Compelling Opportunity: Information Services Corp

Many investors ignore Information Services Corp (TSX:ISV) the minute they hear about it, mostly because it sounds like the generic company bad guys use as a front in the movies.

What a terrible, terrible name. The only worse one I can think of is whatever Encana renamed itself as. (Editor’s note: it’s Ovintiv. Who even writes the garbage around here?)

Even the logo is as exciting as a tub of plain yogurt:

For those of you who didn’t already click the back button (or delete this email) out of boredom, let me talk a little bit about the company. ISV is the exclusive operator of the Saskatchewan registries system, including registering vehicles, companies, and property. It has a contract to operate this until 2033, and investors are protected when it comes time for renewal by the government of Saskatchewan’s large ownership stake in the corporation. This is the bread and butter of the business, and generates about $70 million in revenue on an annual basis.

While registries is a fantastic business, it’s not going to grow much faster than the province’s GDP. The last couple years have been nice, but investors should expect these activities to return to normal levels for 2022 and beyond.

Management has embarked on an acquisition spree in an attempt to reinvest some of the predictable cash flow generated by the registries business. The goal is to build a real estate/law services company (with an emphasis on technology) that uses acquisitions to create sustainable growth.

It’s been a pretty successful model so far:

When ISV first started in the acquisition game, investors were skeptical and the stock languished. It then made a few deals, indicated the future on the acquisition front was bright, and growth investors ate it up. Shares roared past $20 each, then $25. Soon $30 was surpassed, with the stock peaking at $32 back in June of last year.

A few things have helped push the stock back to today’s $23 per share level, which is real close to a 52-week low. The market doesn’t care for most growth by acquisition names today. The deal flow has also seemingly dried up, with ISV not making an acquisition since July, 2020. With no deals comes lackluster growth, the death knell of any such company.

If ISV traded at a high valuation, I would certainly get pessimistic about such things. But it doesn’t. It’s a high quality company with plenty of long-term growth potential — albeit lumpy potential — trading at a very reasonable price. That’s why I’m excited about this name today.

Valuation

ISV shares are trading at a very reasonable valuation on a trailing basis.

Let’s look at P/E first. According to the always-excellent Tikr, ISV earned $29.55M over the last twelve months, or $1.64 per share. That gives us a pretty reasonable P/E ratio of 14x.

Things get more compelling on a free cash flow basis. Free cash flow for 2021 should be around $50M, thanks to large D&A expenses and virtually zero capex. The market cap is around $400M. That’s about 8x FCF.

If you believe analyst projections, next year’s numbers won’t be quite as compelling. The forward P/E sits at around 15x as analysts predict the bottom line will fall slightly after 2021’s significant growth. Next year’s price-to-free cash flow ratio is closer to 10x. It’s still cheap, but not quite as cheap as today.

The stock is also cheap on an EV/EBITDA basis with the stock boasting a trailing EV/EBITDA ratio of just 8.25x.

You don’t find an asset-lite company like ISV with those kinds of trailing valuations very often.

The worry is that ISV will acquire crummier businesses and diworseify (totally a word, ignore any squiggly red lines) itself into some sort of terrible company that deserves a cheap multiple. But through multiple acquisitions, that hasn’t happened. It has doubled revenue since 2016 and still maintained 75% gross margins (down from 92%, but still pretty damn good) and 25% operating margins. This is still a good business, even if subsequent acquisitions are worse than registries. Just about every business is worse than registries.

What about the Saskatchewan Government risk?

When I shared this idea on Twitter last week, a few people were worried the Saskatchewan government would pull an Air Canada/Aimia situation, cancelling the contract to buy up a suddenly weaker ISV for a song.

There are a few reasons why I don’t think that’s a huge risk. One, governments simply don’t act like that. It undermines investor confidence in the province. Two, that risk is mitigated with the government’s large ownership stake in the business. The Government of Saskatchewan owns 31% of ISV. You don’t pivot to become a growth-by-acquisition company without consulting that shareholder. Besides, Saskatchewan has a weird history of government owning business. Like all the liquor stores. And the province’s dominant telecom. Don’t try to understand it. Just embrace it for what it is.

(Aside: even freedom loving Alberta does this. The government owns a bank. In what world does that make any sense?)

ISV basically has to not screw things up too badly and they maintain the contract. They’ve done a fine job for the first nine years of the contract. I see little risk in them not doing so for the next 11 years. Or for 20 years after that.

Upside potential

With Covid helping to usher in a housing boom — even in Saskatchewan — it’s a very reasonable assumption to think the registries business will decline in 2022 or 2023.

But there are still a couple ways registries could continue its hot streak. Remember, oilfield companies have to register mineral rights at land titles. If there’s a drilling boom — and there could be in a world where $100 oil turns into $120 or $140 oil — it bodes well for registries. There’s also the possibility of cheap Saskatchewan being the next it market for Toronto real estate speculators.

Hey, stranger things have happened.

Remember, registries is allowed to raise prices by the rate of inflation each year. And it just signed a new contract with union employees that gives them annual raises in the 2% range. That should help boost the bottom line as well if inflation stays for a few years.

I also think the overall decline in the tech market may help ISV make a few more deals on the services/technology sides of the business. Valuations will get closer to normal and it’ll have potential to make deals that will add immediately to the bottom line.

It doubled revenue in the last five years, and I think the company could easily do it again. There are still many acquisition opportunities, and it’s still relatively small. It does about $165 million in annual revenue as it stands today. It’s basically just a baby.

Let’s assume management only does an okay job on the acquisition front and grows earnings by 75% even though revenue doubles. That still gets us close to $3 per share in earnings in five years. Slap a 15x P/E ratio on it and we’re looking at a $40-$45 stock. And you get paid 4% annually as a dividend, a payout that should creep up over time.

Put the two together and I can easily see a world where ISV delivers 20%+ returns for the next 5 years. Even if things don’t go exactly right. And if it doesn’t do much on the acquisition front, I think downside is pretty limited from here.

The bottom line

ISV sure looks to this author like a compelling opportunity, and I took the chance this week to buy a few more shares at just under $23.

It’s also a little challenging to get in and out, so make sure y’all are using limit orders.

Much like my Saputo idea from a few months ago (which has been a giant nothingburger so far, FYI), I think there’s real disconnect here between the market’s short-term bias and the longer term outlook of an individual company. My strategy is go buy today, tuck it away for a while, and enjoy the nice dividend while I wait.

Disclosure: author is long ISV.to