Hunting for compounders - Tremor and Reach

Attractive risk:return comes in many forms. Yes you have your safe, quality Unilevers but at the sharp end you have the dirt cheap ‘cigar butts’ that Benjamin Graham was so fond of.

It feels as though there are more than your average amount of interesting turnaround prospects at the minute. Perhaps it’s the COVID impact: bombed out share prices, emergency fundraises and transformed balance sheets, revitalised operational strategies…

We’re seeing Schumpeter’s Gale of creative destruction at speeds rarely witnessed, with many companies fitting years of evolution into a period of months.

There could be some once-in-a-generation opportunities out there (the same can be said about the risks, of course).

In Hemingway’s The Sun Also Rises, there is a snippet of dialogue that goes:

How did you go bankrupt?

Two ways. Gradually, then suddenly.

If you invert that you get something like:

How did you recover?

Two ways. Suddenly, then gradually.

Timing can be crucial. With turnarounds, the upside can be sudden and dramatic but sitting tight in the meantime requires a particular mindset.

With that caveat, I’ve started looking for turnarounds - but specifically those that are showing tangible signs of recovery and positive share price momentum.

Two such stocks on my radar are Tremor International (LON:TRMR) and Reach (LON:RCH) so I’ll look at them below - but it would be great to crowdsource some more candidates in the comments.

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Tremor (LON:TRMR)

Revenue: £244.5m

Net debt (TTM): -£51.6m

Market cap: £292.8m

QV Rank: 73

Tremor was formerly Taptica, and before that, Blinkx.

It’s a digital video advertising specialist with operations in more than 60 countries.

There are three core divisions: Tremor Video, which helps advertisers deliver brand stories through innovative video technology and audience data; RhythmOne, its media division; and Unruly, a video marketplace directly integrated with publishers and relationships with global advertisers.

The company deals in programmatic advertising and the bull case says recent acquisitions of RyhthmOne and Unruly have shored up Tremor’s technology stack, turning it into a truly end-to-end video advertising platform.

Breaking it down

And so what does that mean, then?

Economically, it’s almost like a stock exchange, but instead of buyers, sellers, and stocks, it matches brands, customers, and brand content.

It adds value in the middle by optimising those matches, collecting data on otherwise anonymous online users, providing more targeted advertising to them, optimising bids for adverts, and giving its advertiser customers a better return on marketing spend.

What went wrong?

The share price tanked in 2018 due to concerns over new GDPR regulations, even though at the time Tremor was guiding towards ‘adjusted EBITDA for FY 2018 moderately ahead of market expectations.’

It then noted a slowdown in trading at its performance-based advertising division in the 2018 Annual Report.

Aside from that, patience has perhaps worn thin at the various name changes, acquisitions, and complexity of business model. Taptica's previous CEO also resigned in December 2018 over his role in a fraud case involving his previous company.

More than a few flags on the face of it, then.

What’s changed?

You might argue that the pieces of the puzzle are slowly coming together...

Blinkx changes its name to RyhthmOne in 2016. In 2017, Taptica acquires Tremor. Then, in 2019, Taptica acquires RythymOne. Later that year, this expanding entity renames itself Tremor. Then, in 2020, Tremor buys Unruly.

The argument is that now Tremor has finally reached an inflection point in terms of the scale of its digital video advertising platform. But it’s tricky to keep track of.

Having achieved that scale and specialisation, the company pivoted from a hybrid model of performance marketing into a more specialised branding video company in 2019.

The shift in revenue has been rapid.

Q3 2020 trading

Trading momentum sounds positive:

The Company experienced strong demand across its key growth engines in Q3 2020… this strong trading has continued to gather further momentum with the Company's key growth engines - Connected TV ('CTV'), Self-service and Private Marketplaces - attracting significant client interest. Therefore, the Company now expects trading for the full year ended 31 December 2020 to be ahead of market expectations, with revenues and Adjusted EBITDA now expected to be in the range of $340-360 million and $30-36 million respectively.

Conclusion

There’s a trust issue here, with a few too many unrelated flags popping up. It’s also not the simplest business model to understand.

That said, Tremor does back up its earnings with cash flow and there are hints that it might be able to generate solid underlying operating margins.

But there’s a lot of twists to this tale and I’d need a better handle on Tremor’s evolution if I’m to commit capital.

Activist investor Toscafund seems to see value and has built up a large stake (nearly 23%). See here. The company itself has also bought back stock in the past. That said, directors have been selling - see here. So the signals are, as ever, mixed with this one.

Reach (LON:RCH)

Revenue: £640.7m

Net debt (TTM): £2.9m

Market cap: £324.6m

QV Rank: 96

(I hold)

What went wrong?

Reach (LON:RCH) is the fifth biggest online property in the UK, behind Google, Facebook, Microsoft and Amazon. Exalted company indeed for a £325m stock market minnow.

But the group is saddled with a declining Print business and a £2bn+ pension liability.

What’s changed?

A new management team is in and there’s a renewed strategic focus on capturing the data of its millions of engaged customers.

As above, Reach’s aggregated online properties are the fifth largest in the UK. It has nine national newspaper print brands, 110+ regional print brands, 40m online monthly unique users, and it continues to expand its web presence.

The group has some debt and that big pension liability, but it has remained resiliently cash generative despite the structurally challenged print business.

What is the potential upside? How much risk?

It’s not just the national newspapers that are important here - it’s the regional ones too, and their pivot to online.

Reach is catching up with the big shift from print to online advertising and hopes to realise a substantial data opportunity. Increased digital advertising would lead to a higher margin revenue mix.

It’s a vast market and Reach has plenty of low-hanging fruit to aim for. The big 4 have an estimated average customer consent or addressable signup ratio of over 90%. Reach had less than 2% of its audience signed up and giving consent as of FY19.

It’s a significant commercial opportunity and one that the refreshed board is keen to attack.

Revamped, heavyweight board?

Yes. Key new hires include:

Jim Mullen - CEO, appointed August 2019. Ex-CEO of Ladbrokes from 2013-2018. Mullen has spearheaded the Ladbrokes digital evolution and helped drive the expansion of its consumer database.

Simon Fuller - CFO, appointed March 2019. Previously CFO of McColl’s, having joined in 2015 after seven years at Tesco in a variety of divisional finance director roles.

Nick Prettejohn - Chairman, appointed in May 2018. Former CEO of Lloyd’s of London and Prudential UK & Europe.

Capital profile

Debt - Modest net debt of £2.9m.

Pension - The group has a grand total of six pension schemes… It all adds up to a big £2.4bn pension liability with a £250m deficit and committed cash contributions of around £50m per year. That’s material but is easily covered by Reach’s considerable cash flow from operations (which totalled £147.4m in FY19).

In FY19 the pension deficit was reduced by £52.7m to £295.9m before deferred tax. A triennial valuation is ongoing, so we should have more information on contributions going forward later this year. Certainly something to keep on top of.

Cash generation - Free cash flow generative - over the past five years, the group has frequently generated more than 20p per share in annual free cash flow against today’s share price of around 100p.

Catalysts

Reach has a clear strategy going forwards. It’s aiming for:

1. Increased customer engagement - via improved customer experience,
2. A single view of the customer across the group’s substantial online real estate, and
3. Revenue diversification and growth - the group can use its free cash flow to fund new opportunities.

With the above strategy, Reach aims to have 7m Registered Customers by the end of 2022 - these are customers that have provided an email address, have given consent, and are engaging with Reach.

The group has also given more concrete shorter term goals:

• Continue organic investment in the low single millions of pounds
• Continue with progressive dividend policy of at least 5% annual growth
• Continue with ten-year agreed deficit recovery plan
• Scan the market for new acquisition opportunities

H1 2020 results were ‘materially ahead of expectations’:

• Revenue down from £352.6m to £290.8m
• Adjusted operating profit down from £71.3m to £54.9m
• Adjusted profit before tax down from £69.9m to £53.5m
• Adjusted earnings per share down from 19.1p to 14.6p

There are some big gaps between adjusted and statutory figures, which I’m wary of. And the direction of travel continues to be downwards… But this is reflected in the dirt cheap valuation.

Commenting on the interim results for 2020, Jim Mullen, Chief Executive Officer, Reach plc, said:

We have seen a strong recovery in the digital advertising market since the worst impacts of COVID-19 in April which has driven a return to healthy digital revenue growth since July, assisted by increased customer engagement and loyalty. This illustrates the significant potential of the customer value strategy as our websites, apps and newsletters attract increased page views from our scale audience, helping to drive forward digital revenues.

Conclusion

I hold a small position in Reach - there’s an experienced management team in place, resilient cash flows, and the potential scale of the opportunity paired with the valuation suggests possible upside.

That’s not to dismiss the risks here, though. There’s an ongoing triennial pension review and that pension liability is significant. Then there is the execution risk of the strategy.

But there’s potential to build a higher margin digital advertising business here, with low capital investment requirements. At the same time, the group is cutting millions of pounds in costs. So those two forces working in tandem could prove to be significant.