I have recently bought back into Enero, initially on a value trade basis. I think the market has overcooked the downside and downwards momentum has eased. The current market price, looking from a sum of the parts or PE basis, values the company extremely cheaply. I see at least a 50% upside. Using this as another tester for my non-deep dive, small position trade strategy, I see money on the table, jumping in to see if it comes true.

As a previous holder (for a short period of time) I was surprised to see how hard this has been dumped by the market. The amount of profit attributable to non-controlling interests was of concern when I initially looked at half yearly results. Until I saw a tweet that it pointed out to me that OB Media is making all the profit for Enero. The rest of the business' owned by Enero are only breaking even. However, having a think about it, even if you value everything at zero besides OB Media. OB Media is making an annualised profit somewhere in the range of $50-60m based on the half year results (don't know if this is seasonal?). Putting an ultra-conservative 10xPE on OB Media (remembering this business has growing rapidly over the past few years) that would put the value of Enero's ownership of OB Media at a minimum of $250mil with the current market cap sitting at around $173m ($1.87 share price). Looks like the market may have overshoot to the downside, I have taken a small position, initially as a bit of value trade as a result.

I have sold out of Enero Group due to a clear three-point trend line break that I stipulated in my thesis would result in a sell decision. Unfortunately, I wasn't paying close enough attention when the price drop continued a long way past the $3.20 mark I was worried about when I wrote my previous quarterly update straw. Looking at the market depth, there isn't many buyers so I was also very worried this could drop quickly on any unwelcome news. Is the right or wrong decision??? No idea, I am trying to keep within a rules-based system in this case (following QAV podcast concepts regarding momentum). After the last quarterly result, I did not increase my conviction (worrying sign) and my holding IRL was only at 1/3 of a normal position so not much is lost or gained either way.

I will be continuing to monitor Enero. Looking for momentum to be reestablished or good FY end results. The talk of recession isn't a good sign for marketing spends by business but then again Enero did an excellent job over the COVID years in increasing sales.

Enero has today announced the sale of The Leading Edge and The Digital Edge for $1.35M. These two businesses only accounted for between 1.4-1.7% (depending on period used) of revenue for the group so won't have a material impact.

Given the very low percentage of revenue comparatively to the other businesses that makes up Enero's portfolio, the offloading makes sense. My reading on the CEO comments were that these two businesses are too small for the group and given they were purchased in July 2004 could only have gone backwards and/or not growing. Management wants businesses in the group that can scale and add to current capabilities.

With regards to my thesis the QAV three-point trend line has been broken recently, however, this is clearly on the back of market weakness. Will reassess position if price declines below $3.20.

Overview

Enero Group is a group of marketing and communication services companies in Australia and internationally. Its services include strategy, market research and insights, advertising, public relations, communications planning, designing, events management, direct marketing, and programmatic media.

A list of the companies within Enero group is below:

• bmf
• CPR
• The Digital Edge
• Hotwire
• The Leading Edge
• OB media (51% owned by EGG with founders owning the other 49%)
• Orchard
• McDonald Butler Associates (recent acquisition)

The jewel in the Enero crown is OB media which is a fast growing, people light business providing digital ad services.

Customer Value Creation

The companies within the group provide marketing and communication services to a large range of blue chip companies and government bodies. Customers clearly find value in the services offered given the retention rate of over 60% after 4 years. Enero must be providing a positive ROI for customers to have such strong retention.

Local example of work from bmf. bmf is responsible for ad campaigns most Australians would have seen from brands such as Aldi, Tip Top, Sportsbet and Audi and government campaigns for cybercrime and violence against women.

Main Thesis

Thesis for Enero is a smaller sized position for a P/E play type buy initially. I believe Enero is undervalued especially given the revenue and profit growth over the past year that appears to be continuing. The share price has strong momentum. I can see potential for growth to continue through M&A activities and organic growth. The company is net cash and strongly profitable.

The company has strong backing from many of Australia's best fund/money managers including Regal Funds, Perpetual, WAM, Perennial Value and Forager funds. These funds have 47.4% of all shares as of 7/1/22. It will be clear if these funds are all heading to the exit at the same time.

Exit will be at full valuation. However, given the strong growth of the fundamentals of the business, I expect the valuation to grow over time.

 General

• Company isn't a scalable model. Organic growth and acquisitions are way to increase revenues. Lots of cash for acquisitions.
• R+D not required due to the staff creating the content for clients, staff creativity is their end product.
• Previously, wasn't interested because I was worried about marketing spend during COVID, this turned out to be very wrong.
• Revenue is not mainly from Australia but spread around the globe. Revenues are reporting in "net revenues" rather than gross due to the costs being transferred directly through to customers. FY21 revenue is split:
• Australia - $65 mil
• UK and Europe - $35.5 mil
• USA - $60 mil

Positives

• Strong profitability with expanding margins. Business appears to be at a point of operating leverage, revenues have accelerated but costs are flat.
• Strong institutional ownership especially for a $300 mil EV company.
• Highly experienced board and management. Given group companies are run by internal management teams the board and CEO of EGG are responsible for capital allocation within the group more than the day-to-day operations of the business.
• Board experience is extremely impressive:
• Chairwomen experience includes directorships of ANZ, SYD airport, UNICEF. Former CEO of Bank of Melbourne, Westpac NZ and Pacific and Carnival.
• Other directors have extensive experience in corporate Australia.
• Large blue-chip clients and government bodies as clients. These clients have a long relationship with the Enero businesses.
• Net cash business. No real need for R+D as the people are the innovators. Though talent retention is especially important.
• Weathered COVID very well. I thought this company would struggle initially but EGG has proved that sediment wrong.
• International business with revenues split between Australia, US and UK/Europe.
• After every recent quarterly announcement over the past year there has been a jump in the share price. Shows that Enero is beating market expectations.
• Glassdoor reviews of subsidiaries appear generally positive. Important in a business where the talents of the staff are important.
• The share price chart looks vey good. Bottom left to top right. Strong buying after last half results.

Negatives

• No moat. Competitive advantage is the creative people within the business and the experience they have with larger clients.
• Management doesn't have any significant skin in the game. Board is independent, which given the group structure of the business may not be a real issue.
• The 51% ownership of OBmedia makes it hard to determine the final profitability and cash flow. Numbers given are often based on 100% ownership.

Risks

• Management noted in FY22 Q1 update that discretionary travel costs may start to increase due to COVID reopening and there may be wage cost pressures.
• Growth stops. However, this is compensated for by the cheap EV/EBIT ratio.
• Loss of talented staff.
• General macro reduction in marketing spends.
• Fund managers that own the shares all head for the door at the same time.
• Must see margins and revenues remain stable or increase in quarterly updates.
• I could be late to the party here. Share price has already risen from a COVID bottom of around 80c.

Likelihood of loss/Probabilities of outcomes

Loss of capital calculations - using $3.88 share price = MC $334 mil.

Case: Cash = $50 mil (no contingent consideration) + FY21 underlying profit of $22.8 mil

• Down to cash = 85% drop
• 5x FY21 underlying earnings + cash = $164 MC = 51% drop
• 10x FY21 underlying earning + cash = $278 MC = 17% drop
• Current implied EV multiple based on underlying earning = 12.5x

Case: Cash = $30 mil (include contingent consideration) + FY21 underlying profit of $22.8 mil

• Down to cash = 91% drop
• 5x FY21 underlying earnings + cash = $144 MC =57% drop
• 10x FY21 underlying earning + cash = $258 MC = 23% drop
• Current implied EV multiple based on underlying earning = 13.3x

Case: Cash = $30 mil, FY22 EBIT = $45 mil giving underlying profit of $31.5 mil. EV based on contingent consideration being paid.

• 10x FY22 profit = $345 mil MC
• 10x EV/EBIT = $480 mil MC
• Current price EV/EBIT = 6.75x

How I expect this will play out

• Continued growth in the revenue and profitability. This is initially a PE play with a free option on the growth continuing.
• Expect the company to either return cash or make acquisitions at single digit PEs.

When to get out

• Breaking of three-point trend line (QAV podcast strategy). Given the strong share price appreciation, institutional ownership and fundamentals momentum I will be implementing soft stop loss based on the three-point trend line. This is something I will be trialling after review of previous investments I have made. If the price drops from here, something has changed and I am likely wrong (unless clearly in line with a general market decline). After the recent market decline EGG bounced straight off its low point (three-point trend line) and back to previous levels, so hopefully a good indicator of support.
• The fund managers start trying to get out.
• Revenue/profit growth slows.
• Valuation target is reached and you don't see any reason that the growth will continue. Ie, can't justify a higher valuation.

See valuation straw for valuation details. Buying plan - start initially with a 1/3 position. Wait for half year results for any further buying. Likely buy after good result (or get out) then at least another 3 months before next purchase.