Small Cap Value Report (Mon 19 Mar 2018) - ACRL, MCRO

Hi, it's Paul here. Graham's busy, so I'll be writing Monday's report, at a leisurely pace, throughout the afternoon.

Today's biggest faller is;

Accrol Group (LON:ACRL)

Share price: 12p (down 57% today)
No. shares: 129.0m
Market cap: £15.5m

Trading update (profit warning) - I'm sorry to be the harbinger of doom, but this share is unravelling in much the same way that a faulty batch of its products (toilet rolls) might unravel, if a corner of the inner ply gets stuck, and you mistakenly rotate it many times, with the paper dividing into two different widths of single ply, neither of which is well suited to its original purpose, and have to be discarded. I've resisted the urge to write a more vulgar metaphor.

There was some Director selling recently, which looked like rats deserting a sinking ship.

This sounds absolutely horrendous to me;

As previously reported, the Group's trading performance in the current financial year has been significantly impacted by three major issues -
- an escalation in internal costs,
- input costs and
- adverse foreign exchange hedging.

The magnitude of the escalation in costs (circa 50% higher than in year ended 30 April 2017 ("FY17") has only, very recently, become fully apparent to the Board.

Also, the pace of progress in pricing actions to mitigate margin pressure has been slower than forecast but is now picking up pace.

The increased impact of these issues is expected to affect the performance of the Group materially in the year to 30 April 2018.

Some of the corrective, business critical remedial activities (outlined below) have been hampered while the Board transitioned to its new supportive composition.

The new management team believes firmly that the challenges facing the Group are resolvable, given time and experienced handling.

The successful resolution of these issues, however, will be a demanding task and one not without execution risk.

I don't know what to say. Other than, if you still hold this share, then you haven't read the above properly.

This has to be one of the worst outlook statements I've ever seen;

The magnitude of internal cost increases in 2017, combined with ongoing margin pressures, has impacted the Group's financial results and cash flow in the short term. As a consequence, the Group's profit outlook for the current financial year is now expected to be materially below market expectations with an expected adjusted EBITDA loss of circa £5 million.

Net debt, currently at £31 million, is also expected to be higher at the year-end than previously expected, despite a gross £18 million having been raised from shareholders in early December 2017.

The scale of the creditor stretch which had taken place prior to the fundraise was not apparent before new financial disciplines and processes were put in place by the new management team in Q4.

Of the net £17 million raise, over £10 million was paid out to creditors to reduce overdue balances and to reflect new terms of supply. In addition, further funds were absorbed by a recovery in inventory levels, cash costs incurred to break FX contracts, a reduced capacity for invoice discounting and further EBITDA losses.

Net debt at 30 April 2018 is expected to be circa £34 million, which is slightly higher than current levels due principally to working capital fluctuations.   Given the new EBITDA and debt expectations for FY18, the Group is likely to breach one of its banking covenants. Constructive discussions about debt headroom and resetting covenants have already been initiated with the Group's bank.

My opinion - I don't think there's any point in looking into more of the detail provided in today's announcement. It seems crystal clear to me that the equity here is worth nothing, and that the bank has got the bigger problem.

I reviewed the Admission Document here in Nov 2016, which helpfully spelled out all the things that were wrong with the company's business model - e.g. heavy concentration of sales with a small number of clients, advantageously-priced raw materials, vulnerability to depreciating sterling. It now also appears that management were totally incompetent.

Zeus Capital floated this crock. Most of the money raised was to pay off existing shareholders, who sold down a lot of their equity, and got their shareholder loans paid off. I really hope that shareholders take legal action against that lot, and recover some of their losses. If companies are allowed to cynically float on AIM, based on hitting a purple patch of unsustainable profits, and shareholders+promoters walk away with a ton of loot, with no redress when things go wrong, then the golden goose is going to keel over in the not-too-distant-future. Every bad flotation undermines investor appetite for subsequent flotations.

I don't believe for one minute that Accrol was hit by unforeseen bad luck. The basis for my view, is that the Admission Document specifically sets out the deep flaws in this company's business model. Did any of the fund managers that threw away their client funds on this share actually read the Admission Document? I do wonder.

Anyway, the company looks bust to me, so this share seems likely to go to zero.

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Micro Focus International (LON:MCRO)

It's not often that you see an £8bn market cap company more than halve in price in one day, but that's happened today. I've never researched this software company, but it's dropped from around £20 per share, to £8.82 per share, at the time of writing (13:03).

Guidance has been sharply lowered. I'm not sure if the reasons given for the CEO's resignation today were intended to be comical? You decide;

Chris Hsu has submitted his resignation in order to spend more time with his family and pursue another opportunity.  He will step down immediately as the CEO of the company.  

Reasons given for poor performance are;

1.   Issues relating to our new IT system implementation, which have impacted the efficiency of our sales teams, our ability to transact with partners and our cash collection;

2.   Higher attrition of sales personnel due to both integration and system related issues;

3.    Disruption of ex Hewlett Packard Enterprise global customer accounts as a result of the demerger of Hewlett Packard Enterprise; and

4.   Continued sales execution issues particularly in North America.

An IT group that can't implement a new IT system for itself ... doesn't sound great, does it?

Is it me, or do there seem to be more & more profit warnings, and general incompetence at the moment? It does make you wonder why parts of the market are so expensive, when there seems to be a lot of risk about?

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Rather flimsy, but there we go.

Good night all!

Regards, Paul.