Small Cap Value Report (28 Dec 2016) - BOO, LVD, FRP

Good morning!

It's just me reporting today & tomorrow. Then on Friday, Graham will cover anything interesting that crops up on the RNS.

I trust you've had a relaxing & enjoyable break over Christmas. I certainly have - although we always have some kind of drama at this time of year. Last year it was Mum having a heart attack and pneumonia. This year, she slipped down the stairs in the night, breaking one toe, and dislocated another. Thankfully A&E was quiet, and Leighton Hospital in Crewe did a marvellous job in patching her up on Boxing Day.

So instead of catching the remarkably quick train back to London today, as a dutiful son, I've hired a car to drive Mum back home to Bournemouth.

Apparently the roads aren't too busy, because people are not bothering so much with the High Street sales, but instead going online for their seasonal bargains. Thus continuing a long-term trend of business leaking away from the High Street to the internet. The only solution is for rents to come down, hence why I would not be investing in any property companies exposed to the High Street.

Also, I feel that only the best retailers are likely to be able to maintain, let alone increase, their earnings in the next few years. So there are plenty of value traps to avoid in the retailing sector - i.e. companies which appear cheap on historic earnings, but may end up expensive (or even bust) as business declines.

Boohoo.Com (LON:BOO)

Share price: 136p (up 2.9% today)
No. shares: 1,123.3m
Market cap: £1,527.7m

(I hold a small residual long position in this share, indirectly through a local share club of which I am a member)

This share is now way out of my small cap territory, but is a stock which many readers still hold, I understand. This stock has obviously been a huge success for us in 2015 and 2016, yet the share price continues to make new highs, on continued positive newsflow.

Today comes news of a proposed acquisition - of the brand & customer database of bankrupt American online fashion company, Nasty Gal. I'm not familiar with the process by which American bankrupt companies are sold off, but a brief overview is given in BooHoo's announcement today. It seems to be a 30 day auction process, with BooHoo having bid $20m as a "stalking horse". There's more information on the process here on Wikipedia.

Nasty Gal is a good example of how not to do internet retail. It seems to have racked up excessive costs, generated big losses, and clearly reached a point where financial backers refused to stump up any more cash.

BooHoo is wisely only seeking to buy the brand & customer list, but not take on any of the doomed company's bloated cost base;

Nasty Gal delivered net revenue of US$77.1 million in the year ended 1 February 2016. This includes revenue from vintage clothing and third party brands, which are excluded from the proposed transaction.

The Company made a net loss after tax of US$21.0 million after taking into consideration operating costs. The proposed transaction relates to the acquisition of intellectual property assets only and excludes all operating costs.

This is a great reminder of how internet fashion retailing is far from easy. Some people believe that, because there are no barriers to entry, then it must be easy to create & build an internet retailer. To a certain extent, that is true. The difficulty is not creating such a business, it's how to grow it to a meaningful size. That entails massive marketing expenditure, plus being good at everything - from product design & selection, inventory control, managing dispatch & customer returns of typically 30% of sales, new customer acquisition & retention, sourcing from factories all over the world, managing forex, maintaining & updating a complicated website, plus of course relentlessly declining selling prices.

Doing all of this whilst competing with hundreds of other market participants is very far from easy. Hence why personally I only invest in online retailers where management have a decent, sector-relevant, track record.

Incidentally, the founder of Nasty Gal, Sophia Amoruso, wrote a book (perhaps prematurely) called Girl Boss, extolling the virtues of being brazen & bossy in starting up her own business. I've got a copy of it at home, but have only thumbed a few pages, and didn't like the small amount I did read. Perhaps she should have waited for the business to become viable, before setting herself up as a mould-breaking business guru?

Anyway, it remains to be seen whether BooHoo actually will acquire the brand & customers of Nasty Gal. Another higher bid might emerge, we don't know yet. If BooHoo is the winner, I can foresee this turbocharging its progress in the USA - where BooHoo has already established a toehold with its existing brand.

The excitement, longer term, with BOO is that it could operate multiple brands, targeting various sectors of the market, and in many countries. So the growth potential is pretty much unlimited. That's one of the reasons the stock is so expensive now.

Well done to everyone who held on. I sold my BOO shares way too early, and have been kicking myself ever since!

Lavendon (LON:LVD)

Share price: 263.75p (up 2.4% today)
No. shares: 170.0m
Market cap: £448.4m

Higher recommended offer - this is a riveting situation, as two European companies (TVH and Loxam) are competing to outbid each other for Lavendon.

This morning comes news of a higher, 260p cash bid, which is recommended by Lavendon management, from Loxam.

TVH quickly retorted saying it is considering its options, urging Lavendon shareholders to take no action. So clearly there's at least a possibility of yet another higher offer from TVH.

Lavendon then reiterated that it recommends the Loxam offer at 260p.

My opinion - it's great to see that my articles throughout 2016, emphasising the obvious pricing anomaly of LVD shares, has been proven correct. However, as usual, I sold far too early, and threw away half of the potential gain.

So a pattern is emerging here - my articles are good at finding buying opportunities, but I'm hopeless at deciding when to sell. So in future, please completely ignore me when it comes to thinking about when to sell! (not that I ever give advice on that anyway - when to buy or sell is a decision that everyone has to make for themselves).

A key lesson from 2016, to be applied more rigorously in 2017, has to be "run the winners".

Fairpoint (LON:FRP) - (I hold a long position in this share) - CEO resigns - good, is all I can say. Chris Moat has made a total hash of running this company, so his position was untenable.

The Chairman & CFO will hold the fort whilst a new CEO is sought.

Personally, I averaged down on this one recently, because on balance I think the shares could at least partially recover. Although it's very much now a special situation. The cancellation of the unsustainable divis means that the shareholder base is now changing, with high yield investors presumably seeking to exit.

It's true that bank debt is a worry with this group. However, I doubt it will go bust, because there are large debtors on the balance sheet. So the bank would be best placed to continue supporting the company, and allow it time for an orderly wind down of the debtor book, thus using those cash inflows to repay a lot of the bank debt in due course (several years).

Also, we have the curse of Hargreave Hale here - they tend to unceremoniously dump shares in small caps which have under-performed. That's fine for them - because their portfolio is so diversified, it doesn't matter if one share does really badly. However, for everyone else on the shareholder list in that company, it's a nightmare, as HH trash the share price as they try to rapidly exit. They've done this with 3 companies I held this year - SAL, CRAW, and now FRP.

So in future, I'll be jumping out first thing, before HH, in any stocks which warn on profits where HH has a significant holding. This could also provide some nice trading opportunities - i.e. to open short positions in companies which warn on profit, where HH hold a position.

The other opportunity, is that when the share price eventually bottoms out, and HH are out, or almost out, then there's a strong possibility of a decent rebound.

So an institutional investor acting in a clumsy, and predictable way, does perhaps provide opportunities for the rest of us.

Also, from now on, I won't be regarding HH on the >3% list as being positive. I'll regard it as negative, as they create a nasty additional risk for me, of exaggerating downward moves on bad news.

All done for today, see you tomorrow!

Regards, Paul.

(usual disclaimers apply)