Checking in on Infomedia
One stock we follow at Montgomery is Infomedia (ASX: IFM). There are a few things we like about Infomedia:
- It is an Australian success story on a world stage, having established a leading position in global markets providing software to the automotive industry, and in particular to the service departments of Original Equipment Manufacturers;
- Its customers tend to be very sticky – once they start using Infomedia’s products they tend to stay customers; and
- There appears to be a strong growth path ahead of the business, with recently developed products undergoing large trial programs in Europe and the US.
At the same time, there are some issues to consider. Late last year Infomedia reported the loss of a significant contract with Jaguar, with a consequent hit to revenue to take full effect from the second half financial year 2015. In addition, the company has invested in sales and marketing capability in support of its suite of new products, and so costs have been rising ahead of revenues.
We commented on the loss of the Jaguar contract earlier this year, and our view continues to be that it was an unusual situation, and not something that indicates problems more broadly.
Which leaves us with the issue of costs rising without revenues. Essentially this comes down to a judgement about whether the extensive trial programs currently underway can be converted into revenues.
There is an element of judgement in this, but our judgement is that they can. The business case for end users appears to be strong, with early adopters of the new software reporting material revenue and productivity enhancements, and the indications are for trial success rates in the order of 90 per cent.
It will take time for the trials to run their course, and it will take time to complete the required implementation and customer training, but in due course it seems reasonable to expect that the revenue should flow.
It looks to us like the market may be focused on the bumpy short term results, and perhaps not giving enough credit to the longer term growth potential. In any event, we are happy owners of Infomedia at these prices.
Tim Kelley is Montgomery’s Head of Research and the Portfolio Manager of The Montgomery Fund. To learn more about our funds please click here.
Tim joined Montgomery in July 2012 and is a senior member of the investment team. Prior to this, Tim was an Executive Director in the corporate advisory division of Gresham Partners, where he worked for 17 years. Tim focuses on quant investing and market-neutral strategies.
This post was contributed by a representative of Montgomery Investment Management Pty Limited (AFSL No. 354564). The principal purpose of this post is to provide factual information and not provide financial product advice. Additionally, the information provided is not intended to provide any recommendation or opinion about any financial product. Any commentary and statements of opinion however may contain general advice only that is prepared without taking into account your personal objectives, financial circumstances or needs. Because of this, before acting on any of the information provided, you should always consider its appropriateness in light of your personal objectives, financial circumstances and needs and should consider seeking independent advice from a financial advisor if necessary before making any decisions. This post specifically excludes personal advice.
david klumpp
:
I would appreciate it Tim or Roger if you could provide any comment/ update on IFM. Recent market pricing on this stock would suggest nervousness about the key management changes that have occurred or maybe more losses of contracts? Or is this just another miss pricing by the market of good company. I am interested to hear you have had any further meetings with management that can help shed more light on the company’s prospects and long term value.
David
Roger Montgomery
:
Will let you know once we have met with management and other stakeholders…
david klumpp
:
Thank you Roger, look forward to that. In the meantime, I have written to management and asked for comment.
Oscar De Toffol
:
Hello Roger,
I would also appreciate your thoughts on what’s going on at IFM. I thought the recent price drop was probably due to uncertainty created by the sudden departure of the CEO, given some other long-standing individuals had also left fairly recently. It raises the possibility that there’s trouble within management.
Unfortunately, my fears were confirmed today when I received a letter from Richard Graham and Jonathan Pollard regarding their intention to stand for election as directors at the upcoming AGM. They outline their reasons for doing so and it’s not a pretty picture. Having considered the information before me, I don’t feel that I’m in a position to make an informed choice. Meeting with management and stakeholders is probably the only way to get a proper feel for what’s going on. Is it a case of resistance to change within the organisation, or are there genuine shortcomings with the current Board?
Tim Kelley
:
Hi Oscar. We posted our latest thoughts on IFM earlier today. You should be able to find the article on the home page.
Joel M
:
This seems like an unusual business for you to be interested in. Earnings have been stuck around the 4c level for over 10 years, revenue hasn’t grown and return on equity is declining. The current P/E of 25 seems excessively high for a no growth business. Do you really think they can suddenly start growing when they have been unable to do so for over 10 years?
Roger Montgomery
:
Hi Joel,
Charlie Munger once said that if historical numbers were all that mattered, librarians would be the richest investors in the world. The company has developed a new product called Superservice (that didn’t exist in the period you have been inspecting) that has been met with significant support and current uptake. In such situations, the past might not be a good indication of the future. Having said that, we could be wrong and the share price could halve or worse from here.
Joe Rich
:
Hi,
I’m curious as to what valuation method you’ve used, (or perhaps just a custom financial model?)
Using the valuable method, with a few adjustments, I have come up with a value of $0.81c. I have used the following inputs:
– Anticipated medium-term ROE of 36%, up from average of ~26% in the last 3 years.
– Increased ROE based on 2-years worth of consensus analyst forecasts, and the assumption that ROE will then stabilize at ~37% after the next few years.
– Div payout ratio to reduce to ~80% from current level of 94%.
– Require Rate of Return at 9%
– This valuation implies growth of 11% p.a over the next 5 years (70% total earnings growth). This compares to 3.9% p.a earnings growth over the last 5 years.
I tried to adjust the inputs to get a ‘fair value’ valuation. Assuming 80% div payout ratio, we would need to see earnings growth of ~19% p.a for the next 5 years. A lot of this would have to be loaded into years 3-5, under the assumption that ROE would continue upwards to around the 45-50% level during these years. Seems quite high…
Understand that Required Rate and Payout ratio assumptions may well be very different – perhaps this is where the discrepancy comes from?
Or perhaps the valuable method has its limitations with companies that have very high payout ratios? Are there alternate models you could recommend for such companies?
Roger Montgomery
:
Hi Joe,
Perhaps some of the other value investors in our community, and watching here, can offer some help…
Harry Knowles
:
Tim thanks for the up date on IFM as i was about to add to my holding in the company im still learning to look over the longer term rather than the market movement day to day, look forward to further insights on quality companies. cheers Harry
Nathan Arnold
:
Hi Tim and Roger,
As a new investor and a recent Value.Able reader, I’m having a bit of difficulty valuing businesses such as Infomedia and I have a suspicion it is due to the amount of Equity attributed to these types of Software businesses.
Infomedia for example, I’m calculating intrinsic value at around the $0.40 range, which would mean that the stock is a whopping 150% above intrinsic value. Given your enthusiasm for the stock at current prices, I doubt this value is a true indication of your intrinsic value.
Is there another valuation technique more suitable for software type businesses? Quite possible that I would be performing calculations incorrectly also if this doesn’t make sense.
Thanks for any input you can offer!
Roger Montgomery
:
Hi Nathan,
There are indeed differences due to input assumptions such as earnings growth, returns on equity or amounts of incremental capital that can be re-deployed. But the differences can also be because we are using a variety of valuation techniques here at The Montgomery Fund and The Montgomery [Private] Fund. In addition to that there are problems with straight line valuation techniques when a company can massively increase it’s ROE while distributing a large proportion of its earnings.
Greg McLennan
:
That’s fair enough. I was critical of a couple of things relating to their report, but that said, it was a fairly superficial look. There’s definite potential for IFM but it’s not for me at the moment.
Greg McLennan
:
“There appears to be a strong growth path ahead of the business, with recently developed products undergoing large trial programs in Europe and the US.”
One of those coming to fruition this morning…