Description

ADLPartner (ALP)

Disclaimer: ALP is a low liquidity idea with around €45k/day average volume and limited float (22%) on a €49m market cap. If however you are interested in the opportunistic purchase of a company trading at an EV / UFCF of 2.4x, generating a sustainable 9% dividend yield and with secure downside protection (60% discount to run-off value, no debt, cash equal to 55% of market cap), then read on.

Investment Thesis:

ADLPartner is a French company whose core business is the marketing and management of a portfolio of subscription based contracts. The company markets magazine and newspaper subscriptions either directly to the consumer or more generally through its corporate partners’ own loyalty programs (established CAC 40 companies and banks such as BNP Paribas and Société Générale). ADL works with 120 publishers with access to 350 titles covering the vast majority of magazine and newspaper content read by the French population including all the top publications.

It is important to note that the company does not hold any inventory or take on any editorial or publishing risk; instead it owns the financial rights to the subscriptions and essentially inherits a margin from the publishers (historically 45% of the gross face value of monthly subscription revenue).

ADLPartner offers both fixed and open-ended contracts. Based on its 40+ years in the business and the analytical database it has built over time, the company’s preference is to offer open-ended subscriptions, tacitly renewed each month and on a direct debit system. These generate the optimal subscriber life curves with an average duration in excess of 30 months. Open-ended contracts will sometimes also include a 12 month minimum term. ADLPartner currently owns a portfolio of 3.05m open-ended subscriptions each generating on average €68 of annual subscription revenue. I should note that contrary to fixed-term contracts where receivables are booked on the balance sheet day 1, open-ended subscriptions are accounted for off balance sheet. The company estimates that the cash flow stream net of direct costs and taxes discounted at money market rates is €99m as at Jun’15.

ADLPartner has some ancillary business lines such as digital marketing consulting but these are marginal and not core to the thesis. One point of note however is that given the lack of structural growth potential in its core subscription business (subscriber count has been stagnant since 2009 and will remain so at best), the company is looking to diversify its operations to include a portfolio of insurance contracts. Again, similar to the magazine & press business ADLPartner would not be responsible for the underwriting risk but would touch a small % of the premium on contracts that it helps generate. This is relevant as recent weakness in the shares can be attributed to a decline in H1’15 EBITDA (on flat revenues), specifically due to new investment in this operating line. While the company mentions in the notes that these costs are the primary component of the year on year change, it does not specifically break them out. Given the nature of their core subscription business and the historical stability in operating margins, I don’t have reason to believe that the economics of their existing portfolio has been impacted.

My variant perception here is that the market reaction to the headline figures is unwarranted and partly due to a lack of clear communication from management. I believe that the cash flow generation of its open-ended subscription portfolio remains unaffected and that the 2015 results represent a temporary dislocation where the new business line ramp-up costs are not yet generating incremental profits. It should be noted at this point that the Chairman Jean Marie Vigneron and his family are the controlling shareholders with 78% and have a consistent history of (i) conservative operational management (no debt, exceedingly high cash buffer at all times), (ii) returning cash to shareholders (€42m of dividends and share repurchases since 2009) and (iii) divesting unprofitable business lines (exiting certain geographies). As such, I do not believe this foray into insurance is diversification for diversification sake or a management ploy to remain as a going concern in what is a structurally declining industry. Either the venture will succeed or Mr. Vigneron will cut his losses if the capital return is not satisfactory. This temporary dislocation offers investors a very attractive entry point.

Investment opportunity: ALP has recently traded 35% off its high in Jul’15. At the current price of €12.3 per share (€49m market cap), you are buying a business with the following characteristics:

• EV to Unlevered FCF (LTM) of 2.4x

• Dividend yield of 9.0%

• No debt, cash as % of market cap of 55%

• NAV (balance sheet + company DCF of open-ended portfolio) of €30.2 per share (59% discount)

• Adj. TNAV (as above but excluding intangibles and incorporating a 20% discount rate instead of money market rates on the portfolio CFs) of €24.2 per share (49% discount)

• Owner / operator with consistent history of returning cash to shareholders (€42m of dividends and share repurchases since 2009, or 86% of current market cap)

In addition to the recent sell-off explained above, I believe the opportunity exists for the following reasons:

• Hidden value of subscription contracts which due to open-ended nature are accounted for off balance sheet and not readily visible upon screening for NAV bargains

• Large shareholder, minimal float and absence of analyst coverage

• Misunderstood business model in a hairy and structurally declining industry

• Limited disclosure of information and language barrier for non-French speakers (note: I am a native French speaker and have read all the reports in French as these are more complete and informative than the English versions)

• 7.4% of shares are held by treasury and are incorrectly accounted for by financial sources such as Bloomberg who report the wrong market cap metrics

Summary Financials:

Hopefully the summary financials below are self-explanatory and will serve to illustrate some of my earlier points. I will just highlight the following:

• High ROCE business (including cash) due to negative net working capital

• Highly cash generative (€46m of cumulative unlevered FCF since 2009), at this clip the company will have a negative EV in 2-3 years

• Subscriber count has been broadly flat since 2009 despite the structural headwinds in the industry we are all aware of

• Very conservative cash management, constantly in excess of €20m

• Shareholder returns: consistent dividends and share repurchases, special dividend in 2010

• Dividend easily sustainable despite recent weakness in profitability margin for reasons explained previously

Current Valuation Metrics:

A key component in determining today’s NAV is management’s present value calculation of the cash flow stream from the open-ended subscription portfolio. The company’s description is as follows:

“The value of the portfolio of open-ended subscriptions can be calculated by determining the present value of the future net revenues that these subscriptions will generate throughout their useful life. These revenues can be determined accurately using the statistical information accumulated by the Company over several years concerning the behavior of such subscriptions in France and for its subsidiaries. The life curve of subscriptions recruited by a promotional campaign makes it possible to determine, at any time, the residual life expectancy of subscriptions with great accuracy. The net contribution still to be received can be determined by applying the average revenues observed and the margin on direct costs (with discounts deducted) to the number of remaining subscriptions.”

As you will see below I have attempted to reverse engineer this on the very limited information disclosure and available data and get to numbers that broadly seem to make sense. I have then looked to adjust the cost of capital to the more appropriate figure for the VIC community of 20%.

Target Share Price

Given the current valuation metrics I believe ALP’s shares are grossly undervalued and look at potential target prices on two bases, (i) on a NAV/run-off basis with an embedded 20% IRR on the future portfolio cash flows (sensitized for remaining life) and (ii) on a going concern basis with a run-rate EBITDA once this year’s ramp-up cost dislocation works itself through. I am assuming a 5.0x EBITDA multiple as reasonable on a business with good cash flow characteristics but limited growth and long-term visibility.

On both methodologies I arrive at a range of 30-130% upside to the current share price. I believe that the share price will initially correct in the near to medium term (3-12 months) given the high dividend yield, strong balance sheet and eventual reversion to more run-rate metrics as the company faces easy 2015 comps.

Risks

• New business venture is uneconomical and sucks up cash for a period of time

• 2015 margin decline is also due to undisclosed information about the core business (e.g. higher than historical marketing costs to maintain flat subscriber portfolio)

• Historical data on subscriber life curves not predictive of the future

Mitigants

• Shareholder oriented owner operator

• Management acutely aware of the run-off value of the business (explicitly discloses DCF value of open-ended portfolio) which serves as a benchmark for any value creation

Catalyst

• Continued dividend payments and potential “one-off” payment given large cash balance as was effected in 2010

• Share price correction in 2016 on the back of easier 2015 comps due to ramp-up costs