Small Cap Value Report (Mon 14 Aug 2017) - TCM, TRCS

14th Aug '17 by Paul Scott

44 comments 17427 reads

Good morning!

Thank you for the feedback last week, re timing of these reports. The consensus (of those who responded) seems to be that readers prefer us to take our time, and get it right, rather than rush for a deadline. I think the existing 1pm email deadline is a good compromise, so I've resolved to have early nights on school days, and get at least the bulk of my reports out by 1pm.

You've probably already realised that a conventional 9-5 work schedule never suited me. That's why I bowed to the inevitable, leaving full-time employment for the last time in 2002, to become self-employed.

Anyway, on to today's results & trading updates.

Telit Communications (LON:TCM)

Share price: 145p (up 17% at time of writing, but is volatile)
No. shares: 129.8m
Market cap: £188.2m

(at the time of writing, I hold a short position in this share)

Resignation of CEO, and Board to be reinforced - I'm not really meant to write about companies where I hold a short position. However, that rule was only introduced because Stockopedia lost some (idiot) subscribers, who objected to me ringing the alarm bells about Globo some time ago. So every now & then, I do flout this rule, because it's so important to discuss such a topical & controversial stock.

As I predicted, the allegations against the CEO (of having committed fraud in the USA, years ago, and fleeing the country) have been admitted to be true;

Oozi Cats, has resigned from the Board and his employment with immediate effect. The independent review has found that the evidence shows that an indictment was issued against Oozi Cats in the US and that this fact was knowingly withheld from advisers...

The Board's indignation that a fraudster failed to tell them that he was a fraudster, strikes me as quite comical;

...It is a source of considerable anger to the Board that the historical indictment against Oozi Cats was never disclosed to them or previous members of the Board and that they have only been made aware of its existence through third parties...

Surely the company, and its advisers should have checked the background of the former CEO, years ago? Isn't that their job, rather than Tom Winnifrith's (who was the whistleblower in this case,…

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runthejoules

14th Aug '17

Thanks for bringing that to my attention Crazycoops!

Trident

Yes I agree the missing analysis is arguably 'organic growth' i.e. core growth before acquired revenue.

I can only think that in contrast to their trading statement in early 2017 which talked about lengthening sales cycles, they feel they have at least met 'market expectations' despite these longer sales cycles. I suppose that shows some resilience if true, but begs the question of what is underperforming?

Looks like we are going to have to wait until November to have a clearer picture.

jonesj

Bobo, if you want to read one completed report, well log in at about 8:00pm every day.

If you consider the information to be not time sensitive, that should work fine.
If you do consider the information to be time sensitive, well then Paul & Graham are correct to post as soon as they are ready.

For what it's worth, comments show most readers are happy with the current style -flexible timing but with consistent high quality.

bobo

hi jonesj

With a very smiley face on.

I get an email, I don't log on to get the information.

Comments show that those who want "to offer an opinion" are happy. Those who don't either find the mismash disappointing and put up with it or wander away. We have no data on the growth or possible growth of this blog, so who knows.

As to alternative timing; well they send out the email. I just receive it. I have to admit I seldom bother to review the email as it changes on the website (who has enough life?), as you kind of say, it is time dependant and the time has gone.

I shall now return my focus to a very fine Burgundy.

:-)

Smiley off.

Ramridge

Hi John - Firstly let me say how refreshing it is to see a CEO take time out to reply in detail to PIs - the number of thumbs-up given to your post is ample proof of our appreciation.

I generally buy the argument that market forecasts are ultimately owned by the brokers, albeit that the base data comes from the company. So it would be inappropriate to show these in an interim statement. OK.

But I 'd like to come from a different direction to achieve the same purpose.

I have always maintained that the gold standard for market forecasts and guidance goes to Next (LON:NXT)

Here is an extract from their recent trading update

Now I appreciate that this is a £6bn market cap company, much larger than Tracsis. So the upper and lower ranges of your guidance would be wider.

In principle I do not see any reason why Tracsis or for that matter any AIM quoted company (bar the very small ones) cannot follow Next's lead.

Regards, Ram

Arturo82

RE: PURP

Whilst this has been a good investment so far, I believe that the wheels will start to come off the PURP story before long. The bottom line is, when you pay for an estate agency service up front, there is no real incentive for the company to actually sell your property. Reviews of the PURP service confirm that customer service/sales progression is very poor and there will probably be a big difference between properties under offer and completed sales. Also, the quality of the property particulars and photography that I have seen is generally below average. The PURP property "experts" probably lack the vital knowledge of the local market because they cover wide areas and the deferred payment/loan option is likely explained to potential customers in an opaque manner. Time will tell ...

GrahamF

The Sunday Times article on Purplebricks (LON:PURP) was mainly highlighting the sales of shares and options by people closely involved with the company, even the marketing officer of the Australian business. Their point seemed to be principally that sales by so many individuals with inside knowledge is puzzling.

Personally I find it somewhat difficult when to judge when a sale by an insider is a perfectly acceptable harvesting of profit for all the hard work and when to see it as a lack of faith in the future prospects for the share price.

(I hold no direct position; I have a small long position via collective investment)

Cleeve

15th Aug '17

Hi Paul

I think that the Sunday times revealed directors were selling shares ahead of Watchdog programme, essentially large sales shares and the question is why? I hold a small position as not sure the volatility is for me

alan martin

Re TCM. I've followed your lead and sold although I do believe this will come good in the end. Caution says wait and see how things go, as you have pointed out very well, rather too many iffs at the moment. Alan Martin

colinr

I am in favour of you talking about shares you have shorted as it is an additional check for me in case I have missed something bad about a company. Please keep this up if you can.

John McArthur

Trident,

I'm not sure I understand all the points you make but by way of response:

• With regards H1 v H2 splits I think you may be forgetting that our H1 results this year (and H2 last year) were boosted by the impact of SEP and on-trac which were acquired in Sept ’16 and Dec ’16 respectively.

• It is incorrect to say that our revenues are ‘broadly flat’. Last year Group revenue was £31.4M (or £32.6M if you include the revenue from the business in Australia we sold). Our recent trading statement indicates revenue ‘in excess of £34m’. I concede 8% isn’t stellar top line growth but from my viewpoint it’s a good result in an otherwise quiet year that was impacted by all sorts of macro factors that slowed customer spending (i.e. Brexit, the election, Network Rail status, no franchise bidding, etc). Also, for what it's worth, I should reiterate that Tracsis doesn't, and never will, blindly chase revenue for the sake of revenue – we are a highly profitable technology company and pride ourselves on profit/cash growth first and foremost.

• Yes, there are share based payments going through the business. Part of this is an employee share scheme and part of this is a very typical Directors scheme that is directly aligned with delivering shareholder value (EPS and TSR) over a 3 year vesting period. Where management don’t deliver this potential cost isn’t payable i.e. the options lapse in full. Likewise if staff leave early the options lapse. The accounting for this cost getting recycled back into the business confuses me to be honest but our CFO would be happy to walk you through it. Whatever the case, I think this ‘cost’ should absolutely be adjusted back for the purpose of measuring performance as it is a non-cash item that is only payable where investors/shareholders also benefit (I appreciate opinion varies on this subject but this seems due to the myriad companies that pay ludicrous bonuses and stock awards to executives that have no relationship to shareholder benefit).

Hope this is useful.

Regards
John

gsbmba99

Again, responding as best I can:

1) When we bought SEP and On-trac we did not assume that the status quo trading figures for these business would roll forward and indeed the market forecasts reflected this assumption and so too did the price/consideration we paid. All businesses obviously have relative ups/downs and trading purple patches and we are wise to this with on-trac having just had a particularly spectacular record year.

2) Also, and this is important to note, the numbers we have to quote in an RNS (that you state above for SEP and on-trac) are the Companies House reported numbers for revenue and profit. Trading figures for private companies are almost always distorted due to management paying dividends which are typically taken in lieu of salary. In other words, most/all private companies choose divvies over salary but when we buy them we need to adjust this back i.e. pay higher salary costs as the divvies are no longer payable. For On-trac and SEP this was a significant number.

3) Finally, as you may have heard me discuss in the past, I make no distinction between organic Vs acquired growth and neither should anyone else PROVIDED that shareholders aren't paying for M&A via dilution.

From my position as CEO, it makes no difference whether we spend say £5M on buying a company that delivers £Xm profit or spending £5M on R&D and delivering the same profit. The reason people discount M&A is that it usually involves a fundraise (i.e. equivalent dilution so no net gain to investors) and carries execution risk. With Tracsis all M&A growth is funded from retained profit and our execution thus far has been as good (or perhaps even better) than our ability to utilise cash for internal product development.

The ultimate proof of this is clear in our numbers. Over 10 years on AIM we've only raised £4M in equity capital, are currently debt free with a cash pile of c £15M and have bought 8 profitable businesses that are paid for in full. If you choose to ignore this you are overlooking one of our key reasons of success.

Cheers
John

Hi Ramridge,

I totally agree the Next format is much more transparent, and from my point of view I'd far rather include the forecasts so that any 'in line' or 'upgrade' statement can be evidenced back to hard numbers without question. Good companies will benefit from this and dodgy companies will get found out which I would love to see.

The problem with AIM is that most companies (I'm guessing >98%) only have the house broker writing on them so there is no such thing as consensus forecasts, or rather it is a consensus of 1! The house broker provides research to big institutions and high nets as part of the relationship with fees being paid so they will not want other people (such as Tracsis) quoting these openly in public statements.

Like I said previously, the market is definitely changing in this regard which can only be a good thing.

Cheers
John

Brilliant Leader

Fascinating to see this dilemma from a small company perspective John, thanks for sharing.

gsbmba99

John,

Thank you for taking the time to respond to my post.

Perhaps my post wasn't clear, but the quotes I included were from the Tracsis annual report for the year ending 31 July 2016. These numbers represent the contributions from SEP and On-trac to Tracsis under Tracsis ownership for the period they were owned in the year ended 31 July 2016 and management's estimate of the contribution had they been owned for the entire year from 1 August 2015. I presume these numbers would reflect whatever adjustments to executive pay you made after the acquisitions were completed. So, my point that "for SEP and On-trac together, full year inclusion should have benefitted revenue by £3.3m and pre-exceptional PBT by £0.8m excluding any growth" is, I believe, still valid.

In responding to Trident's post you said: "It is incorrect to say that our revenues are ‘broadly flat’. Last year Group revenue was £31.4M (or £32.6M if you include the revenue from the business in Australia we sold). Our recent trading statement indicates revenue ‘in excess of £34m’." If I combine the benefit of full year inclusion for SEP and On-trac of £3.3m to the £31.4m you cite for last year, that gets me to £34.7m as the starting point for this year excluding any growth in SEP, On-trac or the "core" business (excluding the acquistions).

Perhaps this is a philosophical point but I suspect that most people would agree. If full year inclusion of SEP and On-trac is the only reason that the statutory accounts for this year show a higher revenue number than last year, I wouldn't consider that "growth" because nothing actually "grew". You just included more months of SEP and On-trac this year than last year. The management narrative doesn't seem to reflect this.

The trading statement refers to "good trading experienced throughout all parts of the business". I still don't understand how this can be true if the starting point for revenue this year (pro forma for full year SEP and On-trac inclusion) was £31.4m + £3.3m = £34.7m and the business delivered "in excess of £34m".

I certainly acknowledge that the company has done an excellent job of acquiring and integrating businesses using internally generated cash. I also think that there are potentially interesting prospects going forward. I wouldn't be a shareholder unless I did. I accept that you will continue to buy businesses that fit well strategically. I hope to benefit as a result.

There's a great quote in the most recent annual report for Immunodiagnostic Systems Holdings (LON:IDH) attributed to Warren Buffett. "At Berkshire full reporting means giving you the information which we would wish you to give to us if our positions were reversed." The Immunodiagnostic Systems Holdings (LON:IDH) annual report is also worth reading as it gives a remarkably frank assessment of their business. Their shareholder communications, as a whole, offer a very clear picture of all the moving parts, what went up and what went down, and what worked and what didn't.

17th Aug '17

gsbmba99

My final comments if it helps:

- Yes, I appreciate the narrative relating to on-trac and SEP come from our annual report but the statement regarding profit contribution 'had they been acquired in August 2015' is something we are required to include to show annualised revenue and profit contribution (as was) but this was not a forecast on what they would contribute going forwards which is what you seem to be assuming. As mentioned previously, on-trac in particular had a record year prior to acquisition so rolling these profits forward is incorrect. This was made very clear in the market forecasts and from the consideration that was paid.

- Secondly, all revenue and profit streams (whether acquired or existing) still need to be maintained going forwards and this performance is not assured. When we come together with a new business there will often be areas of overlap with revenue/service/people/process cannibalisation. Often this is by design for the greater good i.e. we might choose to kill/reduce a service line in one part of the business to help grow prospects elsewhere. Therefore, measurement of 'M&A' versus 'pure organic' is imprecise and in my view largely irrelevant without understanding the detail.

- What matters is that a company moves the dial from one year to the next without the balance sheet getting weakened or with dilution to shareholders.

The simplest way to do this is look at absolute growth from point A to point B and then adjust back for share dilution, debt, etc. If growth is achieved it doesn't make a bean of difference whether this came via existing revenue streams or new ones.

If you disagree with this point of view (and some people do) then ask yourself this. If Tracsis had not done these deals but instead spent the same amount of time and money developing products and services that delivered the same numbers, would you consider this growth? If the answer is yes then why is this different?

- Finally, with regards providing transparency to shareholders I would like to think we already do this in spades. The detail relating to the above will be covered in the annual report but naturally not in a year end trading update. We are always happy to engage with shareholders - both institutional and private - and I often meet people in Leeds or London should they wish to find out more about our business. To this end if you would like to meet in person I'd welcome the opportunity.

Best regards
J

kokpond

31st Aug '17

TCM moved up more than 21% !?

Rusty2

http://www.stockopedia.com/share-prices/telit-communications-LON:TCM/news/rns/170831tcm3608p.htm/?title=telit-certifies-lte-cat-m1-with-att

In reply to Herbie47 #42 hi herbie47 Thanks very much for your information.It is my 2nd year with Stockopedia. I read quite a lot of your helful comments.It is the best place to learn.thanks again. Best regards. Kokpond

You are welcome.

Small Cap Value Report (Mon 14 Aug 2017) - TCM, TRCS

Telit Communications (LON:TCM)

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Paul Scott

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