Mobile Embrace Drops a Bomb

I was in the process of preparing an update on Mobile Embrace when they dropped a bomb that slashed 42% off the market cap in one afternoon.

Some of the update I prepared involved trying to assess what the FY17 results might be. Given my goals for this website are for complete honesty and disclosure I will provide the numbers I had calculated. I was anticipating revenue of around $80m with NPAT of approximately $7m (1.8cps). At the share price on November 16 of 25c I was indicating this was good value (a forward P/E of 14 among other things).

Given my purchase price of 30c for the example portfolio the downgrade (that I will go into below) is obviously disappointing. Had my new analysis been available I would not be a buyer at 30c. The valuation would be too stretched for my liking given the risks.

However, that is history and all we can do is assess the situation in front of us. We are talking about a share price of 14.5c and updated information. The investment proposition as it stands is now completely different to yesterday.

There are two things I would like to reiterate before carrying on.

1.      Trust in management is a very important part of investing. MBE management have performed well to date in my opinion. I have no specific reason to believe this is the first in a string of negative updates, but there are countless examples of this elsewhere in the share market. In this case I give management the benefit of the doubt. However, I will be watching very closely at what plays out over the next few months.

2.      A growth company should never be judged on a single set of financial results. As stated above, it is possible that this is the first in a string of negative updates. We cannot judge this yet. In the future we will be able to look back and see whether this is a blip on the growth radar or the beginning of the end. As stated above, management gets the benefit of the doubt this time.

 

MBE have guided the following:

H1FY17

Revenue  >$28m

EBITDA >$2m

FY17

Revenue >$70m

EBITDA >$8m

Their commentary around the lower than expected first half revenue discussed compliance changes relating to Australian DCB impacting their processes. This had a negative effect on customer acquisition and impacted their marketing spend. To be honest, I was unimpressed with how they explained it. Their release was confusing and didn’t entirely make sense. However, they are on record saying it is a one-off issue. They appear to be well on the way to a return to business as usual.

 These issues have impacted revenue and EBITDA by $3.8m and $1.7m respectively. This really is an inconsequential amount provided it is in fact a one-off issue.

 

We already knew the Australian DCB market was becoming saturated for MBE. My previous analysis had only factored in 20% revenue growth for FY17.

 

Now onto the good news. The international DCB expansion appears to be going well. Q2 revenue is expected to come in at around $2.5m and the Q4 “exit run-rate” is expected to be >$5m. From these numbers I am assuming approximately $12m from international DCB revenue in FY17. That compares to less than $5m in FY16. $12m equates to 35% of FY16 DCB revenue and 20% of total group revenue. That is beginning to show some promise.

 

The increase in international DCB revenue comes at a cost. The announcement indicated customer acquisition costs are expensed on a monthly basis. Therefore, this impacts short term EBITDA numbers with the payoff occurring in the following periods.

 

Marketing

The marketing channel has been experiencing good growth over last year. Marketing accounted for almost 50% of revenue in FY16. It is obviously a very important part of the business in its own right, but the DCB hiccup highlights the importance of diverse revenue streams. I am assuming 30% growth from the marketing operations for FY17.

My financial estimates following managements guidance:

Revenue - $72m (up 20%)

EBITDA – $8.5m (down 10%)

NPBT – $5.2m (down 25%)

NPAT - $3.9m (down 20%)

EPS – 1.0cps (down 20%)

 

The expenses and marketing costs given the expansion are difficult to estimate. I have estimated a modest increase to most expenses, hence a negative impact of the profit figures. The company has guided >$8m EBITDA, so my profit figures may be a little bit on the low side. I am happy with that given the circumstances.

Management would most likely have budgeted for slightly more revenue growth and therefore over allocated  marketing budget. Hence the lower profit for FY17 even though revenue will increase.

 

I would normally look more closely at operating cash-flow. Given the above this is very difficult to estimate. FY16 had OCF of $6.3m. I am assuming something around $5m this year as a ballpark estimate. The key point is that it is likely to remain well in the positives.

At the current share price of 14.5c the forward P/E ratio using my estimates is around 15. For a growth company with positive OCF, money in the bank and negligible debt that is very attractive. International DCB is trending very well and the marketing business is growing. It is only the (significant) Australian DCB business that has suffered a setback. If international DCB is successful then today’s announcement is simply not important going forward.

 

The critical investment decision is whether the issue is a one-off or a sign of things to come. I am currently satisfied that, given the valuation, other revenue streams and management’s track record, the investment proposition offered at 14.5c is a good one. I purchased more today at 14c.