Update on Isentia
Following our earlier comments on the Isentia (ASX:ISD) result, we have now met with management, of Isentia as well as major competitor, Meltwater, and formed a view on our holding. Our view may change as new information comes to hand over time, but for the time being we have settled a position, and can outline our decision and rationale.
As noted last time, we see a number of issues, including the performance of King Content, the competitive position of the domestic monitoring business, and damage to management credibility. Of these, we see the competitive position of the domestic monitoring business as the central issue for valuation. King Content is too small to figure much in the broader picture, and the main concerns relating to valuation appear to be issues over which management has limited control.
In simple terms, ISD’s domestic monitoring business faces challenges on two fronts. Firstly, to access the media content it provides to clients, ISD must pay copyright fees to the owners of that content, and in Australia the copyright owners are permitted to negotiate collectively. In the past, copyright costs have risen in an orderly fashion, but in 2016, copyright owners put through more aggressive price rises, particularly for the print content that has been a differentiating feature of ISD’s client offerings.
In the ordinary course of business, ISD would look to pass this cost increase through to clients, but in 2016 found itself in an awkward position relative to Meltwater. To begin with, Meltwater enjoyed an extra 6 months of the “old” copyright pricing, so time was on its side. Also, Meltwater faced smaller cost increases than ISD due to its focus on online content over print, and finally, Meltwater appears to have capitalised on its position by offering discounts to new (but apparently not existing) clients. As a result, ISD’s attempts to re-price were met with firm client resistance.
So, the half year result introduced some issues that should resolve themselves over time, being the 6-month contract timing difference and Meltwater’s tactical exploitation of that timing. However, we also have some lasting issues, being the recognition that copyright holders have significant power to influence ISD’s economics, and the potential that Meltwater may see further discounting as an attractive path to gain market share in future. ISD has a dominant (and very valuable) share in the domestic market, and vulnerability to price competition presents real downside risk.
These issues add uncertainty to the ISD outlook and make valuation fairly challenging. When combined with the King Content and management credibility concerns, it would not be surprising to see a lot of investors placing ISD in the “too hard” basket, possibly resulting in the market price diverging from fair value.
The right thing to do in these circumstances of course is to try to objectively gauge value and compare this with the share price, and when we weigh the strengths and weaknesses of the business, our assessment is that value lies above the current share price. Accordingly, we recently added a small amount to our ISD holding. We certainly do not expect ISD to recover all the market value it has lost, and in view of the future uncertainty, it will remain a small part of the portfolio. However, looking at the information we have today, we don’t see a case to sell.
The Montgomery funds own shares in Isentia.