Dusted off the old ISD financial model...

...and updated it for the past two financial results (for JH2017 and DH2018) which I hadn’t bothered about at the time of their release.

No surprises at, all those two results were quite awful.

But the thing that stands out about them is that while the P&L’s were basket cases, the standout feature was the cash flows, which were strong, with the continuing to generate free cash flow in each of those periods, $11.1m in JH2017 and $10.4m in DH2017 (even after payments of acquisition of intangibles...although admittedly some of the working capital reduction that contributed to those strong cash flows probably reflected some rundown of the now-shuttered King Content business).

Still, when a company is undergoing the amount of business turbulence that ISD has been expereincing over the past 12-18months, and yet it is still more than able to wash its face in terms of organic surplus capital generation, then I think that is quite a statement about the nature of such a business.

If the business can somehow be stabilised at revenues around $130m pa, and at an EBITDA margin on 25% in FY2019 (which is not that aggressive an assumption given it is still a far way off the 32% to 34% margins achieved in FY2015 and FY2016), then that would leave the stock trading on a prospective P/E of around 13x, and an EV/EBITDA of a little over 7x.

Which tells me that the stock is certainly not being priced for any upside surprises at all; rather, it is being priced like it is going to continue to disappoint.

And on one aspect, in particular that I think it is likely to surprise on the upside is - due to is cash flow generation - how it’s balance sheet will be de-risked over the next 12 months.

During the current half-year, and during FY2019, even if working capital-to-sales reverts back to the long-run average of 10% (from DH2017’s 4,9%), the company should generate some $33m in cumulative Operating Cash Flow (derived from ~$50m of cumulative EBITDA over that 18-month period).

Out of that it will consume some $2m on PP&E purchases, $12m on payments for intangibles, and it has a $4m deferred consideration that it will need to pay.

So netting off those calls on capital results in Free Cash Flow before servicing of debt or equity providers, of around $15m.

And if the the dividend payout ratio was, say, a sensible 40%, that would consume around $7m, leaving the around $8m for reduction of the company’s current $50m net debt position.

On that basis, plus the $33-$35m EBITDA run rate at the time would leave the company’s Net Debt-to-EBITDA at around 1.2x, which will be a dramatic improvement from the effective 2.3x metric with company exited DH2017.

My sense is that the market has been seriously brutalised and scarred by this former small cap darling.

Which is why it has a mere sub-$200m market value today, and is capitalised at 7x EBITDA, as opposed to having a $800m (or $950m at its peak) market value, and trading at a a ridiculous 17x EBITDA (and, obscenely, 19.8x at its peak).

Of course, there is a risk that the business is fundamentally broken, and about to go extinct in the next few years.

But I don’t think that will be the case; it think the end game is that the residual IP gets gobbled up by someone else. (There is something like $12m pa of fixed cost overhead in this company that could largely be extinguished by any acquirer. And in the context of Pre-Tax Profit running at around $20m pa, that provides scope for some serious value accretion from an acquirer that is able to eliminate duplicated fixed cost overheads.)

But a pure takeover is not the sole investment thesis here.

I think that, even if the company was able to generate around $30m to $33m in EBITDA in FY2019, and the company’s net debt @ 30June 2019 ends up being closer to $42m or $43m, I am quite sure the share price will be closer to $1.40 or $1.50 than it will be to $0.80 or $0.90.