Small Cap Report (22 Feb) - VNET

22nd Feb '13 by Paul Scott

11 comments 9102 reads

Pre 8 a.m. comments

Well I've had better starts to the day, let's put it like that!

Sod's Law has kicked in this morning I'm afraid, in that just 2 days after I published a note on Vianet (LON:VNET), they have warned on profits. There is a lot of detail in the note, but the key points as I see it are these:

H2 trading (Oct 2012 - Mar 2013) below mgt expectations
However, it is quantified, which helps - operating profit likely to be £3.2m vs £3.9m last year (pre exceptional, pre amortisation), so not disastrous.
Cash generation remains strong
Crucially - final dividend maintained at 4p, giving 5.7p for the full year, so that should support the share price.
Increased costs related to launch of iDraught in USA
However, that launch has gone ahead this month (Feb 2013), with customers who have over 2,000 bars - very significant, as this is over 10% of the entire existing customer base added in one go, showing big potential for expansion now they are launching internationally (Edit: I misunderstood this point initially, and have clarified with the company that it is a mixture of pilots & roll-outs, so not 2,000 bars all in one go, but gradually).
Delays in iDraught installations in UK, but "many pub retailers conducting extensive evaluations".
Vending will trade at breakeven in H2, due to a delayed significant order that will kick in 2013/14.
Fuel business - reached breakeven in Q4, they anticipate a strong start to 2013/14.
USA roll-out of iDraught has begun, but £0.4m loss vs expected small profit due to increased start-up costs going for 10 US states, instead of just Colorado as originally planned.

So it seems to me the overall message isn't that bad at all. These are temporary factors, a bump in the growth road, but the business is still strongly profitable & the growth story is intact. Therefore I am expecting to see the shares drop to around 100p today, where I shall be buying more. That's a personal decision, and as always this is in no way intended as advice, readers are urged to do your own research as usual.

Crucially, the maintained 5.7p dividend should prove a strong support for the shares, and today could give an opportunity to lock in a 6% yield if they drop to…

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darlocst

22nd Feb '13

My problem with Vianet, & why I kept my position size v.small, is the constant slippage of timelines. Each part of the group now is performing behind where management forecast 6 months, 1 year, 2 years ago. It damages their credibility.

The US expansion story is potentially exciting but other divisions much less so.

That said, under 100p I'd say its worth holding purely due to divi & US potential.

Paul Scott

Morning darlocst,

Yes those are fair comments. The timescales for VNET's growth have been slipping, but that's often the case with new products & markets. Things rarely pan out as planned.
The beauty of VNET shares is that the growth potential is thrown in for free, and the shares are underpinned by the core Brulines business, which is just a cash cow that finances the (maintained) 5.7p total dividends.

I've just bought more at 87.8p and 90p, since that has locked in a dividend yield of around 6.5%!
Plus I think there's potential for the shares to double or more with a 1-2 year view, as the growth begins.

There were actually some positives in today's statement, e.g. that the USA launch has started, with 2,000 bars being fitted with iDraught units, in 10 States. That's more than 10% of the entire UK installed base in one hit!

The fuel division doesn't interest me at all, and it's at least trading at breakeven, rather than loss-making.

Vending order just delayed, so should kick in in 2013/14. This year's disappointment is next year's soft comparative, so since I always approached this with a 1-2 year investment horizon, I'm only irritated by today's statement. It doesn't seem to undermine the fundamental investing case at all.

I calculate that EPS for 2012/13 should be around 11.5p, so at 90p the with a 5.7p maintained dividend, these look great value to me. How much downside can there be on that sort of price, especially when about 70% of group revenues are recurring, on long term contracts? Good buying opp at 90p in my opinion, but DYOR as usual.

Regards, Paul.

Boros10

I have been keeping an eye on these for a while. Today's annoucement prompted me to delve a bit deeper. Reading back through previous statements you get the feeling management have a tendency to over promise and under deliver. I accept Paul point though that rolling out new products rarely runs smoothly.

I had trouble getting my head around the various profit numbers used in their statements. I think investors need to ignore the EBIT per exceptional pre amortisation line. In 2010 and 2011 Vianet capitalised about £1.5m of software development cost. In the same period it expensed around £300k through the P&L and lumped this in with the acquisition related amortisation charges. I am willing to ignore the latter type of amortisation charge as this is really goodwill but the amortisation of software costs just can't be casually ignored in the same way.

The high level of exceptional charges are not unusual for a business under going such change but investors will not want this to become a habit.

Paul, is the EPS figure you are using adjusted for amortisation and exceptionals?

I do like the potential of the US roll out. It is a vast market and offers scope for earnings growth in the future.

I was tempted to jump in this morning but I'm reluctant to do so without more detailed research and I would probably want to get rid of something else to make room.

Edward Croft

Paul - for moments like this one needs to remember Teddy Roosevelt's speech to troops at the Sorbonne...

It is not the critic who counts; not the man who points out how the strong man stumbles, or where the doer of deeds could have done them better. The credit belongs to the man who is actually in the arena, whose face is marred by dust and sweat and blood; who strives valiantly; who errs, who comes short again and again, because there is no effort without error and shortcoming; but who does actually strive to do the deeds; who knows great enthusiasms, the great devotions; who spends himself in a worthy cause; who at the best knows in the end the triumph of high achievement, and who at the worst, if he fails, at least fails while daring greatly, so that his place shall never be with those cold and timid souls who neither know victory nor defeat.

My favourite quote ever. By the way - that's the first Equity Active note I've read - excellent format - will discuss.

shanklin100

Paul

Are you happy with the treatment of intangible assets at VNET

I guess the £17m+ goodwill must arise from past acquisitions, but am less clear about the "Other intangible assets".

Your Equity Active note mentions neither of the above.

Thoughts welcome. Thank you, Martin

I've just spoken to the company, and am pretty comfortable with everything.
The dividend is safe, so no worries there.
USA expansion is potentially pretty exciting.
So at 98p currently, one is locking in a near-6% divi yield, with good long term growth too.
They indicated contract delays are not going cold, just delayed for technical reasons.
I'll be issuing a full note on Monday.
Regards, Paul.

Munday

23rd Feb '13

On the first time of reading one of Paul's articles, I fiound it to be both interesting and knowledgeable.

brigandchief

Valid comments above however I would suggest weconsider two things First company figues do not go up and up and up, they fluctuate. The clarity oif the data presented instills confidence in this company . There will of course be a tendency to over egg the future and the management here need to think about their credibility in these matters. Having run a company and learning the hard way, I am mildy sympathetic and look forward to a nice divi! Thanks Paul for your analysis, soothes a troubled mind over the weekend and (you won't have that ponch if you keep running!!!)
Cheers david

Monty9

24th Feb '13

Paul, just a guess but I reckon the loss on this one is a drop in the ocean compared to the gains your favoured stocks have shown over recent times. And for those of us who were still thinking about vianet its a good buying opportunity (though so much better had been awake when the RNS came out).

Really enjoying your blog and wish you every success.

25th Feb '13

I've published a detailed update note on Vianet's profit warning through the company I'm involved in, Equity Active. To view the note, please click here (opens pdf). It explains the profit warning in tabulated form which I think aids understanding. Let me know what you think of the note, as feedback would be very helpful.
P.

26th Feb '13

65,000 shares Director buy just announced at around 100p a share. Encouraging!
P.

Small Cap Report (22 Feb) - VNET

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Paul Scott

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