be able to sell oil to the Saudis. I am generally sceptical of an IPO since the reason for floating is usually not in the buyers favour (taking money off the table, couldn’t get a trade sale away, etc.), but if there is one thing to always be sceptical of, it is an IPO from a private equity vendor. Now that does not mean every PE exit is a dog, just that there is a very high likelihood the major upside has been harvested… with just enough meat on the bone to survive a lock-up period.

Special IPO gift bestowed on the market from our PE pals.

 

The story – Did we land on Mayfair?

The narrative on the back of a hot offering (offered at $2.03 with an opening pop of c. 20%) was picked up by the market feverishly. iSentia was a critical media aggregator for corporates and governments alike, with a 90% market share in Australia representing a quasi-monopoly that would levy price increases upon its customers into perpetuity. As it delivered strong ANZ earnings growth, the narrative strengthened and the market bid up the price to a market peak of $4.85 as momentum led to analysts extrapolating past growth far into the future.

Image result for monopoly man cartoon

Keep printing money.

 

Narrative break – Do not collect $200 for passing Go.

Benjamin Graham described Mr.Market as a manic-depressive who is emotional, euphoric and moody. The flip side of such euphoria is punishing when companies are priced for perfect execution. The narrative of iSentia fell apart quickly when people realised that this may not be the cash cow monopoly they initially expected. A confluence of factors hit as: (i) Meltwater, a global player with strong social media capabilities made a concerted push into Australia pressuring iSentia’s pricing; (ii) Traditional media outlets put up paywalls and extraction of value from content came into focus – leading to increased copyright costs; and (iii) King Content, the $48m acquisition into an adjacent service (content marketing) went sour with integration issues and momentum loss causing a projected EBITDA contribution to swing to a loss.

Image result for monopoly do not pass go cartoon

Monopoly man falls on hard times.

 

Where are we now?

While the outlook for iSentia is vastly different today from 2 years ago, the core of the investment case remains the same. The compelling reasons that were initially there to buy it remain:

  • High quality top line stemming from durable recurring domestic software as a service (“SaaS“) revenue
  • Diversified customer base
  • Pricing growth from upselling

Monitoring requirements for organisations in a more complex and disparate media environment are growing rather than shrinking, entrenching the product need to end users. iSentia continues its pivot to add social media capability while the continuous investment into R&D is critical, allowing for the roll out of new products that enable pricing increases and ensuring a product edge ahead of competitors.

Durability

While its cloud capable platform analysing a multitude of media sources is difficult to replicate, global competitors have similar offerings that may be portable to APAC clientele. The threat to iSentia’s moat moving forward is unlikely to materialise from a superior product offering from current competitors but instead from increased churn of larger multinational clients to a holistic solution from a global player. MNCs may prefer a single provider for worldwide media coverage, rather than the regional offering currently promoted by iSentia. Given iSentia’s average revenue per user (“ARPU”) the ability to move down-market to mid-market and smaller firms is limited due to prohibitive costs for end users, hence defence of their core large cap clients is critical. Short-term churn will likely drive price action as the market is sensitive to the threat of Meltwater eating into ISD’s client base, but it will prove difficult for Meltwater to meaningfully alter the long term market structure given iSentia’s 90% penetration. Pricing differential alone is unlikely to induce switching; only offering an advantage when pitching to end users without any current external media analytics. Rather a product edge is required – Meltwater’s core competency is social analytics, while iSentia is (perhaps late to the game) substantively beefing up their social analytics. This has been fleshed out via the addition of sentiment analysis within their core Mediaportal platform as well as completely new products focused on social such as Storyboard. A full product suite serves as the best ongoing defense to their moat, mitigating the risk of ANZ churn. The market appears to be pricing in a negative forward view of ANZ churn, as the Macquarie Australia Conference presentation catalysed a 15% jump in the stock price. The important new information to come out in that deck? Not much… apart from a line on p. 18 that “Q3 client churn returned to historic norms”. A short term stabilising of customers was enough to drive a 15% recovery in SP, hence once the overhang of Meltwater’s initial impact clears and iSentia’s market share retention is clearer to the market we can potentially expect a further recovery. Barring a multi period large scale hemorrhaging of customers, it is fair to ascribe a value to the ANZ business on a standalone basis similar to current trading levels as management continue to drive steady ARPU growth via upselling.

Growth option

The true upside to iSentia and potential for share price appreciation lies within the option value of new markets. The growth strategy communicated by management has been focused on markets with no established player and initial roll out was within Philippines, Malaysia, Thailand, Singapore and Vietnam. iSentia is well placed to capture a leading share in these nascent markets, with no incumbent as a roadblock to establishing client relationships in the region. Management estimate they only serve c. 25% of their target clients in S.E Asia, therefore there is substantial runway left for growth.

Localised players such as Wisers and Hottolink that operate in China and Japan respectively make entry more difficult in other Asian markets; however, this can be treated as a free option with even small penetration into such large addressable markets likely to move the needle. Asia is a key plank of the investment case moving forward, and iSentia have made promising early strides as well as placing the right people in the driving seat with the hire of David Liu (long time media exec, with regional experience as Aegis AsiaPac head) indicative of their appetite for growth.

What could the future look like?

To invest into iSentia means you need to take a view on the following operational drivers:

ANZ customer churn: The critical short-term data that will influence sentiment and market consensus on whether iSentia can restore its former glory. I personally model net churn to peak in FY18 at 5% with a slow deterioration of clients thereafter, as Meltwater steadily chips away

ANZ SaaS pricing: There are two choices for iSentia to battle Meltwater, retain pricing power and risk churn or retain customers and have pricing deteriorate. The latter would be the wise choice. As such, the pricing growth into perpetuity premise is broken and a hit to pricing for basic SaaS products is likely on the horizon

ANZ upselling: Consistent product innovation allows ARPU to grow as clients utilise more products, with opportunity for value added services to increase penetration within existing base. Value added services penetration within existing customer base increased c. 600bps over the two years to FY16, but it is likely this rapid growth will slow, as the largest clients with the biggest budgets are exhausted

Asia customer net adds: Difficult to gauge what the runway will be like but based on the total addressable end markets they are targeting it is reasonable that total customers for rest of the world will increase by 50% by FY25 – this doesn’t translate into strong penetration in target growth markets but is representative of promising client growth

King Content: The turnaround is underway with a new unit head for King Content and it may not turnaround, but the acquisition has a scrap value if jettisoned. Content Marketing does not have the attractive defensive qualities of the core business therefore it is difficult to forecast, however a conservative case is projected with revenues falling until FY18 and stabilising thereafter.

Content acquisition costs: The trend of content for traditional media being paywalled and becoming more expensive is likely to continue and as such, a spike in copyright costs is forecast for FY17 as a new equilibrium is found

Image result for business turnaround cartoon

King Content’s new CEO has parachuted in just in time.

 

Recommendation

Buy.

(Un)fortunately the SP has been grinding higher since I started writing this post, with $1.50 at the outset morphing into $1.90 at the time of publishing. Remains attractive at current levels – consider adding to your portfolio at any price below $2 as the risk/reward skews to the upside with my valuation implying a 25% margin of safety at $2. Entry point offers sufficient downside protection via the core ANZ SaaS revenues, which are relatively sticky. The market will react in the short term to domestic churn, but as churn and pricing impact from the heightened Meltwater competition stabilises the share price will recover. Upside to be driven by a re-rating in the stock to trade in line with SaaS peers as well as meaningful upside within the Asian growth story – an option we are happy to pick up on the cheap at current levels.

Join up to the email subscriber list (see pane to the right) if you would like to get the valuation model for iSentia to understand the valuation drivers, as well as updates for future posts.

Disclosure: I am long iSentia (ASX: ISD)

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