2023-08-18 16:16:36 ET
Summary
- Information Services Corporation reported robust top-line growth but a decline in net income due to weakness in its core land registry business and higher costs.
- ISV renewed its master service agreement with the Province of Saskatchewan, securing the exclusive full-service provider role for Saskatchewan land registries until 2053.
- Despite risks from the Canadian housing market and rising expenses, ISV remains an attractive investment with high margins, a stable outlook, and a low valuation.
About a year ago, I wrote an initiation report on an interesting Canadian small-cap services company called Information Services Corporation ( ISV:CA ). The company was pursuing a roll-up strategy in the land and business registry space with fat margins and high barriers to entry. ISV was trading at undemanding P/E multiples while paying a 4.3% dividend yield, which garnered a buy recommendation from me.
With almost a year gone by and the company recently releasing Q2 earnings, I thought it would be timely to update my thoughts on the prospects for ISV.
(Author's note, all financial figures, unless specified, are expressed in Canadian dollars in this article).
Brief Company Overview
Information Services Corporation provides registry and information management services for public data and records. The company was originally a crown corporation called Saskatchewan Land Information Services Corporation and owned by the Canadian government, but ISV privatized in 2013 through an IPO.
The company's strategy is to acquire and develop complementary businesses to its core land registry business. Over the decade since going public, ISV has acquired multiple businesses including ESC Corporate Services Inc., a provider of business registries and services in Ontario, Enterprise Registry Solutions, a registry service in Ireland, and Paragon Inc., an asset recovery firm in Canada.
Readers who want more details on ISV's business lines are encouraged to read my initiation article from September 2022, as most of the information is still relevant.
H1/23 Earnings Review
Coming back to ISV's recently reported quarterly results, we can see top-line growth continues to be robust, with H1/23 YTD revenues increasing 7.8% YoY to $102.4 million. However, net income actually declined 21.0% YoY to $15.1 million (Figure 1).
Digging through the details, the issue appears to be a combination of weakness in ISV's core land registry business as well as sharply higher costs. On the revenue side, revenues grew YoY primarily due to contribution from the Ontario Property Tax Assessment business that was acquired in June 2022, offset by a decline in the Saskatchewan Land Registry business.
As I mentioned in my initiation article, one of the key risks to ISV was an expected slowdown in the Canadian real estate markets impacting volumes, and that was indeed the case, as Saskatchewan land registry revenues and volumes declined further in 2023 (Figure 2).
However, investors should realize that 2021 and H1/2022 volumes were elevated due to an ultra-low interest rates driven real estate frenzy. If we stretch the data back farther in time, 2023 results are actually inline to better compared to 2019 (Figure 3).
This result is consistent with management's earlier guidance that the land registry business would return to pre-pandemic levels but above 2019 volumes.
More concerning for investors is the large increase in the company's cost structure that more than offset a 7.8% YoY increase in revenues in the first half (Figure 4).
For example, wages grew 24.6% YoY in H1/2023 while IT costs grew 26.5% and occupancy costs rose 35.3%. In fact, the sharp increase in costs reduced ISV's H1/2023 EBITDA margin to 31.6% compared to 35.6% in H1/2022.
Simply put, if management does not rein in costs or increase revenues at a faster rate, then profitability will continue to decline, hurting earnings and valuation.
Anchor Business Renewed To 2053
As part of the quarterly release, ISV also announced that it has renewed its master service agreement ("MSA") with the Province of Saskatchewan to remain the exclusive full-service provider of Saskatchewan land registries until 2053. Under the terms of the renewal, ISV will pay $150 million upfront (paid in July 2023), followed by 5 annual $30 million payments beginning in July 2024, and potential contingency payments beyond 2033.
Looking at the base transaction, it appears to be a fairly good deal for ISV, locking in the lucrative Saskatchewan Land Registry business for the next 30 years for $300 million in payments. I estimate the cost of the deal to ISV to be ~$270 million, using conservative cost of capital assumptions of 8.0%.
On the revenue side, we can see from the company's historical financials that the Saskatchewan Land Registry business had revenues ranging from $40 to $50 million per annum. Assuming the business can generate $45 million in revenues per annum and ignoring costs (the biggest cost in the Land Registry business is the amortization of the management contract; incremental costs to provide the service should be minimal), I estimate the revenues are worth $1.4 billion in payments or $550 million in NPV.
Furthermore, as part of the renewal agreement, ISV "has been granted the right to introduce and/or enhance fees on certain transactions with applicable fee adjustments effective July 29, 2023". This means actual economics could be even better as ISV introduces higher fees to end-users.
Outlook Stable
In terms of the business outlook, management continues to expect real estate activity to be soft in Saskatchewan for the balance of 2023 due to elevated interest rates. However, the registry operations business should continue to generate strong free cash flows in the meantime.
As a result of the extension to the MSA, ISV has updated its revenue and adjusted EBITDA guidance for 2023 to be $207-212 million and $71.0-76.0 million respectively.
Current Valuation Remains Attractive
ISV is currently trading at an enterprise value of $453 million, according to latest reported financials (Figure 6).
However, this figure does not take into account the $150 million in upfront payment to the Province of Saskatchewan. Given ISV's minimal cash balance, I believe the entire payment was drawn against the company's amended credit facility of $250 million. Therefore, the company's adjusted Enterprise Value should be ~$600 million.
Compared to the company's adj. EBITDA guidance of $73.5 million, ISV is currently trading at a Fwd EV/EBITDA of 8.2x. On consensus EPS estimates of $1.82 / share, ISV is trading at 13.1x Fwd P/E (Figure 7).
Both metrics remain reasonable for a high margin, low-capex business in my view.
ISV has also maintained its $0.26/quarter distribution, which annualizes to a 3.9% dividend yield. ISV's dividend remains well covered by earnings.
Risks To ISV
The biggest risk to ISV remains the Canadian housing market. As we have seen so far in 2023, lower transaction volumes have translated into lower revenues for ISV's land registry business. Furthermore, a portion of the land-registry business is based on ad-valorem (value-based) fees, so if real estate values decline, that would negatively impact the ad-valorem fees.
Another key risk is the rise in expenses. Simply put, inflation is propagating through the Canadian economy and has negatively impacted ISV through higher costs. For a service fee-based business like ISV, that may be problematic as service fees are often dictated by rules and regulation and may be slow to adjust. Fortunately, the recent renewal of the Saskatchewan Land Registry MSA allows ISV to adjust land registry fees effective July 29, 2023. This should help ameliorate some of the impact of the higher costs.
Conclusion
Overall, I remain constructive on ISV. Margins in the business and land registry space remains outstanding despite higher costs. The recent renewal of the Saskatchewan Land Registry business locks in an anchor business for the next 30 years.
ISV continues to trade at an attractive 13.1x Fwd P/E multiple and pays a well-covered 3.9% dividend. I think long-term investors will be well rewarded by accumulating shares at current levels.
For further details see:
Information Services Corporation: Registry Roll-Up Continues To Look Attractive