Small Cap Value Report (Fri 29 Dec 2017) - SGI, Final Thoughts

Good afternoon!

As expected, there was very little news this morning of any substance. Almost none, in fact.

Fortunately, Stanley Gibbons (LON:SGI) has graced us with its interim results (at 11:07am), so that gives me something to look at.

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Stanley Gibbons (LON:SGI)

• Share price: 3.75p (-32%)
• No. of shares: 179 million
• Market cap: £7 million

Interim Results

This coin and stamp business now falls below our market cap limit.

There are a couple of interesting features in this announcement. The bottom line is that the shares are probably worthless. But we can still see what the company is doing to manage the situation and produce the best result it possibly can.

1) Cutting loose SG Guernsey.

This is the investments division, which was crippled by the offer to customers that it would buy back their stamps from them. That turned out to be something it could not do, while also remaining solvent.

SG Guernsey has huge potential liabilities of £54 million. These are contingent, so they weren't listed on the balance sheet.

Off-balance sheet financing often involves some unusual business or accounting practices. In this case, Stanley Gibbons was booking profits on its investment products while the potential liability to buy back the corresponding stamps associated with those products kept growing and growing.

The upshot of sending SG Guernsey into administration is that Stanley Gibbons Plc will now be queuing up to get its money back from its former subsidiary, along with the bank and customers. All of these will be unsecured creditors.

The footnotes include a pro forma balance sheet for the group as a whole, since this deal only happened in November (but the main financial statements record the position at the end of September).

The pro forma balance sheet, showing Stanly Gibbons without its investment division, is as follows:

• Non-current assets = £12 million
• Current assets = £30 million, of which £25.5 million is inventories
• Current liabilities = £29 million, of which £17.4 million  is borrowings
• Non-current liabilities = £7 million, mostly pension obligations.

This leaves net assets of £8 million. After such heavy losses and write-downs, it's remarkable that the NAV remains in positive territory. At its peak, in 2014, net assets reached as high as £84 million!

The problem is that the borrowings are repayable on demand, while the inventories are slow-moving and difficult to convert to cash.

This brings us to the next plank of Stanley Gibbons' short-term survival strategy.

2) Running down inventories

Both revenues and gross margin were lower in this six-month period. Revenues are down 4% to £16.6 million while gross margin falls by a massive 640 bps, from 46.5% to 40.1%, "due to the impact of continuing to run the business for cash generation".

This means accepting lower selling prices for inventory, just to get it out the door and convert it to cash. And then not replacing it with new inventory.

If you make it all the way down to footnote 6 in  the accounts, you find that operating cash flow received a £3.2 million boost from reducing inventories. For the prior 12-month period, the boost was some £10.7 million.

Inventory was over £70 million just a few years ago, so there is no doubt that great progress has been made in reducing it.

3) Taking its time to explore refinancing/restructuring options

Stanley Gibbons continues to rely on its bank not to demand immediate repayment of borrowings.

One of the covenants on the debt is that net assets must remain in excess of £20 million. There is no chance of this being achieved in the foreseeable future, without a very significant equity raise.

The only positive is that the company forecasts that it can remain within the limits of its existing facility at least until May 2018, when the facility expires.

According to Footnote 1, the Board believes that the company needs to refinance this debt and it needs an additional £5 million for growth and "to normalise working capital" - i.e. give it the breathing room which it needs to function properly.

The reason the shares crashed again today is as follows:

Whilst discussions with the bank remain constructive there is a risk that the quantum of debt which needs to be refinanced, together with the investment and working capital requirement  cannot be obtained within the current capital structure....As part of these discussions the Board will consider raising further equity or asset sales, however the Board is of the view that whilst alternative finance will be available it is likely to require restructuring of the current indebtedness as part of the solution. 

In other words, when the bank moves on in May, it may not be possible to find a new lender to replace that level of debt - £17 million.

As such, at least some of the debt will probably have to be converted to equity, perhaps alongside an equity raise with shareholders.

Converting debt to equity usually means that existing shareholders are left with very little or zero value.

And it's crucial to bear in mind that Stanley Gibbons is still loss-making, racking up another £3.5 million in losses in the latest 6-month period. Ongoing losses mean that more and more funds will be needed in the eventual restructuring.

So the shares should be marked to zero or as good as zero. They are nearly there at a £7 million market cap now, but still have a little bit more to go.

It's hard to fault present management, as they were handed an impossible situation. Hopefully, the new incarnation of this company will be better-run and worthy of investing in!

I should add that despite the company's difficulties, there isn't really any excuse for releasing the results after 11am on the last day of trading.

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Final Thoughts

Thank you for reading these Stockopedia reports in 2017. It has been a great pleasure for me to be involved and to team up with the legend that is Mr. Paul Scott. I have learned and continue to learn so much from his writing experience, his small-cap expertise and his boundless enthusiasm! I have also learned much from the wisdom of Ed, Ben and the rest of the fantastic crew here.

Additionally, we are blessed here to have some of the most sophisticated readers and commenters you will find anywhere, and I suppose that's particularly true in a UK context. We also, hopefully, write reports which novice and beginner investors alike can make full use of, when it comes to finding fresh ideas and exploring how to analyse stock ideas.

In terms of my own investing year in 2017, I'm satisfied. I still need to run the numbers, but I think I've done well. Volvere (LON:VLE), my largest holding, saw its share price increase by 66%. Burberry (LON:BRBY), my second-largest, is up 20% (plus dividends). H & T (LON:HAT), my third-largest, is up 28% (plus dividends, though I did sell over half of my stake during the year). These three shares together continue to account for 36% of of my portfolio (or 58%, if you exclude cash).

As previously discussed, I also hold shares in United Carpets (LON:UCG), IG Group (LON:IGG) and Next (LON:NXT). These six shares mentioned account for 86% of my portfolio, excluding cash.

Since I'm in the unusual position of planning to buy a house, I have a complication which many of you don't have: a short time horizon! This issue has seriously affected my risk tolerance and my willingness to accept illiquidity with any new positions in my portfolio.

I'll try not to go on at length about this, but it just goes to show that what's suitable for one person isn't necessarily suitable for another. My lower risk tolerance due to my circumstances motivated me to sell several of my legacy illiquid holdings this year, avoid opening any large new illiquid positions, and move into cash. If my circumstances or my psychology were different, my portfolio would be very different. There is no one-size-fits-all portfolio!

For the new year, I would like to very selectively open some new positions, in reasonably liquid stocks. If my conviction is strong enough in particular shares and I feel that there is enough time to get value out of doing so, then I will run down the cash balance. I haven't made a final decision on that yet. I look forward to discussing lots of these new ideas with you all in the months ahead.

In closing, I hope you've all enjoyed the holiday season and will enjoy the New Year celebrations, wherever you are. See you in 2018!

All the best,

Graham