VALUE APPEARS TO BE ON OFFER AT CNIC - 04/05/23

Always on the lookout for what appear to be cheap or undervalued situations, I have for some time been keeping a close eye on the AIM quoted CentralNic (CNIC).

The shares are currently £1.116p and look a highly attractive growth proposition, given that it trades on low valuation multiples following a period of strong acceleration across its markets.

In particular, organic growth of 60% achieved in 2022 has been highly impressive, which is an attractive measure coupled with solid cash generation.

Invariably, when a company appears to look extremely undervalued, questions often arise as to why exactly, often resulting in a degree of scepticism setting in.

That on the whole isn't necessarily a bad thing, as investors can then apply more scrutiny in order to ascertain the credentials of any would-be subject.

In the case of CNIC, it would appear that a large part of investors' reluctance to buy into the story is actually down to a lack of understanding or comprehension of the business and its performance, where it has delivered on that extremely positive organic growth and operational traction.

Having been fortunate enough to catch up with management in a call last week, I feel I can now add some further flesh to the bones, which may assist in assessing a bigger picture of the company and as to why I have bought into the story.  

CNIC has been built over a number of years, via a combination of acquisitions and expansion across the online space, which takes in its own online advertising platform, along with domain name management and a significant product comparison site that is cemented as the number one player in Germany.

To gain a better handle on the aspects of these operations CEO Michael Riedl was happy to expand and help me gain some further insight into what CNIC is actually all about and importantly what may lie ahead for the company.

Riedl says that CNIC operates as two distinct businesses that are loosely linked, those being online marketing, accounting for around 70% of total revenues and online presence providing for the other 30% where he firstly expanded on the larger marketing aspect.

Through this, he says CNIC helps the consumer make informed choices by creating what is described as customer journeys, where they are engaged through general interest media such as social networks, along with news websites and search engines.    

That online journey effectively connects the potential buyers or customers of goods and products to the sellers, which having been built on machine learning technology, provides CNIC with specific insights into what people are actually looking for online, resulting in it being able to offer the best products or services to buy for an individual that closely matches their intent.

Additionally, by working with the world leading aggregators the company has access to commercial inventory which further enhances the proposition.  

Typically, CNIC will place adverts on the likes of social media websites such as Facebook or Tik Tok covering broad categories where the interested customers then click on a link.

That in turn takes the potential customer to an editorial website providing more information or a refining of the product before completing the journey, which culminates at the seller’s website.

CNIC provides the same service via search engines such as Google where it also places advertisements for product categories. Given its strong performance and high level of reviews it frequently features high up in the Google rankings, which is extremely important in providing for ongoing growth opportunities.  

Once a consumer clicks on the link, they are then presented with a number of options for a purchase that is defined or considered as what is most applicable for them. The final stage of the journey is completed when the consumer clicks on the chosen option which in turn then takes them to the seller’s website.

One of the key aspects that differentiates CNIC from many other players in what is a vast and populated market is that it is very hot on privacy settings where it does not have any third-party data collected or shared.

The other important aspect of the business, Riedl says, is the product review or comparison offering, where consumers can be shown the most popular or best priced item they are looking for on the market, which sees CNIC subsequently direct the consumer to the advertiser which best matches the needs.

Referring back to the privacy aspects of its operations the CEO adds, “we do this entire process without the use of any third-party cookies, because we learnt many years ago that not only are these cookies dodgy, but that they are misleading too”.

The latter is a very important aspect in terms of the investment case here as there has been some confusion regarding the company and cookies, with some wrongly believing that the cookie demise will negatively impact CNIC, which is clearly not the case.

Another negative aspect relating to cookies, Riedl explains, is that they are not as time efficient or personable as what CNIC’s

AI based system provides and delivers, which gives consumers the information they need at the right time and moment.

Targeting traffic with precision, the CEO adds that CNIC sees on average almost two hundred people using its process per second, in what is ultimately a massive numbers game.

Riedl is also at pains to stress that their concept and mission is to make sure that there is a really good match achieved between the consumer and advertiser, which with a single click generates most of the money.

Although a truly massive space, it is nevertheless like others, continuing to evolve with new technologies emerging that can perhaps disrupt or impact in a negative way an existing growth path.

To this end, I ask Riedl about AI ChatGPT and how that fits into the market in which CNIC operates. The CEO comments, “the jury is actually still out as to whether the AI based software results can really work and the cost of production is prohibitively high.”

He also says that it is yet to be proven that ChatGPT or any other such generator can actually beat the content that is already being produced.

One of the major drivers for CNIC over the years has been a scaling up through acquisitions, of which there have been plenty, but which has seen sizable debt taken on board, along with specific and significant raises of cash.  

Given that Riedl has only fairly recently succeeded long standing CEO Ben Crawford I was keen to hear more on the way forward and as to whether there was now a shift in strategy.

In terms of the online presence which had been the goal on which to aim for, the new CEO says that he believes that this has now been achieved and that CNIC has made a lot of progress.

Therefore, he expects that later this year and into 2024 they will see the benefits of efficiency in this aspect of the business.  

Whilst online presence is now one complete integrated operation, marketing on the other hand is currently made up of three arms which sees two stand-alone operations, although there is ongoing integration moving forward.  

As for further M&A, the CEO says that there will undoubtedly be additional opportunities given the market size, but they would now expect to do less going forward.

Expanding on this aspect, he adds that the vast majority of key acquisitions have been completed, so the urgency for further M&A is now much less and it will likely see only selected targets that are deemed too good to miss being bolted-on.

The result of this strategy coupled with increasingly strong cash flow will, says Riedl, result in the returning of cash to shareholders, with dividends and share buy backs that appear to be firmly on the agenda.

In terms of the most recent news, this concerns Microsoft, which although only currently having just 2% of the market, is nevertheless seen as a real positive development by the CEO, particularly for the future and growth trajectory.

Rield says that in the case of revenue from this deal, that will start to come through in Q3 for CNIC, but by 2024 they expect a really good material flow with the full potential coming through in two to three years.

The deal doesn’t appear to have captured or stirred the imagination of investors or watchers alike just yet, but the CNIC team certainly sound upbeat on the future prospects of this latest deal and the traction ahead.

Having recently delivered a Trading Update to the market, broker Numis which has initiated coverage and joins Zeus and Berenberg is looking for full year 2023 revenue of $801.8m with EBITDA of $91.4m and EPS of 21.2c, with net debt reducing to $33.7m.

However, given the number of acquisitions the company has made over the years, it hasn’t been particularly easy to digest all of the relative financial information, particularly when it comes to recognising the strong growth and cash generation, aligned to the EBITDA and reported profit performance.

CFO Billy Green, sounds optimistic not only on the prospects, but in terms of investors being able to see and recognise the delivery moving forward and says that it has been debated internally, as to when the company will be able to recognise a bottom-line profit after tax. 

This is an important aspect for investors and watchers alike, so it is extremely interesting and helpful to hear Green expanding on this area.

Had that not have been the case, the CFO believes it would have been a big watershed moment for the business as it would have been the first profit after tax reported by the company externally since 2017.

He says that the last time CNIC actually reported a profit after tax was back in 2017, whilst in the subsequent three years the company was highly acquisitive, investing heavily internally and where it was reporting losses both before and after tax.

The company then flipped from the years of reporting losses before tax in the full year 2021, by delivering a £1.6m profit, increasing substantially to £14.8m in full year 2022.

However, in terms of delivering the numbers, he explains that the only reason the company could not report and record the profit externally was as a result of the annual impairment review.

As part of that process the company recorded a $4m impairment charge on its Australian and New Zealand businesses.

Had that not have been the case, the CFO believes it would have been a big watershed moment for the business, as it would have been the first profit after tax reported by the company externally since 2017.

The result of not being able to achieve that profit recognition, was he said deeply disappointing, but he is pleased that the company is now on track to reporting a profit for full year 2023, which in turn he believes will become that watershed moment.

This should ensure that a strong EBITDA performance will not this time be dripping down into a loss, as it becomes the year that really changes.

“We made progress from operating losses to operating profit a few years ago, after years of losses before tax to a profit before tax and this is the year when we achieve that, in getting back to bottom line profitability.”

Green also adds, “one of the reasons the share price may have been held back is because until we demonstrate bottom line profitability, some investors are going to be turned off, so it is an absolute focus for us.”

That should be good news for investors or those currently sitting on the fence and the delivery of a recognised profit will no doubt be warmly welcomed.

In terms of the debt position which has been reducing, Green says that they continue to have the option of deleveraging the business and reduce the net debt level, given the highly cash generative nature of the business.

Whilst they have already put in place a forecast and a scenario that would see CNIC in a net cash position by next year, this isn’t set in stone though, as he adds that there are potential uses of cash which they could prioritise over getting to the net cash position at that time.

Expanding, he said that as part of a capital allocation process declaring and paying regular annual or twice yearly dividends is a priority and even though that would slow down the process of moving from net debt to net cash, that has to be a clear priority.

“We want to return cash to shareholders and we also want to maintain reinvesting in the business in a moderate fashion and take advantage of opportunities to potentially build business models into one or other markets.”  

Buy-backs, as the CEO had spoken of are also very much on the agenda echoed Green, where he concludes that there are a few things on the go alongside reaching the net cash position.

He also endorses the view that there are likely to be some further bolt-on opportunities, but these will be of much smaller value than has been executed in the past.

With a closing comment the CFO says that they can get to the net cash position next year, but if it isn’t done during that period, it will only be because they will have invested cash moderately and wisely in other areas.

Declaring a dividend and announcing share buy-backs is something that had not been done at CNIC until Riedl stepped into the role of CEO and appears to indicate a step change on a few fronts.

Importantly the generation of cash is key to both the near and longer term investment case at CNIC and is ultimately what shareholders will be keeping a close eye on.

Looking at the various broker forecasts they each make for positive reading with Berenberg highlighting a free cash flow yield averaging 16% per year up to 2025, where according to Numis, it should see cash generated from operations hitting $105m that year.

Some market watchers have expressed concern over the apparent slowing of growth with economic headwinds, but this would appear to be short term and in any case, the shares at the current price would appear to have more than factored this in.

Broker Berenberg as with Zeus and Numis remains positive on the stock and provided the following comment following CNIC's recent update to the market.

" CentralNic is continuing its strong run that started more than three years ago, with the company expecting its Q1 2023 revenue, net

revenue, adjusted EBITDA to grow at c24%, 15% and 15% respectively compared with Q1 2022. While the trailing 12 months yoy proforma organic growth is c45% at end-Q1 2023 compared to 60% at end of FY 2022, the group continues to outperform peers and expects to trade in line with full-year market expectations, despite challenging macroeconomic conditions.

Importantly, the group has continued to diversify its adtech partnerships, with the latest win being Microsoft Bing/ChatGPT, which complements its existing relationships with Google and Yahoo. Recent focus by management on 1) shareholder returns through a maiden dividend (to be proposed at the AGM on 24 April) and a maiden share buyback of $4.3m (already completed) and 2) organic product build-out make CentralNic an appealing investment, especially considering the cheap valuations of c7x P/E."

Clearly the shares appear to be range bound at present and some investors may elect to wait for further delivery before committing.

However, the management team sounds both determined and confident in delivery, where with what appears to be an extensive runway CNIC shares look great value for me at the current price.

There are a number of respected and well known Institutional holders on board here including Kestrel which intriguingly has been upping its stake with further buys this year and which now sees it sitting on 23% of the company.

Kestrel from my own personal experience and observations is an often active investor and I have witnessed other situations where companies that it is invested have subsequently been acquired after an under performance of the share price in terms of the real value.

In relation to CNIC, it would appear to be the case that it could very much become a target for another market player, given the reach, growth and strong cash generation of the operation in relation to the current market value.