J Capital posted a 31 page analyst report on Wisetech during the week where they laid out some audacious claims. Wisetech have provided their response and in it was the following quote:
There is something that grates on me about these type of responses. The majority of investors are on the long side. Buy reports are a reassurance of our investment faith and are welcomed. Short reports are a test of our investment faith and are shunned. The latter should be welcomed, no? We should be looking at the sceptics throwing rocks and testing our ideas.
There will be no long term damage to the shareholders if the J Capital claims are proven to be false.
I think Mark Leonard of Constellation summed up his approach to people who take the other side of his roll-up model in his 2017 Presidents letter
“One of the analysts who covers Constellation recently changed his perennial “sell” recommendation to a “buy”. We lost one of our few critics. Analysts who worry about the quality of earnings and reversion to the mean and the impossibility of trees growing to the sky are valuable.”
And I still think one of the best responses I have read from a short thesis is Reed Hastings from Netflix in 2010 on Whitney Tilson’s short thesis. and a lot can be learned from this. Admittedly Reed was never accused of fraud though.
WTC Organic Growth
Anyway putting this aside I wanted to revisit my notes on WTC and try and come up with an estimate of organic growth. I hold no position in WTC long or short and never have.
I think the disagreement between JCap and WTC on organic growth rates comes from when you consider acquired revenue to form a part of the baseline business and becomes internalised. Is it 1 year, 2 years or more after acquisition?
Let’s look at how WTC approaches the problem of when an acquired business forms part of the main operating business:
Source: 2019 Investor Briefing Materials – August 2019
WTC define the light blue bars as Revenue from acquisitions made since 2012 and not embedded into CargoWise One. The dark blue bars are deemed as organic revenue from existing or new customers, i.e. customers pre-2012, which have increased spend or new customers purchasing the software.
If we look at the way WiseTech presents their definition they consider that all business that was in operation prior to 2012 is their baseline. Any business acquired after that are deemed to be excluded from the organic growth calculation.
Not sure the significance of 2012 as the key hurdle and why this date was chosen. 2012 seems arbitrary to me and a touch cherry picked.
I am going to suggest the measure should be once an acquired business has been in for a full 12 months then they should move from acquired revenue to forming the baseline to calculate organic revenue.
In addition a more appropriate gauge to measure the denominator for organic growth would be taking the revenue as at end FY2017. This is when WTC ramped up acquisitions. This seems to be a more consistent stage when the company moved from not only a platform that invests and grows its business to include a capital allocator function.
As you can see from the table below acquisitions really ramped from FY2018:
Source: WTC Annual Reports
WTC in FY2018 and FY2019 has invested $596m (including potential deferred consideration) in acquisitions for a combined forecast revenue of $116.8m and estimated EBITDA of $15.8m. As the table shows above, the multiples of acquisitions are getting larger, probably moving in step with the expanding WTC multiple.
This probably gets at the heart of why this issue of share price valuation is so important to WTC. WTC is playing the equity arbitrage game of issuing shares at a higher multiple than that what you have to pay when they acquire. This is the standard play book for a roll-up and works well while the confidence remains in the value of your scrip. This model breaks quickly on the way down when you scrip gets marked down.
So let’s try and build a revenue bridge from FY2017 and consider what the organic growth is
Based on my calculation I land somewhere in the middle of JCap and WTC for organic growth. WTC claim >30% and JCap around 10%.
The reason I calculate higher organic growth compared to JCap is I only count the carry over revenue from the prior year acquisition made in a partial year. For example in FY2018 the company acquired $44.8m in revenue. Only $22.8m was booked in the FY2018 as purchases were made during the year. I then carry forward the difference i.e. $22m into the acquisition calculation for FY2019. I am guessing that JCap uses the full amount of $44.8 to exclude in their organic growth calculation hence a much lower organic growth rate.
On the other side the organic growth rate WTC calculates is much higher as they deem the starting denominator of $120.5m when calculating organic growth rates. As mentioned before I think this is a strange starting mark and seems hard to justify.
One thing that does baffle me is the performance of the FY2018 acquisitions. The estimate revenue from all the purchases for this cohort was $44.8m sourced from the company announcements. When compared to the bridge provided in the FY2019 presentation actual revenue from these purchasers in FY2018 was $21.7m and for FY2019 was $19.7m. Based on this the combined revenue was $41.4m a 7.6% fall in revenue from that expected. No organic growth here.
Coupled with this the expected EBITDA for the FY2018 acquired group was $5.9m. Presumably the EBITDA would also fall by at least this amount probably more with operating deleverage.
WTC has acquired $116.8m in expected revenue for FY18-19 with an expected EBITDA margin of approx. 13.5%. This strikes me as odd for a company claiming EBITDA margins of 31%.
However if you subtract the development costs that are capitalised from EBITDA the WTC margin falls to approx. 17.6% for FY19. Maybe the acquired companies were capitalising development costs and under the new WTC control they do not?
Table below shows what the EBITDA margins would look like when capitalised dev costs are subtracted off EBITDA.
WTC states that it believes it will take approx. 3 years to see a ramp up in acquired growth as they showed in their FY2019 investor presentation.
The FY2018 acquired cohort is nearing this milestone over the next 12 months or so. As WTC is shifting its model to being an allocator of capital then this will be a key metric to watch not just organic growth.