And the reason I am buying is because I assess the investment opportunity to lie in the mismatch between ISD's P&L and the Cash Flow Statement.
ISD's P&L is currently wearing around $14m of amortisation charges (~$8m for customer relationships/contracts; current carrying value = $21m; and ~$6m for software; carrying value = $23m).
Variance: Intangibles Amortisation vs Investment ($m)
FY2015: 8.3
FY2016: 5.7
FY2017: 3.1
FY2018: 5.8 Average = $5.8m
That ~$5.8m variance between Amortisation of, and Investment in, Intangibles, is a significant figure in the context of the company's current level of Pre-Tax Profit being of a similar order of magnitude.
In other words, as ISD runs down its intangible assets,on a cash-accounted basis, Cash Pre-Tax Earnings for the company are currently running at a full double the level of Reported Pre-Tax Earnings.
Viewed in valuation terms, this means that, based on the company's guidance for FY2019, the stock is valued on a P/E multiple of some 15 times... which I suspect is the number that the market is superficially "seeing".
However, in cash-accounted terms, I believe it is more like 7 times cash earnings.
Which, if the business has been able to be stabilised (acknowledging that given ISD's chequered history, it is a very big "IF"), the share price has meaningful upside once the disconnect between cash earnings and accounting earnings dissipate.
The one niggle that I needed to overcome when it came to actually pushing the BUY button for ISD was the level of borrowings, which will be close to $45m, I expect, when the company reports its interim results next week.
$45m of Net Debt on ~$20m of EBITDA, i.e., 2.3x, is a little bit over the limits I normally like to tolerate.
However, the redeeming aspect of ISD, in relation to debt servicing and reduction is that the company is highly cash-generative, with around 70% of Operating Cash Flow converting to Free Cash Flow.
This means that ISD's net borrowings, based on my pretty conservative modelling that does not assume any recovery in EBITDA from the current ~$20m annual run-rate, will quite easily fall to below ~$35m within the next 18 months, i.e. by the end of FY2020
Derived, simply, thus: Free Cash Flow over next 18 months:
Cumulative EBITDA = Cumulative Net Receipts = $33m
Less:
- $1.5m increased investment in working capital
- $3.5m in Interest costs;
- $2.5m in Tax Payments,
- $2.5m in PP&E spend,
- $12m in investment in intangibles
=> ~$11m-$12m of Free Cash Flow over the next 18 months
=> Expected Net Debt @ June 2020 balance date = $45m less $11m = $34m
Even if ISD's EBITDA is 18-months hence still only running at the $20m pa to $25m pa level guided for this year, that would result in a Net Debt-to-EBITDA ratio of 1.5 times, which will essentially leave the company financially de-risked.
And trading on an EV/EBITDA multiple of 4x and a Free Cash Flow Yield of 15% to 17% on Enterprise Value, and 25%-%30% on Market Cap.
Clearly, not much has to go right for ISD's share price to be significant higher over the next 12-18 months. Mere demonstration of the fact that the business is not getting any worse will do the trick, I believe.
It is an investment that I think makes the potential rewards more than offset the risks.
..
ISD Price at posting:
28.0¢ Sentiment: Buy Disclosure: Held
