Infomedia repairing its best parts

PORTFOLIO POINT: After losing revenue traction, automotive parts catalogues publisher Infomedia is gearing up for growth with the return of the company’s founder.

Infomedia develops and supplies electronic parts catalogues and service quoting systems for the automotive industry.

More than 50,000 dealers in 160 countries use its catalogues for parts information, and its client list is a who’s who of the global automotive industry.

True believers in Infomedia have had their faith badly shaken. Shares in Infomedia have shed almost three-quarters since 2006. The rising Australian dollar, heavy losses in European sales and the retirement of co-founder Richard Graham from executive duties, was a perfect storm.

Following Graham rejoining as executive chairman in 2010, some broking firms and investment newsletters had prematurely called an Infomedia turnaround, only to confuse value with a value trap. But after a few years of hard slog, the strategy appears to finally be gaining traction.

For all its problems, Infomedia is still the number two player in the global parts publishing industry, has recurring income, high switching costs, high barriers to entry, no debt and, like many successful software companies, is blessed with high profit margins and the ability to scale the business without adding significant extra cost.

Turnaround stories are always tricky to value and let’s not forget this is more speculative in nature. All too often the new chief executive spruiks an exciting plan to restore the company’s fortunes, and then the market underestimates the challenge in implementing it on time and budget. Prospective investors in Infomedia are betting that Graham can restore Infomedia’s culture and get back to the glory days of 2004.

It will not be easy. The car-parts publisher was a mess when Graham, who owns 101 million shares, returned in 2010. As is not uncommon amongst small companies, Infomedia lost momentum when the visionary entrepreneur stepped back and career managers took over.

He had always followed a simple formula: build a good product and sell the same thing many times over to the same people. Infomedia would decide what the industry needed, build the software, sell it to car companies and create recurring income from annual subscription renewals. Then it lifted prices as new software versions with improved features were released.

This lower price/lower customer engagement model worked beautifully with a small sales force and low-cost structure. Infomedia for a time was one of those fabulous businesses that begin each financial year knowing a big chunk of revenue is already locked in through subscription renewals and new sales. There was nothing glamorous about it; just a smart business that ticked over each year.

The new approach hurt Infomedia’s culture. Key staff became disillusioned or resigned, and Infomedia lost the mojo it had when Graham was in charge. The company’s operating margin (EBITDA divided by revenue) slumped from 51.6% in FY04 to 30.9% in FY09. Chief executive Gary Martin resigned in 2010 and Graham became executive chairman.

Graham’s first initiative was to reconnect with key clients overseas and decide if he still understood the parts publishing business after a six-year hiatus. It was a smart move: his “road show” was an opportunity to hear clients’ concerns and sell them on the improved Infomedia.

In emerging fast-growth ventures, the best salesperson is usually the founder. In September 2010, Infomedia signed up Chrysler dealerships; in May this year it renewed its agreement with Hyundai Mobis, which is the parts supplier for Hyundai and Kia’s worldwide dealerships; and renewed its agreement with Ford Motor Company for three years in North America and other markets.

Graham then cleaned up Infomedia’s back-end. He cut $1 million of costs, reconfigured the product development and management approach, changed the budgeting process, re-engaged the broader management team, and tried to spark company morale.

Early gains are promising. Sales revenue was up slightly to $45.7 million in FY12, with most growth from the Different Aspect Software acquisition in 2011. Net profit dropped 15% to $8.4 million in 2011-12, and was at the upper end of previous company guidance. Yet again, the higher Australian dollar hurt profit. About two-thirds of Infomedia sales are in Europe and the US.

Infomedia gave FY13 guidance for revenue of $47-50 million and net profit of $8-9 million. Even though the stated earnings outlook is uninspiring, the share price jumped from 20 cents to 24 cents on the news, on low volume and has continued since.

Potential upside

Infomedia has two potential tailwinds in FY13. The first is a lower Australian dollar, although basing an investment on currency forecasting is a mug’s game. The second, more reliable, ace is the company’s pricing power and scope to kick-start margin growth through higher fees.

Remarkably, Infomedia had not increased prices for six years. How could it when the company was disappointing customers and not delivering on its promises? Even good companies struggle to do much better than CPI-linked price rises in this market, let alone underperformers like Infomedia.

The emerging turnaround has given Graham scope to lift prices, although the magnitude and timing has not been disclosed. My guess is it has been more than the inflation rate and the price gain will be felt more in FY13 than in FY12. Nobody knows if higher prices have increased Infomedia’s customer attrition, because it does not publish its subscription levels and retention rates. There has been no news of contract losses.

Infomedia’s sticky products should have latent pricing power. Once dealerships embed them in their business, it is costly and time consuming to change providers. Infomedia is unlikely to recoup years of pricing inactivity in a few big price increases. More likely is a few years of slightly more aggressive price rises, provided Infomedia backs it up with better products and client support.

Another potential upside is renewed growth in Europe. Infomedia was rocked in 2004 when one of its biggest customers, Ford Europe, announced FordEcat, a rival in-house parts publishing service that killed about 8,000 Infomedia subscriptions in a year. After years of struggle, Infomedia might in FY13 record its first growth in European subscriptions, its largest market, since 2004.

It is also doing better in North America, thanks to the 2010 appointment of Karen Blunden, who was division president of the Automotive Retail Group at technology giant EDS. The North American automotive industry is notoriously tough for small offshore firms, or “foreign cowboys”, to break into. Infomedia’s stronger US presence should pay dividends in the next few years.

Valuation

Skaffold rates Infomedia an A3 company for quality, which is well within the preferred range. While Skaffold values Infomedia currently at 16 cents, implying it is overvalued, the reality is that a turnaround offers the opportunity for significant and surprising leaps in intrinsic value.

Speculators, however, might indeed dive into the stock early and disciplined value investors could wait for more tangible signs of a turnaround in the interim result next year, and for better value to emerge. You tend to pay a higher price for the certainty though.

Infomedia is potentially worth much more than its $71 million market capitalisation. Imagine that Infomedia was offered today as an initial public offering. Even in a terrible float market, my hunch is that a software company with $8 million in net profit, a strong position in a huge global market, tens of thousands of longstanding customers providing recurring, sticky revenue, and a 10% fully franked yield, would be valued at more than $71 million.

Key risks

While there is little point in carmakers becoming information publishers, one major risk is the car industry’s cyclicality itself. The other is backing small-cap turnarounds.

Roger Montgomery is an analyst at Montgomery Investment Management and author of Value.able, available exclusively at rogermontgomery.com.