Purchase #5: Crowd Mobile Ltd

Purchase #5: Crowd Mobile Ltd

Last week I made the 5th purchase for my portfolio, mobile content company Crowd Mobile Ltd (ASX: CM8). Crowd Mobile is… well, if I used the buzzwords like ‘entertainment content services’ or ‘mobile app developer’, that doesn’t really tell us much.

What it is

Basically, it has two businesses. The first runs a bunch of apps built around the company’s question-and-answer (‘Q&A’) technology, where people can text in questions from their mobile phone (at ~$3 a message) and get personalised answers from ‘experts’, although AI is gradually being used to answer some questions.

The second is a mobile subscription (‘Subscription’) services to games and other content (Ad Blocker, Mobile Antivirus, Bongo, etc), a highly complementary business acquired in an acquisition not too long ago. Both of these services are underpinned by the company-owned m-payments platform, which is the platform that processes the payments for both of these businesses.

This is an interesting investment for me because, in my opinion, CM8 is a low quality business. I really don’t like it all that much, but I am of the view that it is very cheap with a reasonable core proposition and good prospects of growth in the near term. I think of this investment more as a ‘trade’, although I am not a trader, and I have an eye to selling it sometime in the next ~3 years if the market re-rates it, unless there are some positive or negative surprises en route. Some key stats:

Market capitalisation: ~$32 million (at $0.145 share price; ~220m shares on issue after recent cap raise)

Enterprise value: ~$35m incl net debt

Revenue: $21.5m at half year

EBITDA: $3.3m at half year

NPAT: loss of $0.9m at half year

Net debt: A$2.8m after cap raise

After the recent capital raising, Crowd Mobile looks very cheap compared to its likely cash earnings in coming years. It has an estimated EV/EBITDA of 5.3x if we double 1H EBITDA, and an even lower multiple on an ‘underlying EBITDA’ basis. The second half is also forecast to be stronger than the first. Profits are punished by high depreciation (‘D&A’) on a historical acquisition; excluding this the company would have earned around $1.6m profit. Reported operating cash flow (OCF) for the half was $1.53m which lines up nicely with the idea (key to the thesis) that I can largely exclude D&A from the initial valuation.

Here’s this from the half-year results:

CM8 is generating strong operating cash flows and has prioritised paying down debt; in around 15-16 months the company should be debt free, which would free up another $3.8m per year. Due to the recent capital raising and debt repayment the FY18 interest expense is already expected to reduce by $1m. So if we add $1.5m in recent operating cash flow (OCF), double it to $3m to approximate a full year, then add an extra $1m in interest reduction, CM8 is priced at ~8.5x 2018’s operating cash flow. That’s before the expected stronger second half, before any revenue growth occurs, and before the repayment of the rest of the debt.

Subtract the rest of the interest expenses, and it looks to be priced at around 5x 2019 operating cash flow (at $0.145 per share).

It appears a capital light business with minimal post-OCF cash requirements other than finance costs and investments in new apps; i.e., it looks as though most of the OCF will come out as free cash flow (FCF).

While the business itself is (in my view) not that good, it is expanding into new countries and has the ability to expand its Q&A apps into several more target audiences. It also has the potential to move into higher-margin verticals (law, tax, finance, etc), as well as target the digital influencer trend (more on these below). I think that there is a good chance of achieving at least some revenue growth. Management also initiated a cost cutting program late last year that is expected to save $0.5m per annum.

The thesis:

In short, my view is that the business is not as bad as it is being priced by the market and it is very cheap for how much cash it is generating. There are a couple of near-term catalysts (rev growth, debt reduction/ cost cuts, possible EBITDA profitability of Q&A segment) that could lead it to re-rate, and it has an OK chance at growing revenue in the future. Any revenue growth it achieves should be a nice positive for the bottom line as the business gets at least some operating leverage.

Growth plans

CM8 has a couple of major growth plans. First is expanding into new countries and/or adding new apps to existing countries. This is fairly straightforward and in my opinion will likely only result in nominal growth as new apps are added or purchased.

• Higher value verticals

One of its more promising potential opportunities is the ability to move up into more important and valuable Q&A ‘verticals’ like law, tax, finance, and similar. In this, people can message an expert to get a quality answer (for a higher price) without having to actually consult a professional. In my view this essentially taps latent demand in the lower end of the market which is currently underserved because of price barriers (e.g. a minimal accountant fee for a personal consult might be, just say, $50-$70).

I’m optimistic about the promise of this biz but think it will be tricky to implement and low-margin, since paying the experts who answer the Qs will eat up a lot of fees. There are also serious regulatory and legal issues to consider.

• Digital influencers

Thousands of people message celebrities on social media every day. All of these queries go unanswered. The premise here is that CM8 can license its Q&A technology and integrate it with social media, and/or create apps that allow people to message celebrities for a fee and have those questions answered by the celeb entourage. CM8 is partnered with Viacom, which owns MTV, Nickelodeon and Paramount, which gives it a reasonable stable of digital influencers to draw from. It also provides a more effective way to grow traffic on CM8’s apps, since the apps can ‘piggyback’ on celeb popularity (think of it as free marketing).

A Geordie Shore-based freemium app has reportedly exceeded expectations since launch and there are more in the works. A previous, related version of this app called ‘Gazmoji’ was ranked as a top-5 paid app in 18 countries for a time. With some initial evidence that this approach works I will be looking to see CM8 replicate it, and think this could be a likely source of growth.

Yes, I am trying to profit from Geordie Shore. I watched an episode once, I think it is the least it can do for me.

• Subscription

This business doesn’t seem to have well-defined growth plans in place, which is a concern given that it is the primary breadwinner. Mainly management is targeting a return to previous levels of performance as this segment has under-delivered since acquisition (an old song whose lyrics many acquirers learn the hard way). However management has been frank about the issues and proactive about fixing them. There has also been a sustained improvement in revenue over the past 4 quarters (click to enlarge):

As long as revenue is maintained at current levels I expect CM8 could turn out quite well. Growth here would obviously be a winning development, but a reversal would prove nasty especially if the Q&A segment doesn’t start pulling its weight.

This post has run over-long already, but management appears well-aligned (large shareholdings in biz) and their remuneration is..acceptable. Equity compensation was pretty wild last year (total package was $834k for CEO Carosa; 2% of mcap) but base salary of $300k is good and execs have participated in cap raisings.

Risks:

There are plenty, and most of them will be pretty obvious – growth not occurring, products falling out of favour, market not re-rating the company, currency movements etc. Here are the major ones as they pertain to this thesis:

• Management decides to diworsify or grow via acquisition once the debt gets paid down. I’m not keen on further acquisitions and would view this also as a sign that core businesses were weak. Note that I refer to buying new businesses, not the acquisition of attractive apps, which is part of the core business strategy.
• Average revenue per message plunges for new countries and/or other verticals like digital influencers. I have estimated a 15% decline in ARPM in 2017 due to expansion into poorer countries, but it’s possible that digital influencers are able to claim such high % fees that revenue soars but results in minimal growth in company earnings.
• CM8 has no real competitive advantage in my opinion, nor much of a bargaining position
• The company’s apps/proposition kind of fizzles and just goes nowhere or gets out-competed in some way. Increasing use of AI to answer questions is an obvious risk if it alienates the customer base (but a nice benefit if it cuts costs).
• Subscription business currently subsidises Q&A and makes most of the money. It’s the biggest vulnerability unless Q&A achieves a big step-change in revenue and positive earnings (I’m not expecting such a big change).

 

CM8 is an ‘ick’ investment in my opinion, but looks very cheap and in my opinion has a fair chance of achieving decent performance and/or not blowing up in my face.

On 29/06/2017, I purchased 3,450 Crowd Mobile shares at $0.145, for a total of $515.20 including brokerage of $14.95. Effective buy price is $0.1494 per share.

I own shares in Crowd Mobile. This is a disclosure and not a recommendation.

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