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Reviewing Isentia

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Reviewing Isentia

As many investors have noted, iSentia Limited (ASX: ISD) delivered a poor earnings announcement yesterday. The Montgomery Fund and Montgomery [Private] Fund both hold positions in ISD, and so this is clearly disappointing for us.  The combined holdings amounted to less than 2% of the assets in those Funds before the announcement, so the damage was contained, but nonetheless, disappointing.

There are several issues to work through in properly understanding the result, and we will be meeting with management in the coming days to better understand these issues and their longer-term implications.  At this stage, we can list the main considerations as follows:

  • King Content has bigger problems than have previously been acknowledged. While it forms only a small part of the valuation of ISD, continuing losses have a relatively large impact to FY17 earnings, and possibly beyond.  The market value of ISD in the near term will be influenced by how long it takes to resolve these problems;
  • The core business has not shown the resilience we had expected in the face of increased domestic competition. This is a more significant issue for valuation, as the strength of the core business is an important driver of long-term value; and
  • Management credibility has taken a hit, as it always does when short-term outlook commentary is quickly found to be wide of the mark. This is perhaps compounded by a sale of shares by the CEO in the second half of 2016, notwithstanding that this represented a small proportion of the total holding.

In terms of value, it is clear that our previous assessment of ISD was optimistic, and responsibility for that rests with us.  The challenge from here is to make a clear-headed assessment of value considering all of the information now available, and compare that with the market price.  At this stage our assessment is that long term value is above the current price, but that view will be examined closely in the days and weeks ahead.

Montgomery funds own shares in iSentia.

INVEST WITH MONTGOMERY

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.

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34 Comments

  1. Chris
    :

    It’s been two weeks and I (like a lot of others) are just wondering if there is any update to this ?

  2. Tommy
    :

    The share price of ISD has dropped 8 days in a row since last Wednesday and capitalisation of the shares has dropped more than 45% since last Wednesday – this record only beaten by BKN which previously dropped 12 days in a row before taken over at 10 times at its low price. Is there something shareholders can do or some alert to directors to contain further losses or stop the short sellers from having a field day at our expense. Are the directors aware of the pain inflicted on the loyal supporters of the company?

  3. John E
    :

    Isentia’s copyright expense increased 40% yoy. This is massive.

    I would like to know the reasons for this as it appears to be a permanent drag on profits and the risk is this expense keeps rising faster than operating cashflow. They didn’t give any explanation on this item.

    I will be ask the company and hopefully receive an appropriate response which I’ll post back back here.

  5. Justin Carroll
    :

    Thanks for the write-up, Tim.

    Your frankness is a credit to you.

    I have posted elsewhere on Montgomery’s blog the unease that I have always felt with the Montgomery team’s increasing willingness to “pay up” for growth – in some cases, to the tune of 30 times forward earnings.

    You ask above “what can we do to minimise these types of experiences in future?”

    I hope I don’t sound presumptuous in saying this but I would suggest that the Montgomery team needs to return to a more fundamental form of value investing. I think the team’s approach has strayed too far from a tried-and-tested sense of value to a willingness – even an overwillingness on occasion – to pay up for growth.

    In the end, if your DCF analysis on a stock that is currently trading at 20, 25, 30 times forward earnings is telling you that the stock is somehow trading at a discount to intrinsic value, something has seriously gone awry.

  6. wade.number
    :

    Hi Roger
    I am a long time follower of the blog. In regards with ISD, I remember a few month ago you mention on Swizter tv some blogger predicted its king content business was going to be a major drag. Do you recall the name of the blogger?

  7. dilon
    :

    Hi !
    Do you still believe these high PE companies can survive. After all value investing is buying stocks cheap. Not at PE 40 ( I know you don’t believe in a single measure but still it Is worth considering as the recent experience suggests).
    In fact this is exactly the opposite of warren buffet does . (Look for mature companies with very low expectations and surprise on the upside )
    I

  8. Michael
    :

    I guess the saving grace for Isentia is the Asian operation. If you buy the shares today you are getting a free option to the growth of Asia. We may see one day the profits generated from Asia will outgrow the Australian operation. I thought Roger was a value investor ?

  9. Lester
    :

    Three cheers for Tim. I always enjoy you concise and frank comments. It is in short supply these days. This feedback was top draw.
    Now most importantly….how do we safeguard /mitigate against this in the future.

    • Tim Kelley
      :

      Thanks Lester. You and Kelvin have hit on what is probably the most important question: what can we do to minimise these types of experiences in future. We will never eliminate them completely, but we certainly need to get closer to it.

  10. Lindsay
    :

    Thanks for the comments Tim.

    I could be wrong but I do vaguely recall Roger talking about ISD advantages saying something along the lines of restricted competition, barriers to entry, exclusive media information access, superior software and ability to increase prices without affecting customer retention (also comparing to REA dynamics).

    Are these advantages not as good as they seemed ?

    There is mention of encroaching competition and customers not putting up with fee hikes.

    Is this a case of a “hick up” with the fundamental business dynamics still remaining intact or, like others have implied, a case of the con artists doing a great job fooling even the best in the fund managing business ?

    • Tim Kelley
      :

      Hi Lindsay. The result indicates that those barriers to competition are not as high as previously thought. We are still working to determine just how high they are today, and how high they may be in the years ahead.

  12. craig.cory.54
    :

    Tim, hi, welcome your thoughts. What the market has done to the share price highlights the big mistake repeated by many investors: that of not doing their exit thinking before they need to. How many times does the prospective downside not get considered and when it happens get caught needing months to recover or even hanging blindly in and suffering even more loss. I’m reminded of the wise words of pugilist/philosopher Iron Mike Tyson, who said ‘everyone has a plan, until they get punched in the face’. Cheers, C.

  14. T
    :

    I look forward to reading the update.

    It looks like even the Montgomery Team is not immune to falling for the hubris of management.

  15. Ray Ellice
    :

    Hi Tim

    Many thanxs for your frank assessment, I bit the bullet yesterday and exited as there are now too many unknowns and management credability is looking very suspect. I think it may take a while to recover much in price. As a growth stock clearly if you miss you get hammered, but I was wondering if you could post an update on Altium when you get the chance, I am far more comfortable with how they are progressing but they have also copped a share price wacking. Having been badly burnt by the crap that went on with management at Bellamy’s and Sirtex, when are we going to be able to find a mechanism to hold these CEO’s and boards more accountable for their actions and more than generous salaries and bonuses. As individual shareholders we have very little voice but a fund manager such as yourself would clearly carry a lot more clout, any thoughts.

    Regards

    Ray

    • Tim Kelley
      :

      Hi Ray. The team is working on Altium and you should see some commentary on it as the work is completed. In terms of board and CEO accountability, it will be interesting to watch the growth of activist investors who are set up for that specific purpose. This could be a healthy trend in the local market because unfortunately, for most investors, there are few real sanctions besides the one you have chosen.

      • Chris
        :

        Ray,

        The Australian Shareholders Association (disclaimer, I am a member) advocates for retail shareholders.

        Chris.

  16. James Cork
    :

    That’s probably the most succinct mea culpa i can recall reading on this blog, and i’ve been a regular reader for 5-6 years. Thanks for putting the hand up – mistake evaluation and recognition is a critical part of the never-ending learning process.

  17. Colin
    :

    A few questions:

    Agree with the 1st and 3rd points. However, can you elaborate on point 2 stating that the core business is not as resilient? I note a decent result on SaaS/Vas for ANZ (5% combinedgrowth) only dragged by the social segments. But this was apparent since the last FY. Also strong growth in the segment for Asia.

    It does feel like an overreaction to slug a 40% off the market cap even with this underwhelming result. And this was already on top of the Nov update which took almost 25-30% off. Has the business outlook soured that much? Or is this just the market punishing management for its earlier guidance (which I think it is)

    • Tim Kelley
      :

      Hi Colin. 2nd point is really aimed at increased customer churn experienced in November and December as a result of price increases put through to recover higher copyright costs. More important for full year than for 1H, but it indicates some vulnerability to price competition.

  18. John E
    :

    Thanks for your comments Tim.

    Can you please share your views after meeting with management. Many of your subscribers own ISD and are not feeling too good today.

    The business is now being priced as a non growth stock. Clearly as you mentioned, if they have lost their moat and differentiation in the Aust market, the long term damage may be terminal.

    Thanks

  19. Greg Scott
    :

    Hi Tim.
    Thanks for your thoughts on ISD. As any realistic investor knows, you cannot possibly always pick the winners. Some disappointments are inevitable.

    However, the point of this comment is to raise the issue of management commentary. Although ISD is a case in point, it seems to me that more generally across all companies, management have become “spruikers” of company results. It is OK to point out the positives of a business, but to me, commentary often seems like a sales pitch. I want factual information and a realistic discussion of the company prospects.
    Maybe I am too cynical, but maybe too much emphasis is being place on management bonuses and pay structures (e.g TSR calculations and the like) when reporting to shareholders. Open, warts and all discussion of results seem in short supply. I would appreciate any thoughts of yours?

    • Tim Kelley
      :

      Agree 100% Greg. Any management incentive based on short-medium TSR will incentivise “spruiking”, and where the quantum of those incentives is excessive, truth will increasingly be a casualty.

      • Kelvin Ng
        :

        Hi Tim, thanks for the concise and frank assessment.
        A closely related issue is that even excellent fund managers such as yourselves may become captured by charismatic management teams and lose objectivity – it wouldn’t be the first time that happened and it won’t be the last.
        VTG reports next week, and I hope Montgomery’s objectivity has not been swayed by Maxine Horne, who is clearly extremely charismatic.
        More importantly for the long term, what process has Montgomery got in place to guard against this danger?
        Thanks.
        Kelvin

      • campbell reynolds
        :

        Hi Tim any news from i-Sentia management on the long term outlook? It would be fantastic to get some insight from you guys:)

      • Tim Kelley
        :

        Not yet, Campbell. We are meeting with management later this week, and should be able to offer some thoughts next week.

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