Small Cap Value Report (7 Apr 2015) - SOM, GBG, FLYB, SNTY, ADT

7th Apr '15 by Paul Scott

48 comments 37299 reads

Good morning! It's good to be back, after the long weekend.

Cheshire investor evening

I'm still in Cheshire, visiting family, and have decided that it would be fun to do an investor evening up here, featuring a local listed company giving a presentation, drinks & networking, and a meal afterwards. So I'm trying to sound out potential interest. Therefore if you would be interested in coming to a Mello-type evening in Cheshire (I've found a venue not far from the M6, a large pub, with outstandingly good food, in Winsford (CW7 3AA), and have capacity for about 30 people.

If you would be interested in coming, pls let me know either by a comment below, or emailing me, or through Twitter. If there's enough interest, then I'll go ahead with it. People moan that everything is London-centric, so I thought it would be nice to do something a bit further north.

Somero Enterprises Inc (LON:SOM)

Share price: 121.5p (up 5% today)
No. shares: 56.2m
Market Cap: £68.3m

(at the time of writing, I have a long position in this company)

Final results - for calendar 2014. These figures look strikingly good. I've had my eye on this company for a while. It seems to be the market leader in making machines which level concrete floors, using high precision laser-guided technology. This creates extremely flat floors for warehouses & factories. I was a bit worried that the company's growth might not be sustainable, but the figures out today, together with strong outlook comments, have blown away those concerns.

Turnover rose 31.5% to $59.3m, and operating profit almost doubled, from $6.4m to $12.6m (note that the company reports in US$). As far as I can tell, the growth seems to be be all organic, which is very impressive.

As you can see from the table on the above right, sales in Russia and the M.East dropped sharply, but strong growth in all other regions offset those falls several times over.

Taxation - note that 2014 contained a one-off benefit from a negative tax charge, so this has inflated earnings, and hence needs to be adjusted out when valuing the company. The group charged tax of 16.6% to the P&L in 2013, and that reversed round to a tax credit of -17.3% in 2014.

Note also that the number of diluted shares has fallen a…

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Henry Walpole

9th Apr '15

Hi MacroVal

You say 'What is being sold here are telephone calls'. This is far from the whole story. Yes Synety (LON:SNTY) is a telco and as such can offer extremely competitive call rates but the company has stated that call rates are only going down and therefore this is not their main focus.

They are primarily providing software as a service and the software they have developed is very attractive and competitively priced in its target market.

The fact they are also a telco enables them to be very competitive in their market place. I have researched many of the competitors out there and although in many cases the headline subscription rates offered may undercut Synety (LON:SNTY) or even be 'free', when you factor in call costs, availability of support and levels of functionality then I believe Synety has a very strong offering.

Kind regards
Jon

MacroVal

10th Apr '15

I know when the conversation is becoming stale, and one's opinion is less welcome than it was before, so I'll keep this succinct.

How many members of the IASB know what a 'cloud computer' is?

It takes them 10 - 15 years to adjust a standard. The revenue and cost of goods IFRS/ IAS - I assume now IFRS 15 - was added to the agenda in 2002 - and issued in 2014!!

We we're still playing 'snake' on Nokia mobile phones in 2002 - by 2014 Facebook had taken over the world.

Synety's GROSS margin could move towards 100% as technology improves - that's because the accounting bods think they're still accounting for oil and banking.

Just because the costs are pushed further down the 'Statement of Consolidated Comprehensive Income' (or whatever it's called this week) inflating gross margins doesn't mean that this business is high margin. It means we're measuring the relative economic flow of value incorrectly.

Synety's is haemorrhaging cash. It's non profitable. It's margins aren't razor thin - I was wrong - they're non existent.

'Early stage' in the tech industry is the first 3 - 6 months maximum. Not 3 years down the line after going cap in hand to shareholders time and again.

And the final point to close on - since this company is so 'high margin' - why does it need to be listed? Why does it need my capital? Which of it's competitors are listed?

I can PERHAPS understand an initial fund raising - but servers, office space, etc etc are all rented. Reaching breakeven in these companies is easy in the first month - unless the company has over traded, bought plush offices, had big expense accounts, hired a receptionist, tried to impress shareholders and get RNSs out... and of course, we need to keep paying c. 100k salaries to the directors (Presumably so they can buy more Synety shares as a PR exercise).

Tech companies worth their salt are either self started, or some bright spark VC gives then the (tiny) amount of capital they need to pump prime them.

Ok rant over. Have a good day everyone.

portugull

Thank you Paul for your valuable opinion on Flybe. I would be very interested to know why Flybe are finding it so difficult to dispose of the surplus planes.

Do the planes only have a potential market in Europe?

cig

From stalking aviation forums, it seems the E195 is squeezed on all sides: smaller planes are more economic on the small plane routes (like FlyBe's), and on routes where it would be good, it gets too close to the capacity of the smallest single aisles workhorses (737 and A32x). They also sold very few of them (hundred something, vs thousands for the mainstream planes), so any airline using them would have to get their pilots certified for the type, specific maintenance contracts, etc, which is hard to justify when the Boeing and Airbus are ubiquitous with solid support. It would make a good add-on to an airline that already has a fleet but there's none in Europe I think and very few worldwide, and probably none of them need extra planes at the moment (or they would have taken them presumably). Can't even convert them to biz jet use as it's too big for a normal biz jet, and again too small if money no object, in which case you'd want something bigger so that your four poster bed fits in.

And it doesn't get better with time as the next gen E-jets are round the corner, and generally at some point previous generation planes are worth zero for airline use as with say 10-20% efficiency savings you repay the capital costs of a new plane pretty fast in fuel savings and it gets uneconomic to fly the old ones at all.

It would be interesting to know what the worst case scenario's cost is for FlyBe, if they have to pay the lease to maturity but only get the scrap aluminium price.

Thank you Cig. It sounds to me as if Flybe are going to have to think "outside the box" if they are going to do any sort of deal on these planes.

shauniekent

13th Apr '15

MacroVal – a couple of responses to some points you made on Synety (LON:SNTY) . FWIW you've raised some interesting points and made me think. I always want to hear the bear case. Always.

1, Margins aren't razor thin – I think you base this on the company never breaking even. I've created a cash flow model and I believe they will – but will be keeping a close eye on continued growth and on the cost base.

2. USP/defensive moat – I think the fact that they are now established, have the trust of existing clients and sell products that work and serve a useful purpose is enough. True it's not rocket science but a most businesses aren't. I see there are similar types of products out there but they don't look nearly as professional, functional or well developed –most are crm specific too. Synety do have an early mover advantage against anyone wanting to clone them - including the considerable money (and risk) spent on the path to breakeven (which is yet to be seen).

The point is, if they do reach break even, and growth continues at anywhere similar levels to the past 2 years, then the share price will be materially higher. I don't think a rerating will wait until that point (by my models mid 2016), it will happen in advance.

As an aside – Synety may yet fail to achieve breakeven with current resources, but communication from the company via RNS and otherwise is markedly different to other companies on AIM often touted as high growth and promising jam (the list is long but CAP, Coms etc etc). They are far more transparent and their actions (director purchases) seem to back up their promising words. This isn't something to base an investment on, but it does smell like an honest and well run company. My only doubt is that they previously said they had enough cash to break even. They didn't, and have raised more cash. They now say they have enough….which I now do not trust without doing my own analysis of cash flow.
Paul has already commented on very high customer retention and also the high take up of the product once a free trial has completed. This alone demonstrates the product is of value to customers.

3.Why is Synety listed? – good question. I think the answer is probably to raise the money needed to fund its growth (as we've seen). Paul, I and others here now believe they are fully funded to break even.

Synety does come with risk, but I don't believe it's the typical basket case you seem to be picturing.

Shaun (long SNTY)

Ah Synety

Well, I never try to present a bear case - just the facts as I see them.

One point that seems to have arisen a few times in other comments: That management now think they have enough money to meet their objectives.

In recent fundraising, they fell hugely short of targets?

So we are to assume mgmt. asked for far more than they required? How can they raise much less than they budgeted / applied for, and yet still have sufficient resources as they always intended?

And I have to circle back to ask - what are these funds for? Scaling these businesses is about more server space (rented) - that's it really. Product is built , designed and ready to replicate and ship - at near zero cost.

Checking their legal advisors website:

"The net proceeds of the Placing will be used primarily to continue to expand UK operations, including investing in the sales and marketing team and customer services departments"

It's salaries! They need shareholders funds to pay wages!

So the product is only saleable of its pushed by sales teams and supported by human beings. Try calling Microsoft to say that Windows isn't working.

MacroVal – completely agree money may be going largely towards salaries. But I’m comfortable with this as a large proportion of revenues are recurring. Client retention is very high. ARR is building quickly and once above breakeven point (by my forecasts mid 2016) all extra revenue drops to the bottom line. Operational gearing if they get there will be big.

Not by my model if they maintain ARR growth at 20% per quarter, and keep costs the same as last year, they will rech break even with 0.2m to spare.

Obviously costs could rise and growth could easily be higher than 20% (I chose this as a conservative forecast).
Shaun

14th Apr '15

It worries me that I just can't stop fining fault with everything that should be a positive about this company.

ARR - we need to be careful with what that means. It's not 'Annually Recurring Revenue' - it's "annualIZED Recurring Revenue"

Like most software providers, the vast majority of customers will be paying monthly (Do we have a breakdown of actual ANNUAL recurring revenue - the number of customers who are tie in for at least 1 year?).

Easy in, easy out. Let's say Synety have a bad month technically, a server fails. I've pointed out fungibility of this product in the past. In 3 months, this business can disappear as people very easily switch to Twilio, Calldrip, Callfire... the list goes on.

There's no loyalty in telephone calls - look at network providers for mobile phones. It's a race to bottom cost wise.

Breakeven will not be a Holy Grail - once that point is reached, that defensive moat becomes even more important. How long before it slips back out of breakeven? That's more marketing costs, more sales costs.

The recurring point I present to you - If this product is any good, people will use it.

If this product requires 'partnerships' with CRM firms, an army of salesmen and marketeers and a board of 5 directors on a hundred grand a year - it's probably not that great a product.

15th Apr '15

Your right on ARR. Ive factored that into my model. But i say Synety is commendable unlike many in that it doesnt accrue this future revenue.
I think you are over egging the idea of business/technology failure. They have business continuity plans in place but this type of risk is common to many companies.
Their product is not telephone calls.
Break even is the holy grail......as long as growth continue AND costs remain broadly same or less. This is what investors need to watch closely.
Finally, how many companies can sell their services without salesmen and marketing teams? Id say having sales teams is not at all unusual in a business. Key point as weve bother mentioned already is costs (and growth). Lets see what the next kpis and half yr results show.
Aimho Shaun

JollyBiologist

The directors' salaries do seem a bit on the high side. Cleaver raked in £227,000 last year, including a £73,000 bonus. How does this compare to other companies in a similar position? He might have "skin in the game" in the form of lots of shares, but he's still getting richly rewarded well before the company is making any money! I'm a holder, but that's certainly given me food for thought.

Hi MacroVal

Synety (LON:SNTY) recognise that re telephone calls 'It's a race to the bottom'. They are primarily a software as a service (SaaS) provider, the telephone calls are an additional source of income (circa 31% of gross profit) not the main focus. However because they are a telco they can compete very well in that space and still make a decent gross margin (circa 79%).

With all SaaS providers there is always significant upfront costs associated with acquiring customers. However what is important is that the churn is low and the lifetime value of the customer (LTV) relative to cost of acquisition (CAC) is sufficiently high.

Two industry accepted metrics for assessing whether SaaS companies are sustainable are:

LTV should be > 3 times CAC
Months to recover CAC should be < 12 months

If you look at the recent Investor Presentation on the Synety website the Months to recover CAC is around 4 months, significantly below the 12 months stated above.

Synety do not quote LTV although they state it is increasing. However even with a standard 12 month contract it would match the above metric of 3 times CAC.
Given that Synety advise their churn rates are very low and customers love the product it is likely that LTV significantly exceeds this.

Regarding your point 'If this product is any good, people will use it.' The product is good and people do use it but that does not obviate the need for sales people to introduce new customers to the product. Around 70% of free trials convert to paying customers which indicates to me the product must be pretty good.

Jon

Hi JollyBiologist

I agree Cleaver does appear to be doing quite well here however he has claimed that he has invested more in Synety (LON:SNTY) shares (£468k) than his total after tax remuneration since joining Synety (formerly Zenergy) in 2011.

Jon

Hi Jon,

Thanks for this. Very interesting. I'm still not sure how he justifies a bonus! But they do all seem to have belief in the product and the company.

Paul

16th Apr '15

The 3 best paid directors have spent roughly 25% of their post tax income (inc bonuses) on Synety shares in the last couple of months.

High salary or otherwise - that is a clear enough signal and shows strong confidence.

Shaun

Paul Scott

17th Apr '15

The Directors at Synety (LON:SNTY) are massively committed to making the company work, that has never been in any doubt. Where they went wrong (which they admit) is that they thought the stock market would be receptive to further funding rounds, on the back of strong KPIs.

What has actually happened, in that the bull market in small caps ended in Mar 2014, and the window for more cash slammed shut. They needed more money, came back for more, and it all got pretty ugly. So a fundraising which should have been easy at 150-160p ended up being a disaster at 90p. I think the broker deserves at least as much of the blame as management actually.

The KPIs have been pretty good whilst all this was going on.

Hence why I personally backed up the truck & filled my boots (to mix the metaphors!) at 90p. I'll lighten the load a bit on the next big share price rise (c. 150-200p), to de-risk things somewhat, but I think this stock is a lot more promising than some people think.

You always get people commenting negatively when the share price has slumped. I don't take any notice of that kind of market sentiment. It's all about DYOR and then reaping the rewards or the losses accordingly, from your own decisions. I'm not really interested in other peoples' views on this stock, as am happy that I know the company and the risk/reward as well as I'm ever going to. So it's now down to management to deliver.

Regards, Paul.

Personally I still can't tell if Synety directors are genuine or confidence tricksters. While I have doubts I can't invest, or look at KPIs (too easy to fake in the later case). You may very well be right they're genuine, but in the meantime the doubters may help explain the relatively low valuation. (Which reinforces the investment case should they be legit!)

Hi Cig,

Of course they are genuine, there's no question whatsoever about that.
The only issue is whether or not the business model will succeed. We don't know that bit yet!

Regards, Paul.

20th Apr '15

Wow @ cig - Well I wouldn't go so far as to suggest confidence tricksters - But the salaries here are far too high for jam tomorrow, when nothing is being produced. Again, all the development work - the capex - is already spent. Money coming out now is just to 'run' operations. That should be spent sparingly until success is more reasonably assumed - or at least until the company turns a profit.

Re: Paul on share price movement - to be clear on my comments - nothing I've said is in any way in relation to the share price - I couldn't even tell you what it was / had been at the time of my comments. It's about the company and the business model.

Looking now - Yes - Share price could probably cycle back up to 170 - 200p

But that doesn't change nature of underlying company :)

So this will probably be a good trade - my points have been about good corporate governance, appropriate use of RNS and not selling snake oil as something else.

Of course, that isn't to say that investors can't make good money investing in snake oil.

Small Cap Value Report (7 Apr 2015) - SOM, GBG, FLYB, SNTY, ADT

Cheshire investor evening

Somero Enterprises Inc (LON:SOM)

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Paul Scott

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