Ann: Ceasing to be a substantial holder, page-122

I don't think solvency is even a remote risk with ISD.

Despite the downturn in the business and the restructuring charges that have been incurred as cash flows, the company has been able to reduce its net debt by 17% over the past 12 months (by $9m in nominal terms).

(And that includes having paid a $1.3m dividend and $2.4m for a deferred acquisition settlement; it it wasn't for those calls on capital, borrowings would have reduced by almost one-quarter.)

So, given the dividend is on hold and that there is only $0.8m in near-term contingent acquisition payment due, given the strong cash flow generation characteristics of the business, I fully expect net borrowings to fall by a further $8m or $9m in the current 12 months, to finish calendar 2019 at around $32m.

Given the $20m pa EBITDA run-rate, that will leave the company's Net Debt-to-EBITDA at an eminently-manageable 1.6x. This is a significant improvement on the current Net Debt-to-EBITDA of 2.2x.

(And even if EBITDA was to ease yet again by a further 10%, to $18m, it would still result in comfortable Net Debt-to-EBITDA of 1.8x).

In fact, some crude modelling will show that, even if EBITDA continued to fall every year, by around 10%pa, and there was a response by a 2.5% reduction in investment in Intangibles and PP&E, Net Debt would continue to fall at an accelerating rate, and the company would be debt free in around 5 years' time, due exclusively to organic surplus capital generation.

For scenario demonstration purposes, the indicative surplus capital flows, and the attendant reduction in borrowings (and improvement in Net-Debt to EBITDA metrics) is shown in the table below:




Clearly, ISD's balance sheet will have no problem repairing itself organically, and quite quickly, too.

For the net debt to not come down organically would require, by my calculations, EBITDA to fall by around a very significant one-third every year, going forward. (But, clearly, if that transpired, shareholders would have plenty of other concerns with their investment other than whether ISD's commercial lenders will be repaid).


So, I feel strongly that solvency is not an issue.

Rather, the issue is when and how the market recognises the fundamental value in the stock.

Because, as can be seen from the above table, even if EBITDA continues to fall each year for the foreseeable future, the cumulative surplus capital that will be generated by the business over the next 5/6 years will be around $40m. Which is a significant quantum in the context of a company with a similar market cap and an Enterprise Value of just twice that amount.



For further context, assuming current level of EBITDA is able to be preserved at around the $19m to $20m pa level (accompanied by management continuing to maintain, not reduce, the current level of investment in PP&E and Intangibles).

In that case, the company will reach a point where Net Debt falls below EBITDA in a little more than two years' time and it would be debt-free just two years after that (refer below).



Under this scenario, Cumulative Free Cash Flow over the period under review would amount to somewhere around $50m, equivalent to 125% of the current net debt and two-thirds of the EV of the company today.

Viewed yet another way, current FCF of $8m to $9m pa (recall the FY2019 figure of $6.6m includes $2.4m of deferred acquisition outlay which will not recur). That's in excess of a 20% FCF yield (or less than a Free Cash Flow multiple of 5 times).

One thing is for certain, if EBITDA can be stabilised in the next 12 to 18 months at around the current level (or even not too far off it), there is no way this company's Free Cash Flow will continue to be capitalised by the market at just FIVE times.

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