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Stockwatch: Melbourne IT (MLB)

June 16th, 2009 · Greg Atkinson · 28 Comments

Established back in 1996, Melbourne IT (ASX:MLB) has grown from a company focused on registering Australian domain names to being listed on the ASX in 1999 and is now a provider of a range of web based services. From 2003 the company expanded rapidly via a number of strategic acquisitions and now must not only deal with the  global economic downturn, but also face intense competition in a number of it’s key product areas.

In simple terms Melbourne IT (website) is company that manages domain names, offers website hosting packages and provides associated software and services. It offers a variety of products both directly under it’s own brands and also via a network of global resellers. Much of the company’s earning are defensive in nature since even in a downturn businesses need to keep their websites online and domain names registered.

But the conundrum Melbourne IT face is that they offer a range of products and services that allows them to tap into a global market, but this also means global competitors can also tap into their market. For example as more businesses and homes in Australia gain access to broadband this will drive up demand for website hosting, website design and domain registration, but these solutions can be increasingly delivered by companies, small businesses or even individuals scattered across the globe.

So far the company appears to have done pretty well in integrating the acquisitions it has made and for many years management have reported doubt digit growth. As of the end of December 2008, Melbourne IT had an operating margin of 17.3%, a Return on Equity of 19.3% and Net Profit at 8.8%. If you put this together with a generous fully franked dividend then there is a lot to like about the company’s shares at current prices.

    Melbourne IT (ASX:MLB) 2 Year Price Chart

melb-it-2-year-chart-jun-09

But a few good performance indicators and a battered stock price are not  good enough reasons to leap in and buy the stock.  In the 2009 AGM Presentation there is a bullet point that reads  “Final quarter 2008 – evidence of slowdown in all divisions” so this indicates that their business areas are now being hit by the global economic slowdown. But how much of a hit will company revenue and  profits take?

It is not possible to predict exactly how Melbourne IT will fare in the months ahead but  I also noted in the AGM material that the company planned to allocate funds to a fairly large CAPEX budget, and therefore the management team will need to manage this very carefully if revenue falls significantly.

The other issue that concerns me a little is that many IT related companies  start off small and nimble but as they grow their cost base also expands. Instead of just being a small company run by a few tech focused people these types of companies become much more formal as they grow and therefore have additional organisational costs such as training, HR,  offices, marketing and an increasing number of managers and executives.

This means they can no longer compete with low cost operations or suppliers  of cheap hosting packages based in the U.S for example. In a roundabout way their success can actually become a weak point. To counter this Melbourne IT focuses on areas such as quality, innovation and customer support, but following this strategy also drives up costs and the company has to rely on clients being willing to pay for a higher grade of service and products.

In addition global giants like Yahoo, Google and Microsoft seem to be spreading into many of the same business areas as MLB as well as range of domestic competitors including Telstra.  So Melbourne IT is operating in a very competitive global environment and it will be a challenge for management to maintain or improve on current profit margins in the years ahead.

But the company in the past has shown it can grow revenue even in a very competitive environment, so perhaps Melbourne IT is well worth looking at for investors who are seeking a stock that could deliver both income via dividends and share price growth over the medium to long term.

The author of this article has no direct or indirect stock holdings in MLB at this time.


28 responses so far ↓

  • 1 Anon // Sep 21, 2009 at 10:26 pm

    Hey Greg, I dont know much about MLB but thought I might pass on some other tech stocks to watch.

    Intergrated Research – Profits increased during the correction and in VOIP sector.

    DBS – Owns 400,000+ internet domains – online real estate.

    Servcorp – Virtual office.

  • 2 Pete // Sep 21, 2009 at 10:31 pm

    Last year I had invested in QML (QMASTOR LIMITED) which is an IT company with exposure to the mining sector.

    It has bounced quite nicely since the start of this year.

    But…a word of warning to IT investors (and this goes for any smaller caps) – be very careful shallow of trading volumes (such as with QML).

    The last thing you want is to be caught out wanting to sell your shares at the current market price, and finding that the only buyers around are asking for a 50% discount.

    All it takes is one person to get a bit desperate and take up that discount offer…and the share price plummets.

    (I didn’t get caught out, but was a bit concerned)

  • 3 Anon // Sep 21, 2009 at 10:46 pm

    Yep agree Pete.
    Also, if you are playing with small caps you must act quickly on new information. If you are too slow and the news was bad you can easily be down 30-50% in an hour.

  • 4 Senator13 // Sep 21, 2009 at 11:57 pm

    Hi Anon, how does the Servcorp concept actually work? I have seen a few things written about them and not taken any notice and recently I noticed an office has opened in a building near where I work.

    Yes small caps do require a very close eye and a quick sell finger. A few years back I dabbled in a few. Did ok trading TAP Oil but other smaller guys I took a bath on and came off worse for it overall. Main problem was that I did not have the time to watch them every single day and just hang on too long. So now I have just been sticking to the big guys. If way down the track when I have more time to watch everything I might venture back into a few because there are some pretty innovative and interesting businesses out there. But for me, I won’t be back to them for many years.

  • 5 Anon // Sep 22, 2009 at 6:59 am

    “If way down the track when I have more time to watch everything I might venture back into a few because there are some pretty innovative and interesting businesses out there. But for me, I won’t be back to them for many years.”

    In a few years most of the value will disappear.
    The small cap sector was absolutely punished in this crash due to lack of liquidity and everyone running to safe haven large cap stocks. In the 70’s when we had high inflation small caps actually out performed large caps by a significant margin for over a decade.

    On Inflation and small caps vs large caps:
    “Outside of the commodity space, mid cap and small cap growth stocks are likely to outperform the large cap indices as they have the potential to maintain the balance between genuine earnings growth and inflationary earnings growth. This .. [is] .. because large mature companies which operate in mature markets have far less scope for natural revenue expansion than less mature growing companies who operate in growing maarket segments. The natural growth of these smaller stocks can help protect the investor from the inflationary effect on stock prices.”
    http://www.slideshare.net/moneyvidya.com/how-to-invest-when-inflation-is-high

    Historical outperformance emerging from recessions:
    “Since 1970, data show that 12 months after coming
    out of a recession, small caps were outperforming
    large caps by an average of 13% for an average return
    of 36%. Furthermore, the outperformance lasted for
    an average of 33 months. In the first seven months of
    2009, small cap stocks rose 33.2% on a total return
    basis, outperforming large caps by 10.7%. Based on
    the past average, that outperformance could continue
    for at least another two and a half years if the
    … recession ended sometime around mid-2009.”

    Historical outperformance from 73-83.
    “In fact, from 1973 through 1983, small-company stocks decisively outperformed large-company stocks every single year, including 1977 and 1981 in which the S&P had negative years and small-company stocks returned 25.4% and 13.9%, respectively.”
    http://taylorfrigon.blogspot.com/2009/02/return-of-1970s-part-2.html

    We need to adapt to new market conditions. Buying bluechips and holding may have done well in the past but arguably will not do well in the next 10 years IMO. Investors thought this would work in the 70’s because of what happened in the 50’s and 60’s — dejavu?

  • 6 Greg Atkinson // Sep 22, 2009 at 7:16 am

    I was going to invest in Servcorp years ago but went in another direction that ended in disaster. I am still keen on SRV although I noticed they have closed an office in Tokyo so perhaps the GFC has been hitting their overseas operations?

    I might look at SRV in more detail next time I write a stockwatch article.

    As for Small Caps, I have done really well from some of them and also seen a total wipe-out with others. Personally I find Small Caps are hard to follow and there is not a lot of research available on most of them. But they still tempt me because it is generally easier to understand what these companies do and the directors are more approachable.

  • 7 Anon // Sep 22, 2009 at 7:18 am

    “Hi Anon, how does the Servcorp concept actually work? I have seen a few things written about them and not taken any notice and recently I noticed an office has opened in a building near where I work.”

    If you go onto their website: http://www.servcorp.com it explains their product offerings and how they work etc.

  • 8 Anon // Sep 22, 2009 at 7:29 am

    “As for Small Caps, I have done really well from some of them and also seen a total wipe-out with others”

    Hey Greg — we have all experienced this. I guess aslong as we are right more than we are wrong (with sound money management) we should come out on top in the end !

  • 9 Greg Atkinson // Sep 22, 2009 at 7:52 am

    Hi Anon – yes I hope to have more winners than losers, but it still hurts 🙂 As I wrote in my “investment tips” if you get into stocks you have to expect to have some really bad days and take some hits.

    The problem is that when you look back at a stock that has failed it all looks obvious that the company was going to falter. That makes it even more painful!

    BTW I see MLB has not done much since I posted the blog about them. I wonder what is keeping their share price down?

  • 10 Anon // Sep 22, 2009 at 8:23 am

    “The problem is that when you look back at a stock that has failed it all looks obvious that the company was going to falter. That makes it even more painful!”

    If only we could make our investments with Hindsight.

    “BTW I see MLB has not done much since I posted the blog about them. I wonder what is keeping their share price down?”

    Profits could be falling further?
    Directors have bght some at around this price – so thats a good omen.
    Its just comeout of 5 years of profit growth — its going to be difficult to grow from here.
    Margin erosion and commoditisation are obviously issues for this company. But like you said historically it can hold its own in a competitive landscape. I am not very familiar with this company so I can’t really comment much more.
    Recently, the entire tech sector has been underperforming the market:
    http://bespokeinvest.typepad.com/bespoke/2009/09/is-the-tech-sector-running-out-of-gas.html
    So this sector could be the next one to pop?
    Lots of quality hedge funds have been buying tech stocks in their latest 13f filings and it appears to be the right time in the business cycle to be buying techs: http://www.onlineinvestingai.com/blog/wp-content/uploads/2008/12/business_cycle_stock_market_sectors_29_1_08.jpg

  • 11 Anon // Sep 22, 2009 at 8:54 am

    hey some others for consideration for “stock watch” articles.

    ATP – luxury industry, currently being priced as a distressed debt asset when it has very low net debt.

    AVG – Wine industry.

    CKT – Japanese REIT.

    CYG – Auto/infra industries

    ELX – Lasers

    MVP – Pain relief

    WFL – MIS industry.

    Note this is not advice only meant for conversation purposes. You must seek professional advice if you want financial advice.

  • 12 Pete // Sep 22, 2009 at 10:08 am

    Good posts there Anon, and some nice info on smallcaps/inflation thanks.

    Personally I like smallcaps. The bigger companies are nearly always overpriced and it is hard to tell where larger caps growth comes from (speculation? manipulation? institutional investors?). At least with smallcaps you know they are driven by speculation, and hence their volatility.

    I see the tech sector as a bit like the finances sector – they do most of their revenue generating by creating a product and then just sitting around raking in profits.

    Which is good, when the sectors are healthy. But somewhat disastrous when excess competition exists.

    As China and India grow, their capacity for producing IT products also grows. And now google seems to be taking over the planet. See the problem with the tech sector is that it is a global market. You can easily sell products globally. Whilst that can be an advantage, it can also be a huge disadvantage when you realise who you are up against in the global market.

    Personally I just don’t see much room for huge profits from IT products (besides the big fish like google, microsoft, facebook, etc) and I am going to avoid that sector.

  • 13 Anon // Sep 22, 2009 at 11:23 am

    “As China and India grow, their capacity for producing IT products also grows. And now google seems to be taking over the planet. See the problem with the tech sector is that it is a global market. You can easily sell products globally. Whilst that can be an advantage, it can also be a huge disadvantage when you realise who you are up against in the global market.”

    This is true.

    Also given difficulties obtaining credit now and possibly in the future + higher interest rates — this may create bigger moats for higher capital intensive industries.
    In turn, lots of entrepreneurs may move into the lower capex industries like the tech sector, creating additional margin pressures.

  • 14 Anon // Sep 24, 2009 at 9:45 pm

    Servcorp is going abit crazy. Has anyone got an intrinsic valuation for this?
    Also, today ATP began to rise.

  • 15 Greg Atkinson // Sep 25, 2009 at 9:10 am

    Anon – Servcorp have been talking about expanding overseas so I guess people see this as a sign that things are picking up for the company. I will have a look into SRV on the weekend.

  • 16 Anon // Sep 30, 2009 at 10:46 am

    Hey ATP is rocketing. Its up 40% since i mentioned it last week at 9.5c. The mispricing is being corrected.

  • 17 Anon // Sep 30, 2009 at 11:11 am

    DBS (Dark Blue Sea) I feel is very mispriced.
    It has approx 400,000 domain names. At the current market cap you are only ascribing 35-40$ per domain name. I have personally seen the crap ones DBS owns go for 500$US (to private buyers) – let alone the good ones. Plus this is one of the biggest holders of domain names in the world with no debt and cash in the bank. Photon owns a substantial stake and is increasing it. Its not going bankrupt.
    You also have the chance to get a “super site.” Where one mega site can go for 450-600million which is 30-40x the current market cap.
    Given its cyclical earnings its current high pe is a bullish sign.
    As inflation/interest rates roar and credit tightens entrepreneurs will be forced into industries that require lower levels of investment. Consequently, quality domain names will arguably be in greater demand pushing prices up further.

    Please remember this is just for discussion. This isn’t advice. Always seek a qualified financial advisor who knows your circumstances when making decisions.

  • 18 Anon // Oct 2, 2009 at 9:54 am

    DBS Takeover sigh. I didn;t think photon would have taken this over. There goes shareholders ability to get more value out of this :/ I had targets of 2$+ longterm on this grr.
    I think the price is too low – photon is getting this too cheap !

  • 19 Greg Atkinson // Oct 2, 2009 at 5:28 pm

    Anon I am not a fan of a lot of smaller ISP’s these days as I think they will struggle to grow beyond being a niche player. As for SRV, I wrote a few quick notes on them the other day.

  • 20 Anon // Oct 2, 2009 at 5:48 pm

    Hey, DBS isn’t an ISP? I’m not sure if you were commenting about DBS or just voicing your opinion about ISPs generally. DBS is basically the equivalent of Lend Lease but for online real estate. They take cheap domains, develop the domains and sell them for alot more than they paid for them – making money off advertising as they hold the online properties. They have other avenues of earnings but I was more concerned with the main asset values when trying to work out intrinsic values, the others were a bonus.

    I know what you mean about smaller ISPs. They may struggle to become more than a niche player, but you still can make decent returns off them if they are severely mispriced.

    I myself am a value investor and I try to be a bottom up investor (which is hard especially if the entire industry is struggling) – so as soon as there are significant differences between price and value my eyes light up.

    I read your piece on servcorp – it was very good. I think anything that reduces costs and allows businesses to make more money is a good thing in high inflationary environments.

  • 21 Anon // Oct 2, 2009 at 6:18 pm

    Heres another pick. Medical Developments (MVP).

    I feel there may be a health care/biotech surge in equities in the next 6-12 months. I cant explain why, merely my intuition is guiding me in this direction so I should listen.

    MVP description:
    “MVP is a leader in emergency pain relief and respiratory products. The Company manufactures
    a fast acting inhaled analgesic for pre-hospital and emergency pain relief called Penthrox. It is
    used in all Australian Ambulance Services, the Australian Defence Forces, Sports Medicine and
    for analgesia during short surgical procedures in Dentistry and Cosmetics.”
    *from company announcement

    “Veterinary: Veterinary division is responsible for the development, marketing, sales and supply of a range of veterinary equipment with a specific focus on anaesthesia and surgical consumables: Anaesthetic machines (both open circuit and closed circuit); Breathing circuits and equipment; Vaporisers; and Breathing monitors.”
    http://www.morningstar.com.au

    I think the Veterinary healthcare arena could be a big growth ticket in the future. Given aging demographics, elderly are likely to seek more companionship from pets. Additionally, more and more people are treating pets as members of the family (they are even buying them health insurance !).

    One of the main problems with pet anaesthesia is that pets wake up too quickly off it and it can be dangerous. MVP’s pain relief method gives significant advantages here as quoted in one of their recent announcements:
    “Methoxyflurane has considerable potential for veterinary use and it is expected that this approval will open another
    significant market. The drug has some distinct advantages for veterinary medicine including the
    slowness with which animals emerge from anaesthesia and therefore the ability to manage
    animal welfare post-anaesthesia. Further, MVP have been developing novel delivery methods
    for Methoxyflurane that will include the management of post-operative pain, which it is hoped
    will be incorporated into the product offering following regulatory approval.”
    Also, they now have FDA approval (which was very costly and a long process). So they can now actively market their Methoxyflurane product(s) in the US.

    Before the previous manufacturer stopped producing Methoxflurance they were servicing quite a few clients which provided profitability at many multiples of MVP’s current earning capacity. If MVP can recapture even parts of this business (given they are the only ones doing it now) profitability has the potential to rise considerably. If this doesn’t work out it has other divisions that provide alternative growth paths and base profitability to protect downside risk, whilst giving reasonable upside.

    Balance sheet clean, buying back shares at depressed prices and directors loading up.

    Please remember this is just for discussion. This isn’t advice. Always seek a qualified financial advisor who knows your circumstances when making decisions.

  • 22 Greg Atkinson // Oct 3, 2009 at 7:44 am

    Sorry Anon my choice of the term ISP was not the best. I should have written smaller ISP/Web companies. Anyway I also try and be a value investor and that is another reason I struggle with the smaller ISP/Web companies…they are simply too difficult to get a feel for. They might look like good value from the outside, but inside they might be a mess and have little growth potential.

  • 23 Anon // Oct 3, 2009 at 9:05 am

    “They might look like good value from the outside, but inside they might be a mess and have little growth potential.”

    Yeah, it isn’t easy. The more uncertain I am about something the greater the margin of safety I require.
    Sometimes the biggest messes can give you great profits aslong as you price it correctly. But as you know this is alot easier said than done !
    The Wine industry is clearly in value territory now – but its abit like a minefield because theres alot of debt on the balance sheets. But when you buy something for 10-20% of its tangible assets (sometimes already written down) you have to begin to wonder if mr market has over done it again. When things in an industry go from bad to worst in history + the economy and market have imploded than that is usually a good time to buy. The no.2-3 wine producer Australian Vintage (used to be McGuigan Simeon Wines Limited)in Australia has gone from 6$ to 30c..There has been very little dilution over the last 4 years and they have controlled their debt levels for several years (not excessively borrowing more and more) so value is arguably still there.

    I guess at the end of the day you gotta do what works for you and everyone is different. You have good instincts which cant be learnt from books or taught.

    In the bigcap arena I like Tabcorp. I worked out even with all the earnings uncertainty, in a worst case scenario — because the yield is so high, longterm, there is very little risk for capital loss. The market has priced in earnings uncertainty to near worst case. If Tabcorp can reclaw back some earnings (which appears likely) this will be repriced. So its basically like a high yielding bond with superior capital appreciation potential. I also like the new ceo. Given Gaming companies have alot of cyclical earning streams (they are not purely defensive) they are usually bght at this stage of the business investment cycle historically too.

    Please remember this is just for discussion. This isn’t advice. Always seek a qualified financial advisor who knows your circumstances when making decisions.

  • 24 Anon // Jun 24, 2010 at 12:44 pm

    MLB looks very interesting here. Very surprised in its latest results – i didn’t think they could keep up eps growth. I think they got margin improvement, which was remarkable given the environment.
    Good ff yield…this may go higher?

    Please remember this is just for discussion. This isn’t advice. Always seek a qualified financial advisor who knows your circumstances when making decisions.

  • 25 Plornt // Aug 7, 2010 at 3:01 pm

    Sept 22 Post:

    AVG – Down ~24%

    CKT – Taken over at 1.10 I think? so up about 40%

    CYG – Up ~31%

    ELX – Flat

    MVP – Flat

    WFL – Down 41%

    So while most portfolios have done DOWN, or have only gone up alittle since September 2009, this set of stocks has actually gone up ~7%.
    I guess this shows buying bigger companies isn’t necessarily less risky at all, just less volatile which I guess is risky if you dont have the psychological makeup to handle the swings.

    All posts by this poster is not financial advice or a reccomendation to do something. Can change my mind quickly on any decision I make, given markets always change. Have positions in instruments discussed unless otherwise indicated.

  • 26 Plornt // Dec 19, 2011 at 4:27 pm

    Previous portfolio posted on Sept 22 2009 (post 11):

    ATP – Down ~5%

    AVG – Down ~10%

    CKT – Taken over at 1.10 I think? so up about 40%

    CYG – Up ~40%

    ELX – Down ~40%

    MVP – Up ~200%

    WFL — Bankrupt

    So if equal weight was put into all these value stocks, the portfolio would likely be still higher than Sept 22 2009. Around 10% up versus the XAO returns of -12% over the period, or an outperformance of 22% from buy and hold investing.

    All posts by this poster is not financial advice or a reccomendation to do something. Can change my mind quickly on any decision I make, given markets always change. Have positions in instruments discussed unless otherwise indicated.

  • 27 Plornt // Sep 15, 2012 at 4:07 pm

    Previous portfolio posted on Sept 22 2009 (post 11):

    ATP — Down ~33%

    AVG – Up 55%

    CKT – Taken over at 1.10 I think? so up about 40%

    CYG – Up ~83%

    ELX – Up ~20%

    MVP – Up ~650%

    WFL — Bankrupt

    Simple net / net type strategy up ~102% – XAO down ~5 outperformance 99% with no tax and no transaction costs for 3 years !
    No economic knowledge is needed ! Trading is hopeless. ~34% annual return !

  • 28 Greg Atkinson // Dec 10, 2012 at 3:58 pm

    Just a quick update. MLB shares closed today at $1.73 so they have not done a lot over the last few years although they did trade up around $2.30 at one stage.

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