Looking inside iSentia’s moat

I was recently asked by a reader about my thoughts on iSentia, specifically the quality of its moat. So I thought I’d share my answer here (and actually write something about moats for once).

iSentia is loved by many fund managers and market commentators as a quality growth company that appears to tick all the boxes – supposedly a wide moat business leveraged to blue sky growth in both Asia and social media.

Surely it’s fairly valued at 23x P/E?

As always, the answer lies beyond the company narrative and headline numbers. The question to ask here is whether growth is happening inside or outside the moat. The answer to this question has huge implications on your expected returns as an investor.

What is iSentia’s moat?

iSentia (formerly Media Monitor, re-branded to Sentia Media, before adding an “i” for that extra bit of new media sexiness) is essentially a middle man that aggregates media content and presents what is relevant to its clients (otherwise known as a “press clipping service”).

It’s been the only player of scale in Australasia over the past 30 years because traditional media monitoring is extremely labour intensive (you literally need a human being to sit there and listen to what is being said on Television, Radio etc) hence only one profitable player was sustainable. AAP tried to muscle into the market and despite taking market share from iSentia, was never financially viable and eventually had to be sold to iSentia.

ACCC has already done a lot of work on this topic here.

A classic legacy moat under pressure

As we all know, suppliers of content to iSentia (i.e. traditional media providers) are facing massive headwinds and the volume of unique contents being generated is in rapid decline (in line with traditional media’s share of eyeballs). Additionally, media content is increasingly digitised, indexable and searchable.

Revenue growth in iSentia’s core ANZ media monitoring business slowed to 1.9% year-on-year during 1H FY2016, implying a negative real underlying growth rate once we factor in iSentia’s 4% price increase.

In fact the 4% price increase achieved (with 5% actually targeted) is surprisingly low given iSentia’s monopolistic positioning within the traditional media monitoring market.

We can therefore deduce that although the moat is wide enough to keep competitors out, what it is protecting is clearly in secular decline and is much less price inelastic than one would assume.

As of today, iSentia’s Australasian media monitoring business comprises c.60% of iSentia’s total revenue and is declining as a proportion of its total revenue.

Is iSentia really finding growth in Asia?

The remaining c.40% of iSentia’s revenue, Asia and Value Added Services (“VAS”), is what drives iSentia’s growth and excites iSentia’s proponents.

iSentia’s Asian headline revenue growth of 22% YoY during 1H FY2016 appears to support this narrative. However, take into account the following:

• AUD depreciation (iSentia’s exact currency mix isn’t disclosed, but a reasonable proxy would be the c.19% decline against the $USD); and
• its Hong Kong acquisition in May 2015 (c.200 new clients)

Then iSentia’s headline Asian growth rate of 22% suddenly appears a lot less impressive. In fact, iSentia’s number of VAS customers in Asia has actually decreased despite extremely favourable tailwinds.

iSentia has just announced 4 acquisitions in Vietnam, Hong Kong, Thailand and Korea, adding roughly $4m to its Asian revenue. It’s difficult to see how iSentia is able to transfer its ANZ competitive advantage into Asia through these sub-scale acquisitions in disparate markets (note: “Asia-Pacific” is anything but a homogenous single market and it’s both arrogant and ignorant to assert that they will “eventually mature and catch up to Australia and hence a massive opportunity!”). However, these acquisitions do deliver an incremental 15% top-line growth to support iSentia’s Asian growth narrative.

Blue sky opportunity in Social Media?

As the flavour du jour, social media is another growth opportunity that excite many of iSentia’s proponents.

We have to firstly recognise that iSentia does not have native social media monitoring capabilities in the same way it does in traditional media. iSentia builds on top of publicly available data feeds from the likes of Datasift and GNIP.

Pronouncements such as “iSentia is now one of only 34 companies globally with certification and access to Facebook Topic data” may sound impressive and infer that iSentia is in the big leagues – until we dig a little deeper and the real story is that its data provider, Datasift, acquired an exclusive Facebook partnership and iSentia just happens to be one of its customers.

So in the highly competitive and sophisticated social media monitoring market, iSentia is simply a customer to another company that is successfully building itself a moat.

iSentia’s incremental ROIC

There are few remaining opportunities to meaningfully deploy capital within iSentia’s core high ROIC Australasian media monitoring business.

In fact, iSentia’s previous private equity owners took advantage of the last remaining high ROIC capital deployment opportunity during FY2014 when it acquired AAP’s Australasian media monitoring business – adding a whole lot of incremental revenue with minimal incremental costs. This acquisition, along with off-shoring of iSentia’s operations, delivered iSentia a nice step-change increase in EBITDA margins heading into FY2015 and positioned it beautifully for the IPO.

iSentia’s latest deployment of capital, the debt funded acquisition of King Content, clearly shows it is running out of quality capital deployment opportunities. At a hefty acquisition price of 10x prospective EBITDA and with margins significantly lower than iSentia, it’s difficult to see this acquisition not being dilutive to both ROIC and margins.

Putting questions of strategic fit aside, the content marketing market is highly competitive with very low barriers to entry. Whilst King Content having Lenovo in Europe as its largest single customer may sound impressive, let’s invert this logic – if a small-ish Australian player can successfully sell to Lenovo in Europe, then are there any real market entry barriers in this space? Unless you have a moat, excess profit margins will inevitably be competed away.

Investment Implications

iSentia is a legacy moat business in secular decline with no further opportunities for re-investment of capital. Remember, as an investor today, you do not benefit from the high ROIC of capital invested yesterday (i.e. you are investing today at 23x P/E).

To support its capital market narrative, iSentia is investing for growth outside its moat through acquisitions of Asian and Social Media businesses – at much lower incremental ROICs and within vastly less favourable competitive landscapes.

Why does it matter if growth is from outside the moat if growth is still being delivered?

In the short-run your P&L may look the same, however your outcome as an investor beyond the short-run is very different. A business with the opportunity to reinvest capital at high ROIC has the potential of becoming the proverbial “compounding machine” that will continue to reward investors on a recurring basis. You could pay a high multiple for one of these businesses and still make a lot of money.

iSentia is not one of these businesses.

Update (17/11/16): A BAD trading update today from iSentia, they appear to have been fleeced on the King Content deal

Note: The above blog post constitutes the author’s personal views only and is not to be construed as investment advice. Being obviously passionate about the art of investing, the author may from time to time hold positions in the aforementioned stocks consistent with the views and opinions expressed in this blog post.