Downgrades haunt Isentia

There was an air of desperation about Isentia's profit downgrade today. Apparently the decline in revenue in late 2017 – see Isentia's poor second half – has intensified. Today the company announced that first-quarter revenues were ‘down on a mid-single digit percentage basis'.

After refusing to provide 2018 guidance at the 2017 results, today management clarified that revenues for this financial year would likely be in the range of $133m–138m. With management excluding King Content's performance from its 2018 guidance – more on that shortly – it implies underlying revenues will fall 2–6% this financial year.

This is what we were worried about in our about-face review in March (see Backing out of Isentia). The company is not only unable to put through price rises any more, it's having trouble retaining clients too. Hence the line in today's announcement that Isentia's sales team was being reorganised to ‘concentrate on customer retention and growth'. The word order is telling.

So our fears are being realised. An emerging competitor and technology-led disruption to the industry appears to be threatening Isentia's market share and margins.

The 2018 guidance for earnings before interest, tax, depreciation and amortisation (EBITDA) is now $32m-36m, which compares with the $51m delivered in 2016. Falling revenues in a high-margin business are poisonous: the guidance implies EBITDA margins as low as 24% this year compared with 33% in 2016.

Holy sheet

In fact, the 2018 result will be even worse because the ghost of King Content roams still. The new guidance numbers exclude losses from King Content, which have continued into the current half.

As a result, management announced it will ‘exit' the business entirely. It was unclear from the announcement whether King will be shut or sold. What is clear is that Isentia will be stuck with $30m-odd of debt it wouldn't otherwise have had.

This is now Isentia's fourth profit downgrade this calendar year. With so much bad news our interest would normally be piqued, particularly as the company remains a clear market leader. The share price fell 40% on today's announcement, and you can now buy the company for an enterprise value of around $270m.

At the low end of guidance, the stock is trading on a forecast enterprise value to EBITDA multiple of a little over eight times. It seems ‘superficially cheap', just as it did at the time of our last review (see Isentia's poor second half).

Damaged goods

Yet, we continue to have concerns about the sustainability of earnings. This is probably why the long-rumoured takeover has failed to appear thus far. Suitors have understood that Isentia's competitive position is threatened.

Management might yet decide to cut prices. Doing so would meet Meltwater head on and blunt that company's pricing advantage. Cutting prices is probably the right strategic decision but existing management will have trouble stomaching it in our view.

Perhaps this task will fall to new management.

In Backing out of Isentia, we said that the market pricing implied the stock was a ‘value trap'. So it has proven, and we contend that earnings are still at risk. It's hard, though, to quantify that risk and, given that we're unable to pinpoint a price at which we'd be comfortable buying the stock, we're switching our recommendation to AVOID.