Amaysim’s amazing margin expansion

When a company surprises on the downside it is important to ask why. Conversely, when a company surprises on the upside, it is important to ask how.

Readers of find the moat would know by now that there are an infinite number of ways for a company to increase its short-run accounting profitability independent of the actual underlying economics of the business. Without exceptions though, it is always a case of robbing Paul to pay Peter.

Therefore, how a company achieves its outperformance and what it infers about the company’s true underlying economics is in my view a lot more important than whether or not it manages to win the cat and mouse game of beating consensus headline numbers.

Case in point, Amaysim (“AYS”) beat its Prospectus pro forma FY2016 EBITDA forecast of $31.7m, delivering underlying FY2016 EBITDA of $35.4m. This is more impressive considering it was perceived by the market to be not on track to do so just 6 months prior.

Shareholders were jubilant and Amaysim share price rocketed more than 20% in response.

Essentially, having missed its prospectus revenue forecast (despite the inclusion of an acquisition), Amaysim was able to nonetheless beat its prospectus EBITDA forecast largely through a gross margin expansion of 618bps during 2H FY2016.

Gross margin expansion of this magnitude would imply a very material change to Amaysim’s underlying economics which would be pivotal to any investment thesis in Amaysim today – hence it is important for us to really understand how it was achieved.

Amaysim’s 600bps+ gross margin expansion

We know between FY2012 and FY2014, Amaysim generated consistent gross profit margins of around 22%:

This makes good sense given Amaysim’s COGS comprise primarily of network related expenses paid to Optus under a wholesale network supply agreement and that Amaysim prices on a “cost plus model”. Amaysim defines its gross profit as follows (along with key drivers):

We then saw a step increase in gross profit margin percentage during FY2015 when it launched a “Product Repositioning” ahead of its IPO – essentially a $5 price increase. This resulted in a step-up in ARPU from $20.9 to $26.1.

Price increases are powerful levers in that every dollar of increase falls directly to the bottom line and here we can see an impressive corresponding increase in gross profit margin to c.30% which management have cited as the “baseline” going forward for Amaysim:

However, just when we thought Amaysim would miss its prospectus EBITDA foercast, Amaysim’s 2H FY2016 gross profit margin steps-up by another whopping 618bps to 36.7%!

But this time there is no corresponding increase in ARPU. ARPU had in fact fallen during 2H FY2016. Given Amaysim’s “cost plus” pricing model, a margin expansion of this magnitude fully realised within 6 short months is extremely strange.

In other words, during 2H FY2016, Amaysim managed to take on $17.8m of incremental services revenue while incurring only $4.8m of incremental network related expenses.

Whilst the FY2015 gross profit margin expansion can be explained simply with “There was a $5 price increase”, no such direct or concise explanation can be found:

Interesting, when gross margin per user exceeded prospectus forecasts by a mere $0.08 during 1H FY2016, it featured prominently in Amaysim’s investor presentation (literally the 4th bullet point in its Executive Summary). Yet when this same metric increased by close to $0.80 during 2H FY2016, Amaysim stayed strangely silent. In fact there was no explicit mentioning of the 36.7% gross profit margin achieved during the half.

Queried about this on the conference call, we got no closer to the answer, and more specifically when asked whether this gross profit margin was likely to be sustained going forward:

we’ve always said I guess as a baseline that this business will consistently deliver around a 30% gross margin, albeit this year we’re showing 34% gross margin, looking forward we don’t have a crystal ball in terms of how we see the outcomes of the market developing….

When such an important question in context of Amaysim’s underlying economics remain unanswered, rather than applaud the company anyway for having delivered the numbers, we need to press harder.

The next obvious area of investigation is the acquisition of Vaya Pty Ltd at the commencement of 2H FY2016.

Amaysim’s acquisition of Vaya Pty Ltd

On 1st of January 2016 Amaysim completed the acquisition of Vaya Pty Ltd which added c.140,000 subscribers to Amaysim for an enterprise value of $70m.

Amaysim did not disclose what Vaya actually contributed (or would have contributed) financially during the period:

However, we can estimate using its stated monthly ARPU and subscriber numbers that it probably generates around $3m of revenue per month (or c.$18m of revenue contribution to 2H FY2016). So we can see that the majority of Amaysim’s revenue growth during 2H FY2016 was likely attributable to Vaya:

Unanswered questions regarding Vaya

What stood out in this transaction was the $50m of “Optus liability” which Amaysim had taken on as part of the $70m enterprise value it paid for Vaya:

This raises some further unanswered questions:

How did Vaya with c.$3m of monthly run-rate revenue (significantly less than this in previous periods given we know that Vaya’s subscriber numbers have “doubled in the last 2 years”) manage to accrue $50m of unpaid invoices and clawback commissions to Optus?

And in turn how was it that Vaya could continue to operate solvently as a going concern?

Why would Amaysim then take on and guarantee what would appear to be a very doubtful debt from Optus’ perspective?

I suspect the answers to these questions will help us also answer how Amaysim managed to achieve its incredible gross profit margin expansion during 2H FY2016.

Update (30/11/16): Amaysim’s amazing gross profit margins comes back down to earth via a trading update:

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.