Small Cap Value Report (1 Jul 2016) - SAL, QTX

1st Jul '16 by Paul Scott

54 comments 22261 reads

Good morning!

Mark Carney, Governor of the Bank of England, gave a speech yesterday (video link) which triggered a further fall in sterling. The key points I jotted down were;

Economic outlook for UK has deteriorated
More monetary easing may be needed over summer, have tools at their disposal
Limits to what the BoE can do

Therefore, it's looking like sterling may remain low for some time. This further reinforces my current strategy of trying to buy bombed out shares where there are considerable overseas (esp. dollar) earnings. Also companies which are UK exporters. So for example I bought some Portmeirion (LON:PMP) yesterday, as it should benefit from the weaker pound.

I think this is also quite bullish for the domestic property market. Anecdotally, I've heard that some buyers are pulling out of house purchases. Although I'm also hearing that overseas buyers are steaming into the London market, seeing cheaper sterling as a buying opportunity.

Ultimately, house prices are driven by demand & supply, and the cost & availability of mortgages. The bottom line is that, with interest rates this low (and likely to stay low), then buying a house is more affordable than renting (if you can come up with a deposit). For this reason, I'm looking closely at housing-related shares which have been sold off heavily. I currently hold Persimmon (LON:PSN) . Rightly or wrongly, my current view is that any downturn in the housing market is likely to be temporary. In my lifetime, house price crashes have only happened when interest rates are so high that mortgage repayments become onerous. We couldn't be further away from that scenario now if we tried.

Indices

A lot of people expected a massive sell-off after the Brexit vote, and are now confused to see the FTSE 100 hitting a 9-month high. As mentioned before, that is mainly because the index is dominated by companies which generate earnings in dollars.

I thought it would be interesting to see how the various indices have performed over the period since Brexit. Here are the figures as of last night;

(table corrupted, so here are figures manually)

FTSE 100 +2.6%

Mid Caps (MCX) -6.1%

Small caps (SMXX) -5.9%

Aim (AXX) -2.6%

(from CoB June 23 to CoB June 30 2016)

As you can see, whilst large caps are up, mid and smaller caps are down about 6% in the last week.

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Aislabie

1st Jul '16

I am willing to be a contrarian about interest rates as it seems to me that the collapse of the pound will need to be arrested to avoid the inflation from imported fuel, food, etc.
The recession then follows as mortgages and corporate borrowing costs rise. I don't of course want this to happen but I cannot realistically see it being avoided
5% rates by December - that's my bet

cig

I'd recommend getting some interest rates options then, you can easily become a multi-millionaire if you're right (the best quote I see pays 1700 times your stake if rates are at 5% in December).

Problem with the "collapse" of the pound is that so far it is just -10%. Such a move will get you something like 3% inflation worst case, as domestic inputs are unlikely to move. Doubt the BoE will react at all to that kind of move in a likely recessionary environment.

Rusty2

Can't see interest rates going up this year.

We are only a week into the change and I don't believe that people yet understand that the EU's desire to take over the city has almost no chance of being stopped or even negotiated. This will very quickly collapse the UK tax revenues (and house prices) requiring far more robust action than is yet being discussed.
I appreciate your suggestion and will look into an area I have no current experience with.
So far I have been using Stockopedia to look very closely at any stocks that have significant sterling debt as well as those that have significant non-sterling income. There appear to still be opportunities in these areas.

Betting on rates via stocks is not very efficient. Here's the product I was looking at:

https://www.theice.com/products/37650331/Options-On-Three-Month-Short-Sterling-Future

Losing out on finance is possible, though I suspect it won't be that bad because people are sticky, so even in the worst case deal, it's likely that financial institutions would move legal entities and some key regulated functions, but would keep some London staff working "remotely" as moving/replacing everyone is a pain and many finance jobs can be done from anywhere (see India). Also on the plus side the London may get some "offshore" style business that wasn't previously possible.

That may still result in lower tax revenues, but that's deflationary, as this means the state spending less, thus newly unemployed people (direct staffers or contractors) competing for fewer jobs and likely taking a pay cut.

It's hard to guess if that results in lower house prices, but if it does that's also deflationary.

So the only thing that could produce inflation is a further massive decline in the exchange rate, not offset by recessionary conditions. Seems somewhat far fetched to me, even if the City was indeed obliterated.

cic

2nd Jul '16

Regarding SAL, there will be other assets in S&P+ which will be liquidated, so I assume there will be adjustments in addition to the 450k debt w/o that have not been disclosed to arrive at the £275k. The RNS states that: "In addition to this, S&P+ had been expected to contribute £180,000 of profit before taxation ("PBT") to the consolidated SpaceandPeople group results for 2016 which will now be a loss of approximately £200,000 instead." What does this mean? I interpreted it to mean that the loss of £200k is S&P+ loss, so that in effect the previously forecast SAL profits would now have to be reduced by: £275k (one off) plus 380k (£180 (expected S&P+ profit now £200k loss). But I have seen elsewhere this interpreted as the profit for SAL now expected to be £200k loss. What is your interpretation, Paul. Could you ask the management for clarification, please. Another point: Formed in 2012 S&P+ has a very short history. The latest Companies House report is 2014 but the directors seem to have been well paid considering the size and performance of the business. I read that the business of S&P+ is not directly related to SAL core business, but just what does it do? I have not been able to answer that question. I've not done a lot of digging to be sure, but I sense a red flag here. Incidentally, I would have thought that a company that wants to be transparent and engage with shareholders would have filed its subsidiary accounts with Companies House at the same time as it published its PLC accounts - that it has not suggests something to hide.

Whitbyview

I have to say that I agree with you. I have been making an assessment of my shares that fell after the Brexit vote and Berkeley Group (LON:BKG) is one that I have averaged down. I did discuss on a thread here the option of diversifying a little and buying a different builder but I just think that the management of Berkeley Group (LON:BKG) are so on top of the market. Before anyone said anything about there being any value in builders this week and when the share prices were plummeting, they were buying a serious number of their own shares (see RNS). I read on another bulletin board someone saying they thought they were trying to support the share price. As if. They were buying in my opinion because they know their business and they are the only ones that can see their order book - I even read a quote from Tony P which I recall said they hadn't lost a single London sale. That may have changed by now of course. The management could be wrong but the people that shorted this share have certainly had their fingers well and truly burnt after a 5% rise on Friday alone. It's a sad fact that many Europhiles I know now think the UK is the last place on earth they want to support or live but London hasn't changed as a physical attraction and with the fall in the pound it just got a whole lot cheaper for many buyers. At the end of the day, no one knows but given the improvement in the EPS (and sentiment) from the buyback at the recent bottom of the market and the substantial divi, I'm prepared to take the risk.

rhomboid1

3rd Jul '16

Thanks Paul for the interview with Spaceandpeople (LON:SAL) CEO , very useful , I'm not persuaded of the investment case but appreciate the background.

Paul Scott

Thanks rhomboid1,

I like the CEO of Spaceandpeople (LON:SAL) and am happy to let him explain things as he sees them.

My agenda is to just put stuff out there that I think is interesting, and then let people make up their own minds.

At the current level, I feel that SAL has obviously disappointed, but personally I'm happy to give them the benefit of the doubt.

DYOR as usual. Others may disagree, which is fine. No big deal.

Regards, Paul.

underscored

It's not different this time. http://mhanson.com/2242-2/ (US but relevant).

"“Shadow Demand” is simply unorthodox, or non-traditional demand – as opposed to end-user, shelter buyer demand – with access to cheap and easy credit and liquidity that becomes the dominant driver of both incremental demand and prices."

The UK housing market has nothing to do with owner occupiers, hence the detachment from wages.

Jon1958

"S&P+, our London based above-the-line ("ATL") advertising support company's main goal was customer and revenue diversification. In 2014 they transacted one large project that dominated the resources of the small team. In 2015 they broadened their offer and a larger number of smaller contracts were won, further establishing this unique business model. Revenues were lower than 2014 at £2.4 million, but I view the progress made in 2015 as being a real success."

This was MB in April this year regarding an investment he has just abandoned.

'Nuff said? Good luck to holders. I'm out.

tiswas

Paul

Thanks for the SAL interview.

Can I lean on your accountancy skills? Why does the 51% ownership of S&P+ mean that the one-off loss is £275,000 rather than as you suggested £475,000 being the £425,000 loan and the £50,000 inter-company debt? They are writing off all of the £475k are they not, it is all SAL's money even though they only own 51%?

Cannot get my head around it.

Thanks and regards

Rob

Laughton

I'm with you tiswas regarding SAL.

Here is a company making a profit of 1M so whatever the real impact on their P&L these figures are not insignificant. I still don't feel that management has given a clear explanation of the real costs to SAL. Maybe they expect the other 49% owners to cough up their share of the £425,000 loan but will they or will they just walk away?

Then SAL says IN ADDITION TO THIS, instead of the £180,000 profit contribution expected, there will now be a loss of £200,000. Why is that? OK, I understand that S&P+ is going to be put into administration so SAL will not receive a "profit" this year but why will they also lose £200,000? And that on top of having to write off their £425,000 loan?

Hi Laughton

As I understand it the 49% shareholders were directors of the company. PLC made the full loan or a PLC sub, and so no one else is on the hook for the balance.

I have been in touch with the company seeking clarification but basically have been told to take a hike as it is an accountancy issue and they do not see it as their responsibility to explain this to a shareholder. Even though I only have a punt sized stake here that does not make me happy and so I am hoping that Paul will either know the answer or at least use his relationship with the CEO to get us one.

Not impressed!

I would add, I am not saying that the company is wrong. I would just like to understand why from an accounting perspective the loss is so much less than the amount of loan written off.

4th Jul '16

I may be talking to myself here but the response from the company was:

The reason that the one-off loss in the Group results will be less than the total amount of £475,000 is that part of it is eliminated on consolidation as SpaceandPeople are not 100% owners of the S&P+ subsidiary.

Does this make sense? Is this accounting gobbledygook if they are still writing off £475k?

Thanks

It a company lends 100 to another company, this shows up as an asset worth 100 on the lender's balance sheet, and as a liability worth 100 on the borrower's balance sheet (balancing the cash movement between the two). If the lender is a majority owner of the borrower, accounts are consolidated and so the liability comes back on the owner-lender's balance sheet, pro rata of ownership hence a net asset worth 49 (100 asset - 51 liability) for 51% ownership, reflecting the proportion the lender owes to itself.

The other loss is the 51% share in the subsidiary's negative results.

Thanks cig, that makes sense.

Bearing in mind the company said:

The loan of £425,000 that SpaceandPeople has provided to S&P+ will be written off as will approximately £50,000 of intercompany debts resulting in a one-off loss of approximately £275,000.

So where does the balance of the £200,000 written off show in the accounts. Does it only appear in the cashflow statement rather than the p&l?

Surely, whichever way you cut it, SAL had an asset of £425,000 plus £50,000 and now they don't.

etzanas

5th Jul '16

Maybe there is some equity left in S&P+, so SAL will recover part of the loan due by the other owners? Anyway, I find the answer from the CEO to Paul way too short. He would better go into the details instead of always finding things obvious. I have the feeling that he is not doing the detailed work, this is why there are so many surprises in this company.

Small Cap Value Report (1 Jul 2016) - SAL, QTX

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Paul Scott

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