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Posted on 27 Oct 2017 by Steve Johnson

Isentia Shows That “Good” Businesses Can be Risky Too

Isentia Shows That “Good” Businesses Can be Risky Too

 

Isentia’s shares were trading at $3.50 this time last year. Yesterday the stock closed at $1.05. There’s nothing unheard of about a 70% share price fall. Forager investors have experienced a few of those over the years. What’s interesting about this one is that Isentia was supposedly a “high quality” business – one with a competitive advantage that allows it to earn above average returns on capital.

You expect to lose your money every now and then buying highly leveraged mining services businesses. You don’t necessarily expect it buying at the quality end of the spectrum.

Lesson learned on competitive advantage

Isentia’s business is media monitoring. Teams of people scan newspapers and television broadcasts every day and collate a report of relevant news and articles for their clients. It is a simple business but one that tends towards a market place with one dominant provider.

There is little economic sense in replicating the large team of people required to scan and dissect hundreds of newspapers, magazines and TV shows every day. Once a media monitoring business has the largest coverage and most clients, it becomes self-fulfilling.

Unfortunately for Isentia, the increasing prevalence of online content eroded that competitive advantage. Website content and social media has become far more important than print, and a computer can do the job.

Here is an example of how dramatically the media monitoring world has changed.

When Dick Smith entered receivership in January 2016, Forager’s website crashed under the weight of unprecedented traffic to our site. Numerous press articles mentioned Forager thanks to a blog post written in October 2015 titled Dick Smith is the Greatest Private Equity Heist of all Time. A typical post on Forager’s blog gets about 1,500 unique views. In that first week of January, more than 200,000 saw the Dick Smith post.

Our PR agency at the time sent us a daily report – provided by Isentia owned Media Monitors – which highlighted newspaper articles that mentioned Forager. None of them featured prominently when we looked at the sources of traffic to our site. The most prominent source, by some multiple of its nearest competitor, was Reddit.

We pointed this out to the agency. They asked the same question some of you are asking now: what’s Reddit?

I will let you answer that for yourself. The point is that the most important reference to our business was coming from somewhere the PR company had never heard of and Media Monitors wasn’t monitoring.

The world has changed. And the only thing keeping Isentia in business was that most of its clients are too slow to notice, or unaware of how to deal with it. Yesterday’s announcement suggests they are slowly catching up.

Most “growth” investors think the world is going to change more than it is. At the other end of the spectrum, value investors can often get caught thinking the world will stay as it is forever (see our September Quarterly Report for more on this topic).

It is a long way down when the moat dries up

The consequences of incorrectly analysing or overestimating competitive advantage can be severe.

As at 30 June 2017, Isentia’s balance sheet showed $5m worth property plant and equipment and another $37m of working capital (cash and receivables less payables). For roughly $40m you could replicate the physical assets of Isentia. Given it made $35m of pre-tax income in the 2016 financial year, you can see why it was considered a wonderful business.

The $3.50 share price a year ago implied a market capitalisation of $700m. Throw in about $60m of debt and the assumption was that the total business was worth $760m (its “enterprise value”). The implied value of its moat – the gap between the value of its physical assets and the market valuation – was more than $700m.

Businesses that don’t need much capital can make for wonderful investments. We actively seek them out and are prepared to pay a premium for them. It is essential, however, to be confident that the moat is sustainable when buying these types of companies. When 90% of your company’s value is moat, it is a long way down when the moat dries up.

Isentia Shows That “Good” Businesses Can be Risky Too
Isentia Shows That “Good” Businesses Can be Risky Too  Isentia Shows That “Good” Businesses Can be Risky Too  Isentia Shows That “Good” Businesses Can be Risky Too  Isentia Shows That “Good” Businesses Can be Risky Too

5 thoughts on “Isentia Shows That “Good” Businesses Can be Risky Too

  1. For the record Media Monitors as you referred to it (the whole company had been rebranded iSentia years before) had been monitorinng social media including Reddit for some years by the start of 2016. The problem you faced was with your PR agency who apparently had only signed up for press and broadcast monitoring for your account, not internet or social media monitoring. It would be like me signing up for Foxtel and complaining about not getting a phone. Different products and services. How do I know? I worked for the company for a number of years and sold their products and services to clients from PR agencies to blue chip corporates and all levels of government. You can’t expect Grange on a cask wine budget.

    • Fair point Manos. My argument remains though that they have a strong competitive advantage in the labour-intensive traditional aspects of their business. When it comes to monitoring digital and social media – which I would argue is now far more important than traditional – I can buy a very good product for a small fraction of the price Isentia is charging.

  2. It is also worth considering that people reading a hardcopy newspaper are likely to then go and type in something like “Forager Funds” into Google or Bing so just looking at your website traffic sources does not show the actual newspaper article as being the source of the interest.

    Last time I did SEO work, which is awhile ago now, Google had blocked the search term used from being passed to the site, keeping that valuable data for themselves.

    If it was a large national paper you might be able to correlate the traffic based on when the paper came out, but there could be other things happening to mask that as well.

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