We were hoping for bad news from iSentia when it reported its 2016 result in late August. We didn’t get it. Contrary to the concerns we raised in Risks rising for iSentia in July, management confirmed the company would report strong earnings growth in 2017 and laid out its ‘2020 strategy’. As a result, the stock has risen 16% since then (and around 30% since the August low).
What surprised us – and the market – was iSentia’s apparent pricing power. Late in the 2016 financial year the media monitoring and analysis company implemented a 10% price increase, larger than the usual annual 4–5%. Admittedly this partly reflected iSentia passing on higher content costs, as it signed a new licensing agreement with the media industry in April.
But, according to management, there was no discernible effect on client ‘churn’, which remains around 1% of revenue (but 5% of client numbers, implying iSentia’s large company clients are ‘stickier’). In other words, clients took the price rise on the chin rather than cancelling their subscriptions.
Pricing power evident in 2016 year
Incorporating social media into core product a wise move
More growth to come from 2020 strategy
This is often a sign of a great business, although price rises and pricing power are not necessarily the same thing. Occasionally companies push pricing too hard, which allows competitors to gain a foothold (we’re looking at you, Woolworths).
Chart 1 shows iSentia’s average revenue per client in Australia and New Zealand (including spending on add-on services). iSentia’s success at boosting client spend might one day encourage the price-conscious among them to try smaller and less-expensive competitors such as Meltwater. But it’s not happening yet.
At a recent management briefing we attended, iSentia responded to the competitive threat with: ‘We sell confidence’. Only iSentia has the scale and resources to pay people to sit in rooms listening to television and radio broadcasts. The company’s clients subscribe because they don’t want media content missed.
If you’re in the marketing or public relations department of a top 100 company – and iSentia counts 87 of the companies in the S&P/ASX 100 index as clients – then the average annual $34,000 cost of subscribing to iSentia’s services isn’t significant. It’s virtually an essential service.
The company is also taking steps to ‘widen the moat’. At the results presentation, management announced that its social media monitoring product would become available to all clients this financial year. So rather than social media monitoring being a stand-alone product that incurs an additional fee, it will be bundled in with mainstream media monitoring.
This makes sense for two reasons. First, social media is likely to become a much larger part of the media monitoring industry over time; to separate mainstream and social media monitoring looks like a false distinction. And second, it will help differentiate iSentia’s full-service approach from the less comprehensive service offered by competitors.
All this should help cement iSentia’s already strong pricing power. But what about our other concern from iSentia’s unfriendly trends: that the ongoing decline in the volume of content from print media sources was a risk to revenue?
Here the risk seems lower than expected. iSentia has invested significant time in pushing its clients on to fixed fee subscriptions. It’s been very successful, with fixed fee subscriptions rising from less than 40% of domestic revenue in December 2014 to 78% of revenue recently. Management expects fixed-fee subscriptions might eventually hit 85% of revenue.
You can see iSentia’s 2016 results in Table 1. But it was management’s confidence in the future that explained why the share price jumped in the aftermath.
iSentia forecast that both revenue and earnings before interest, tax, depreciation and amortisation (EBITDA) would grow in the ‘low to mid-teens’ in the 2017 financial year. With the help of the 10% price increase – and further earnings growth from the 2015 acquisition of King Content – that implies EBITDA will be $57m–59m. In earnings per share terms, this equates to a forecast of around 19 cents (before the amortisation of acquired intangibles).
|Year to 30 June||2016||2015|| /(–)
|* Final dividend 4.43 cents, 100% franked, ex date 5 Sep|
|# before the amortisation of acquired intangibles|
Companies with a private equity heritage have an unfortunate habit of disappointing the market soon after the private equity firm has sold its stake. While Quadrant sold out of iSentia in August 2015, there’s no sign of disappointment yet. Quite the contrary.
Management announced its ‘2020 strategy’ with the 2016 results, which aims to deliver ‘strong revenue and earnings per share growth’ for the three years beyond 2017. The media intelligence market is forecast to grow 6% a year over the next five years, driven by social media, so there are some helpful tailwinds.
Management’s 2020 strategy identifies around $200m of incremental revenue opportunities. As iSentia’s 2016 revenues were $156m, a more-than-doubling seems optimistic, although presumably it includes revenue targeted beyond 2020.
One of the largest revenue opportunities management has identified is King Content which, despite our initial scepticism, seems to be exceeding expectations under iSentia’s ownership. Nevertheless, content marketing is a lower margin and more competitive business than iSentia’s core media monitoring service.
On top of this, management aims to increase Asian revenues to 40% of the company’s total (from 24% currently). With existing operations in China, Singapore, Malaysia, Thailand, Indonesia, Philippines, Hong Kong, Vietnam, as well as the recently acquired South Korea, this is probably the more attractive growth opportunity. Expect more acquisitions in Asia.
Summing up, iSentia might have significant revenue growth potential, but it’s likely to be at lower margins. Given that – and despite the high quality of its core business – the stock isn’t particularly cheap.
While iSentia should report earnings per share of about 19 cents this year, that’s inflated by a low tax rate. On an enterprise value to EBITDA basis, which removes the effect of tax, the stock is trading on 15 times, which is certainly a premium multiple. The 3% free cash flow yield doesn’t scream value either.
iSentia is a great business, but the stock isn’t sufficiently attractive at current prices. It’s clear that we’ve been too conservative, though, so we’re lifting our price guide to Buy up to $3.25 and Sell above $6.00. We’ll continue to hope for an opportunity but the recommendation is HOLD for now.