Selling Integrated Research Limited (ASX:IRI) (D'oh!)

I sold my Integrated Research shares today, breaking even on the trade. Here are my reasons:

1) As pointed out in episode 9 of the 3 Wise Monkeys podcast, founder Stephen Killelea sold $57.5 million of stock last year, three months prior to the release of disappointing profit guidance. I knew this before buying.

2) CEOs have come and gone on a regular basis. The last, John Merakovsky, resigned after 17 months for personal reasons as did the previous one, Darc Rasmussen,  although he lasted three and a half years.

3) I am uncomfortable with the way the company accounts for revenue. Net profit has more than doubled from 2013 to 2018 and yet dividends rose just 30% over the same period. This is because cash flow has been weak. Cash flow has been weak because in 2015 IRI changed its business model from selling perpetual licenses (for a one-off upfront fee) to selling term software licenses of between one and five years (with a fee spread across the duration of the contract). The idea was to increase recurring revenue and the company has succeeded in doing so as customers now need to buy a new license at the end of their term to keep using the product.

The trouble is that the amount a customer is willing to pay for a perpetual license is far greater than what they will pay for an annual license. If IRI was to start recognising revenue across the term of the license then the company would experience a steep decline in profits. Instead, it recognises the full multi-year sale upfront and book a long-term receivable on the balance sheet. This is why receivables have more than tripled from about $23 million in 2013 to about $70 million today whilst revenue hasn't even doubled.

I guess the difference between IRI's term licenses and a SaaS model is that the customer is locked into a long-term contract with IRI, but from a cash-flow perspective there is little between them. If you value IRI based on its cash-flows (rather than profits) then it is a lot more expensive, too expensive for me to have bought it in the first place.

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