I've followed a few of the messages over the last few days and I must say I'm quite amazed at 2 things:
1. How many people seem to have an opinion as to the value of CM8, but don't appear to have actually looked at the financial accounts of the business, or recent financial announcements; and
2. For those who have read the financials, how poor people are at understanding the financials information which has been released.
The half year accounts provided significant details about the CM8 business and broke down a lot of information between the Q&A division and Subscription (Track) division.
It is also very apparent that people don't understand depreciation and amortisation or how CM8 treats intangible assets.
Basically, CM8 is super conservative when it comes to accounting around intangibles as they do not capitalise intangible assets and then amortise them later (most other companies capitalise and amortise which has the impact of boosting those companies EBITDA). CM8 capitalised NIL intangibles during the 6 month period ended December 2015.
The substantial increase in intangibles came because of the Track acquisition. There was a $36.5m increase in intangibles of which $17.9m was allocated to Goodwill (which does not get amortised), and the balance to identifiable intangibles (which does get amortised). This is also very conservative - a lot of companies would have put a lot more to goodwill.
Is the market valuation of CM8 high or low?
Businesses get value based on cashflows, and the risks associated with those cashflows. Our best guidance as to the earnings of the business is to annualise the most recent quarterly accounts.
EBITDA is a good metric for valuation as it is a good proxy for cashflows and ignores funding structures. If you want to get really technical, some argue that EBITDA less Maintenance Capex is a better proxy on the assumption that there is ongoing Capex required to maintain the existing business (and those costs often get incurred irrespective as to whether the costs qualify for capitalisation under accounting standards). The value doesn't change, but the implied multiple does.
Do you remember the part above where I say that CM8 doesn't capitalise any Capex?? They already expense it. So for CM8, their EBITDA, is like other companies EBITDA less Capex!
So annualised EBITDA for CM8 is $13m (4x $3.25m). And this is after CM8 have increased their expense base as part of the Track acquisition to position the group for growth.
What is the current Enterprise Value (EV) for CM8?
If we include all the performance shares and assume they will be converted into Ordinary Shares, there are 163.22m shares on issue (I'm going to ignore the options as any exercise of those will result in extra cash coming in which will further boost the EV for CM8. At $0.20, CM8 has a market capitalisation of $32.64m.
Debt (and vendor finance and deferred consideration) at December 2015 was A$24.24m. Cash was A$5.9m. This gives net debt at December 2015 of A$18.34m. But to work out the debt as at March we need to work out how much extra cash was generated in Jan-Mar 2016.
For Jan-Mar, EBITDA was $3.25m (normalised), so lets say take off an extra A$0.3m for extra non-normal costs relating to transactions, refinancing efforts, etc. We need to deduct interest payments, which would be about A$0.2m per month (based on the bank debt at 12% and Vendor debt at 15%). So there should be about an extra A$2.34m of cash.
Total net debt at March 2016 should be about A$16.0m
Therefore, enterprise value is A$48.64m (at March 2015, based on current share price).
EV/EBITDA multiples and what does this mean?
So based on the above the EV/EBITDA multiple is 3.74x (A$48.64m / A$13.0m).
Or thought about another way, assets of $48.64m generate earning of A$13.0m (or 26.7% per annum).
Now given the Risk Free return is somewhere between 0-3% depending on what part of the world you are in, this return is a huge premium over the risk free return. And given broad market return expectations are around 6-7% above risk free returns, the returns generated by CM8 are very strong indeed.
Now this could mean 2 things:
1. The market has got it wrong and is currently miss-pricing CM8; or
2. The market actually expects normal market returns, but expects CM8 earnings to decline heavily over coming years.
If we assume that the market requires CM8 to provide a 15% return due to say the smaller nature of the business, and doing an NPV of the earnings then the current pricing is implying that CM8's earnings will decline by 13% per annum in perpetuity.
Is this likely? Let's look at history. We know that the Q&A business is growing based on message volumes (up 59% on the prior comparable period). The acquisition presentation for Track also showed us its history. Between FY10 and FY15 (so 5 years), Track had a Compound Annual Growth Rate (CAGR) for revenue of 38.9% and a CAGR for EBITDA of 45.8%. If you want to look at a shorter period where the growth is off a higher base (and therefore growth is lower), the CAGR for the 3 year period FY12-FY15 for revenue is 8.3% and for EBITDA is 15.3%.
So in my view, the decline in earnings implied by the market is totally in-appropriate and not supported by recent performance.
What should the EV/EBITDA multiple be? Go and do some research and benchmark some other global tech companies with decent revenues and positive earnings. But in my view, the EV/EBITDA multiple should probably be in the range of 7-10x.
Is the debt too high or the cost of debt too high?
This seems to be the biggest excuse provided for the share price being at the current levels.
In reality this is a ridiculous view to take. Based on the earnings, CM8 has an interest coverage ratio of 5.34x. This is heaps of coverage.
And with net debt of A$16m and EBITDA of $13m, the debt will be fully paid off in about 1.5 years once you take interest into account.
As an aside, on that basis alone, the stock price should increase in order to generate a market cap of $48m within 1.5 years, or a stock price of $0.30. And then the risk will be even lower and people will price it higher again.
The fact that the interest rate on the debt is higher than people like does not justify a heavy discount because at most they are overpaying about $0.5m too much interest. This doesn't justify a big discount in the stock price. It justifies a $0.5m discount.
What's going to happen?
Either:
- the market will wake up and price CM8 accordingly in a short period of time once they actually take the time to understand it
- refinancing the debt will give people an excuse to reprice the shares and it will go up
- the market will stay of the same opinion and inside 18 months it will be 50% higher without any other assume derisking
I also have no expectations of a debt refinancing until the full year accounts are released (or at least the management accounts are available to banks). I think Dom's biggest mistake was providing some suggestion it would happen in the March quarter. If it does happen before the full year accounts then that is an added bonus.
What do I think will actually happen?
I actually don't care. I personally think CM8 is so low risk due to the cash generation that the debt will get paid down and then refinanced. The growth in earnings will also come through which will clearly justify higher EV/EBITDA multiples.
It might take 18 months, but I think in 18 months time, people are going to look back and be astounded that the price got down to $0.20. I think in 18 months you could see a price somewhere around $0.60-$0.90. (Anyway, that is my target).
I have heaps of CM8 from pre-IPO, again on market and then as a sub-underwriter in the rights issue. I'm due a large payment in the next 2-3 weeks, so I actually hope the price stays down because at these prices I'm prepared to put another large investment into this. I think it is that good.
Cheers
Marv
DISCLOSURE: I hold heaps of CM8
Expand
(20min delay)