Small cap Value Report (Tue 3 Oct 2017) - RBG, SIV

Good morning, it's Paul here!

Many thanks to Graham for producing excellent reports last week & yesterday. This enabled me have a stress-free holiday in Dubrovnik, Croatia. What a beautiful, unspoiled place! If you haven't been, then I highly recommend it.

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Revolution Bars (LON:RBG)

Share price: 210.6p
No. shares: 50.0m
Market cap: £105.3m

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

Preliminary results - for the 52 weeks ended 1 Jul 2017.

This is a UK premium bars chain, with 2 formats, "Revolution", and "Revolucion de Cuba".

The figures are only really of passing interest, since an agreed 203p cash takeover bid from Stonegate (a fairly large, acquisitive pubs group) is now well-progressed. The share price has stuck at around 210p, so clearly the market is factoring in the possibility of a higher, competing bid. The only other player we know about currently, is nightclubs operator, Deltic. They have issued a number of RNSs, saying that the Stonegate bid undervalued Revolution (correct, it does - I think Revolution could be worth up to 300p/share if a number of rival bidders got involved - it stacks up on a EV/EBITA multiple at that level, once duplicated central costs are stipped out). So this is a situation where Revolution is worth more to a trade buyer, than to a financial buyer, such as private equity.

I've looked through its accounts, and Deltic does not look a particularly credible bidder - it doesn't have any money to make a cash bid. So it would need to raise cash from somewhere. It's possible that Deltic's shareholders might have deep pockets, independently of Deltic, who knows? Their announcements to date indicate perhaps not. They're pushing for a merger. I don't see there being any appetite for that. The market just dislikes bar groups - there's widespread indifference or distrust of them.

Note 1 outlines prior year adjustments made by the new FD. This reads like a catalogue of errors. It is now abundantly clear that RBG had a pretty hopeless finance department, which just wasn't up to the job - hence the profit warning in May, which was caused by poor budgeting. The new FD seems tons better. In a meeting with him earlier this year, he was clearly on top of the job & dealing with the issues. For me, there's definitely been an important lesson learned - 2 FDs leaving in fairly rapid succession is definitely a short term sell signal, no matter what excuses are given.

The cashflow statement is the best way to understand RBG. It generated £10.0m post-tax operating cashflow, which largely funded £12.8m in capex (the bulk of which related to new site openings). So, as I've mentioned before, this is a successful, self-funding roll-out. The key strength is that it is almost net debt free - net debt was only £3.2m at 1 Jul 2017. That's very unusual - most bars groups end up swamped in debt, and that's why they go bust so often in recessions. Building a differentiated bars group, using minimal debt, RBG is building a much stronger business. It also has a terrific multi-year pipeline of new sites - a lot of which are former HMV sites, which are in the process of planning applications. These new sites typically hit the ground running, and are highly profitable, with a great ROI.

Outlook comments are confident. This bit is intriguing!

Given the recommended cash offer for the business from Stonegate, it is likely that the ownership of the Company will change in the next few weeks.  However, such an event is not certain and, whatever the outcome of the potential transactions, the business is well placed to succeed.

Current trading is a bit softer, but still (just) positive on LFL basis. Gross margins have risen too, so profitability should be doing alright - despite cost pressures. The new FD has identified & is implementing £1-2m of cost savings which should offset other cost increases.

We have two strong brands that are trading well in a challenging market.  In the first quarter of the new period, like-for-like** sales are +0.3% and our first new opening this year in Belfast has achieved the best initial sales levels of all twelve openings in the last two years averaging £80k per full week since opening.

So clearly Belfast is the place to go, if you want to party! I seem to recall that most RBG sites do around £40k per week sales, so the Belfast site should be staggeringly profitable at double that.

My opinion - It's such a pity that (a) the stock market fails to grasp what a good business this is, and (b) an opportunistic bidder is going to grab the future upside for themselves, on the cheap.

It's possible (unlikely though) that Deltic might produce a sensible competing offer. However, I am still holding out some hope that a third party might pop up with a better competing approach. Although time is now very tight - because the Stonegate offer is going to a vote of RBG shareholders on 17 Oct 2017, and if successful, then the shares de-list on 23 Oct 2017.

So it's a straightforward choice now - bank 210p in cash by selling in the market now. Or hold out for 2 weeks, in the hope that a higher competing offer comes along. The downside is that you get paid 203p (the Stonegate bid now looks certain to go ahead, if no other offer is received). So this share is now really 203p in cash, plus a 7p call option on any possible upside from another bidder.

I feel disappointed and frustrated that the market chose to dismiss or ignore the many positives of this company. However, its own goal profit warning in May 2017 just reinforced negative prejudices, so at that point I suppose a trade sale was inevitable. Maybe RBG was too small to be a separately listed company? Anyway, it's a missed opportunity, but I suppose cashing out at a small profit, is a satisfactory outcome for what was, in May 2017, by far my heaviest loss on any position in quite some time.

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ST Ives (LON:SIV)

Share price: 78.5p (down 1.3% today)
No. shares: 142.8m
Market cap: £112.1m

Full year results - for the 52 weeks ended 28 Jul 2017.

I've never really understood what this business does, because they explain it so badly! I imagine that calling your business segments "Strategic marketing", and "Marketing activation" means absolutely nothing to most investors. I think it's much better to outline the main activities in plain english (e.g. we print & distribute chequebooks, and post out targeted mailshots), rather than invent fancy, but (to most people) meaningless titles.

I last looked at this company here on 10 Aug 2017, when I concluded that there could be grounds for optimism. Although the weak balance sheet remains an impediment for me.

I only have time to make a couple of key points on today's results;

Net debt - this has dropped very considerably, helped by property disposals. It was £54.6m at 28 Jul 2017, much improved from £80.8m a year ago. The narrative also mentions that further debt reduction is a priority - excellent stuff.

Dividends - have been slashed, to 1.95p for the full year, down from 7.8p last year. This seems to have been a planned move, as broker consensus shown on Stockopedia is for 2.0p divis. I see this as positive move - companies with weak balance sheets should not be paying generous divis.

Adj. EPS - down 24% to 13.39p. That ties in with the 10 Aug trading update, when consensus forecast was 12.9p. So not a good result compared with last year, but at least it's not getting any worse.

The problem seems to be legacy businesses, a term which is mentioned 7 times in today's results. The company says it is taking "decisive action" to remedy performance in those business. 

Outlook comments - 

Trading across our Strategic Marketing segment has recovered and we have been encouraged by the new projects being won from existing and new clients. Our pipeline for the first half of the new financial year is very encouraging and we are excited by the opportunities that the increased collaboration between our businesses is generating.

While trading conditions within our Marketing Activation segment continue to be very challenging, we have taken decisive action to increase efficiency and reduce costs, and remain focused on diversifying into other sectors. Similarly, within our Books business we have taken further steps to ensure that the cost base reflects the future level of volumes we now expect.

Overall, we remain confident in the long-term growth strategy currently being pursued in Strategic Marketing, and in the quality of our businesses within that segment, as illustrated by the major international clients and contracts they continue to attract. However, we recognise the need to address, decisively, the effect that the legacy businesses are having on the Group's overall performance and on our ability to generate value for shareholders. This, together with further strengthening of our balance sheet, remains a top priority for the Board looking forward. 

Balance sheet - this is always the clincher (negatively) for me with this share, making me steer clear of it. Whilst net debt has reduced a lot, gross debt is still too high, at £80.2m, which is partially offset by £25.7m in cash (maybe window-dressed for the year end, I wonder?)

Also I see there is £15.9m in deferred consideration sitting in current liabilities - if that's all payable in cash (not shares), then it's a big cash outflow in the next 12 months. Maybe that's why they're so keen to reduce the bank debt?

Pension deficit - requires overpayments of £3.8m this year, and £3.0m p.a. subsequently, so another hefty cash outflow.

My opinion - it looks cheap on a PER basis, but that's because there are legacy issues, a pension deficit, and too much debt.

I don't understand the businesses enough to be able to assess their prospects. So I think the crux with this share would be to do more research, and find out more about each constituent part. If legacy businesses are loss-making, but can be restructured easily into profitability, then that could provide nice upside? Or, if legacy businesses are withering away (which the term legacy does rather suggest) then these could be problematic liabilities.

Overall, there's too much uncertainty to make me want to look any further.

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I have to park things there for the moment, due to a trip to London, for a charity lunch tomorrow, being held at the House of Lords. If I'm feeling up to it, I'll write a couple more sections tonight, but am recovering from a nasty tummy bug, so might need to rest.

I see that results from SCS (LON:SCS) have been well received, with the share price up today.

Regards, Paul.