Why IPH Ltd is well positioned for future growth

Patent and trademark services firm IPH Ltd (ASX: IPH) announced its results for 2016 earlier today. Its share price hardly budged on the news with shares changing hands for $6.21 in early afternoon trading, up less than 1% on yesterday’s close.

Thanks to a number of acquisitions that IPH made during financial year 2016, its statutory results were littered with one-off and non-cash items. However, on an underlying basis, revenue rose 51% to $143.1 million, net profit after tax (NPAT) increased 50% to $46.9 million and earnings-per-share (EPS) were up by 32% to 26.2 cents. The company also increased its dividend by 56% to 21 cents per share representing a partially franked dividend yield of 3.4% at current prices.

IPH generates a third of its revenue in South East Asia and bills the majority of work in US dollars so a weaker Aussie dollar assisted its 2016 performance. Excluding both currency impacts and contributions from acquisitions, Australian revenue rose 1% and Asian revenue increased 10%. Meanwhile, adjusted earnings before interest, tax, depreciation and amortisation (EBITDA) increased 11% in Australia and 9% in Asia.

These results reflect the fact that Australia is a mature low growth market whereas demand for intellectual property (IP) services is growing strongly in Asia. IPH is already the market leader for patents and trademarks in Australia and for patents in Singapore. It is aiming to establish similar dominance in other parts of Asia. The company believes that providing wide geographical coverage will attract clients looking for IP protection across multiple jurisdictions.

During 2016, IPH expanded its Asian presence by opening a second office in Singapore as well as new offices in Shanghai, Indonesia and Thailand. It also received Wholly Foreign-Owned Enterprise (WOFE) approval in Shanghai and Beijing giving it permission to set up business there.

One thing I like about businesses such as IPH is that they have very low capital requirements and so generate lots of free cash. The company converted 89% of statutory EBITDA into operating cash flow before interest and tax in 2016. However, the ratio would have been higher if not for a $6.4 million rise in receivables. It is worth keeping an eye on the receivables balance to make sure that it doesn’t significantly outpace revenue growth over time which could signal accounting irregularities.

The company finished the year with $58.8 million in cash and access to a $97 million borrowing facility and so has plenty of funding capacity to make further acquisitions. However, some of that cash balance will have been used to fund the $35.6 million acquisition of Cullens Patent and Trade Mark Attorneys which completed on 1 July 2016. Like most of its purchases, IPH funded the Cullens deal with half cash and half shares escrowed for two years.

Issuing lots of equity to vendors could put pressure on IPH’s share price when the shares are released from escrow. The company seems well aware of this potential issue and has appointed Macquarie and Morgans Financial to advise it on a share sale facility to ensure sales occur in an orderly manner.

2017 profits will be boosted by a full year contribution from recent acquisitions as well as the ramp up of newly established Asian offices. However, results will be impacted by the company’s intention to invest between $3 million and $4 million in Practice Insight, a data analysis software application for IP firms acquired in 2015.

Whilst roll-up models are fraught with difficulty particularly when applied to “white-collar” professions, IPH has executed satisfactorily to date. Also, I like its strategy of becoming a “one-stop” service provider for Australia and Asia and its exposure to high growth developing markets.

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Motley Fool contributor Matt Brazier owns shares of IPH Ltd. The Motley Fool Australia has no position in any of the stocks mentioned. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Bruce Jackson.

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