Making the transition
A slightly longer break from blogging than I envisaged – but I’m back and clearing the cobwebs from the keyboard with a post on Communisis. I spent most of the last few weeks on holiday, so it’s quite nice to come back and catch up with shares which have done interesting things in that time. In that category, without a doubt, is the small cap marketing/printing company that’s been a constituent of the portfolio since late 2011. It hasn’t just been the last couple of weeks that the gears have really started turning, though; Communisis has been on a pretty beefy bullish run since more or less the start of this year. There’s quite a lot to be said here and a lot of catching up for me to do, so I’ll split it up into two posts – this first one will primarily focus on why the price has moved, and if there’s anything I can learn from it for future investments.
My reasoning behind looking at the price movement and the last year and half before the current valuation is twofold, and the factors are connected. Firstly, the scale of the price movement – Communisis has risen about 170% in the time I’ve been holding it, which is a gain similar to that which I made on the substantial number of Barratt shares I sold out of the portfolio a few months ago. Secondly, and while this might sound obvious, I still haven’t sold, and didn’t sell any in the run-up. That implies one of two things – either an enormous misspricing was clear when I purchased the shares, so large that it could endure a doubling in share price without hitting its intrinsic value, or that the company has fundamentally changed in the time I’ve owned it.
The difficulty with the second of those reasons is separating what you knew before and what you knew after the purchase. How much of the fundamental change the company has endured – and, as a rather quick spoiler to my rhetorical question above, it has changed quite a lot – how much of that change was predictable at the point of purchase? If there were clues back then, we can take them forward to future investment decisions. If it was simply blind luck – and simple blind luck is a far more prevalent factor that most people are wont to admit – then it is of no real consequence to future decisions.
The logical place to start, then, is with what I said about Communisis back when I purchased it. Did I recognise the potential? As I’ve noted before, I’m in something of a privleged position as a blogger because my past thoughts are for all to see. It constantly surprises me how what I actually said and what I thought I said differ – so to any private investors, here’s a emphatic recommendation to always write down your thoughts and read them back; it’s the only way to keep yourself intellectually honest.
I think, looking at my first post on Communisis (and notably one of my first ever posts full stop) that I had the inklings of what would later become the real drivers of transformation – the way the business is split up segmentally. There was a large, relatively unprofitable declining segment, and a smaller and more modern higher-margin segment. That time, though, I erred on the side of caution – their product was intangible and, as an investor ignorant of their specific market, I can’t pass comment on their offering versus their competitors. A few months later I was a little more positive – mostly because the price had dropped 20% in one day, which felt like it pushed me over my margin of uncertainty. The rest of that post, though, is also relevant – not just the price change. Communisis had released an IMS detailing how they were planning to cut from 14 sites down to 9 (significant cost cutting, clearly) and how the higher margin segment was growing quite substantially, something which I’m happy to say I did recognise at the time – I was a little uncertain whether I had.
In hindsight, these were the clear signs of what was to come. The company and management were engineering a shift away from the low margin, high volume work – as evidenced by both the falling revenues in the mass-mail segment and the way they were cutting down sites. This makes the potential for mispricing slightly more clear – at first glance, or even second and third glance for me, Communisis looked like a business in a dying industry. Its operations were tied up in a declining segment. Returns in the growing segment were far better, and as the company migrated its contracts (an enormous intangible asset here – their long term customer relationships), things picked up.
So that’s driven the share price growth? Mostly, I think, it’s just the neverending string of positive RNSs they’ve been releasing. A nine-year contract win with Nationwide at the start of the year, a growing international revenue base, numerous contract extensions, an equity raising which was used for further growth and restructuring costs, and – most recently – the big spike caused by the Lloyds contract. That Lloyds contract is apparently the ‘largest available contract of its kind in the UK’, which is a relatively ambiguous term (‘its kind’ just depends on how widely you define it). It’s clearly a big deal, though – Lloyds is an enormous bank and ‘all transactional customer communications’ sounds like a substantial haul.
The sum total is to paint a relentlessly positive picture. We can see top line growth from the contract wins, revenue visibility from the contract extensions and the length of the contracts being won, and a double whammy of improvements in operating profit – both through cost-cutting (they’re managing to close sites while doing the rest of it) and through the better profile of work related to the more hi-tech stuff.
The key question
The bit I care about most is how much of my decision was luck and how much was good judgement. The problem with answering it is that it is, essentially, impossible. There are a few things I can take away, though, and these are things that I’ve been taking account of more recently anyway. Firstly – look for an obfuscating factor; something which hides the real direction the business is travelling. Direct mail and the stigma attached to it obscured the potential in the rapidly growing digital segment here. Secondly, don’t sell too soon – and, while I don’t want to pre-empt my next post, I’m still feeling pretty positive on Communisis. It feels as if momentum has taken hold with these shares; after trading thinly for so long, and after my having purchased due to a 20% fall in one day on no news (!), the shares seem far more followed and better traded now.
Really, though, the key driver of Communisis’s success seems to be that it’s doing what it does better than its competitors, and I’m not sure I knew that at the point of purchase. That’s down to management, mostly, and judging them in a business I don’t know much about is far beyond me.
Still, to end on a positive note, it is a nice endorsement for a simple investment strategy. Don’t worry about newsflow, noise or temporary movements; buy businesses which look cheap and have a good balance of risks and you’ll outperform. Not everything will work – for every Communisis there’ll be a Morson which slips from your grasp – but some of your bets will always surprise you. If you’ve stacked the deck in your favour to start with, surprises should be more positive than negative.