Small Cap Value Report (9 Mar 2017) - TTR, STM, CMS, SHRE

Good morning!

Thanks for the suggestions today, I'll try to cover the three I was originally looking at (32Red (LON:TTR), Share (LON:SHRE) and Cineworld (LON:CINE) ) in addition to the comment requests.

Best regards

Graham

---

32Red (LON:TTR)

Share price: 194.5p (+0.3%)
No. shares: 85.3m
Market cap: £166m

Final Results

I'll keep this brief as it looks as if this will be delisting shortly.

PBT is up 511% to £6.5 million, and the new year is off to a good start with revenues up 20% in the first nine weeks.

So while the share price is at an all-time high, the forward earnings multiple is not too extraordinary. Brokers are forecasting further significant earnings increases out to 2018, so that the multiple could be reduced to almost as low as ten times PBT within the next few years, if targets are hit!

The Board cites the following factors in its recommendation, in addition to the premium against the prevailing share price:

the Offer representing an attractive valuation when considered against 32Red's historic earnings and prospects; ·      

the relative lack of liquidity in 32Red Shares and the fact that the Offer provides 32Red Shareholders with a certain opportunity to realise their investment in 32Red wholly for cash; and ·     

the level of irrevocable undertakings to accept (or procure the acceptance of) the Offer, representing, in aggregate 71.1 per cent. of the 32Red Shares.

1) seems reasonable, although some bulls might argue that, given the trading momentum and earnings forecasts, the valuation is closer to "fair" than "attractive".

2) is also reasonable, if most shareholders have a preference for liquidity. (I don't  personally care about liquidity very much, although I know that puts me in the minority!)

3) is important, because it means that it's almost certainly going ahead. Kindred Group (formerly known as Unibet) is a strong buyer and so I don't see how the deal could possibly fall through.

So the share price should reflect something which is very close to the risk-free discount rate over the length of time it will take to complete the deal, with just Unibet's credit risk attached to it.

On that basis I reckon the 195p offer price in the market today is quite fair.

---

STM (LON:STM)

Share price: 37p (-6%)
No. shares: 59.4m
Market cap: £22m

Budget Changes

STM has been affected by yesterday's budget and unfortunately, it strikes me as serious.

The company says that for individuals outside the EEA, with a UK pension, who wish to transfer to an overseas pension scheme (QROPS), they could suffer a 25% exit tax unless they transfer to a fund which is in they country they're residing in at the time.

Consequences:

This change is likely to have an impact on STM's ability to grow the number of QROPS policies it administers; however it is not anticipated that this tax change will impact the Group's existing QROPS business, which generated recurring revenue from annual management charges of approximately £8.4 million in 2016.  Overall, the Group's pension business represented approximately 50% of total revenue in 2016 (approximately £9 million) with annual recurring revenues representing over 90% of this figure.

Apparently, 80% of new QROPS business is outside the EEA, and therefore vulnerable to the proposed exit tax.

So that means something like 80% of 50% of STM's total business is affected, i.e.  up to 40% of the entire company.

While existing policies won't be affected, it might be very difficult to convince new customers to pay an exit tax, when they can simply avoid it by choosing some alternative.

The statement says it's possible that the SIPP side of the business will grow, but it strikes me that SIPPs are simple, fairy mainstream products which don't require a specialist like STM.

So I'm surprised the shares haven't fallen by more, unless I've missed something?

---

Communisis (LON:CMS)

Share price: 51.75p (-2%)
No. shares: 209.4m
Market cap: £108m

Preliminary Results

Good improvement in results here:

•     Adjusted earnings per share up 17% to 6.07p (2015 5.18p)

•     Adjusted profit before tax up 15% to £16.7m (2015 £14.5m) 

•     Free cash flow 7% higher at £12.9m (2015 £12.0m)

•     Net debt reduced by £9m to £30m (2015 £39m) 

•     Full year dividend per share increased by 10% to 2.42p (2015 2.20p)

Outlook: Trading is in line so far in 2017, and the Board "is looking forward to another positive year".

Balance sheet: Paul has written previously about the financial position at Communisis being somewhat questionable, and I again note the negative NTAV.

Something I value highly is a tidy balance sheet, and so regardless of the level of indebtedness, it does strike me that £330 million-odd is an awfully large amount of total assets for this business to be carrying, relative to profits and cash flow.

Within that figure, there is almost £60 million of loans & borrowings, and £55 million of pension deficit.

Net debt (subtracting cash) is a more manageable £30 million, and is down considerably from £39 million a year ago.

My opinion:

My main concern here wouldn't be the debt, it would be the sheer size of the balance sheet compared to profits. That goes hand in hand with a low operating margin of 4%-5%. If you want companies that are going to compound returns over time, you need them to be good at capital allocation and so on the basis of the size of the balance sheet, I wouldn't be terribly interested in investing here.

Having said that,I can see the importance of Communisis in the value it creates (managing client communications for major corporates). It's all about whether a cheap valuation can do enough to compensate for the weak margins and oversized asset base .

And there's no doubt that the PE is cheap (6.5x PBT) and the dividend yield is pretty good. So maybe if you have faith that the business is going to be in decent shape for the next few years and want to collect some dividends, an investment here could make sense?

---

Share (LON:SHRE)

Share price: 27.75p (+2%)
No. shares: 143.7m
Market cap: £40m

Preliminary Results

I've had half an eye on this company for a while now as a potential value opportunity, if/when interest rates start to rise.

Assets under administration are now a very impressive £3.7 billion - or nearly 100 times the market cap.

As is the case with Jarvis Securities (LON:JIM) and other such brokers, the fee income from activity/accounts needs to be considered separately from the interest income, which is close to zero in the current interest rate environment.

Non-interest revenue improved by 8% at Share Centre this year to reach £13.8 million, of which £7 million was commissions (i.e. from trading activity) and £6.8 million from fees (account charges and the like).

Share Centre positions itself in the market with "a simple low fixed-rate account administration fee", so while there are fee-free stockbroking accounts which beat it for value in this respect, it remains a more attractive choice than those which charge a percent of account size.

On the interest side of the equation:

Cash held on behalf of customers at 31 December 2016 was up 65% to £296m (31 December 2015: £179m). This was partly due to the acquisition of accounts but also reflected customers' inability to earn an interest return on their cash elsewhere. 

Interest income however reduced by 35% to £0.8m (2015: £1.3m), which reflected the decrease in interest rates by the Bank of England. In addition, a number of our counterparties, for regulatory reasons, are showing limited appetite to accept client money deposits and stopped paying interest. 

In "normal" circumstances, the spread which Share Centre could earn by lending out this £300 million cash pile would be a tremendous source of income. (The problem is that we don't know when normal circumstances will return, of course!)

They also repeat the warning that they believe their industry peers are using "higher risk counterparties" to earn higher rates. So perhaps there is an element of hidden risk in those companies.

Outlook

A "high degree of confidence" in the future.

On the assumption that market conditions and the government/regulatory backdrop remain supportive, we expect to see the benefits of our investment strategy start to flow through in increased revenue, underlying earnings and assets under administration, accelerated further if more partnership or acquisition opportunities materialise.

My opinion

Did I mention that Share Centre made an operating loss this year? Unfortunately they did, just as they made one last year. But as with last year, profits on their investment in London Stock Exchange (LON:LSE) shares turned the end result into a profit.

I'll probably keep this on my watchlist for the time being - it's the sort of stock I'd like to buy at the right price, so I'll wait to see whether the share price becomes more appetising or there are more concrete signs that the company's efforts are paying off in terms of the promised increases in earnings.

There are no balance sheet concerns whatsoever. I consider it fairly low-risk and would simply want to get a reasonable price on future earnings and dividends.

---

Apologies - I ran out of time at this point!

Regards

Graham