Small Cap Value Report (Wed 4 Mar 2020) - PHD, INTU, NANO, MPAC

Good morning, it's Paul here with the SCVR for Weds.

This is a placeholder post, to enable readers to add your comments from 7am. I'll be writing the main report throughout the morning, adding each section as it's written. Official finish time is 1pm each weekday.

Estimated timings today - I'm running a bit late, so will keep writing until 4pm.
Edit at 16:09 - today's report is now finished.

Let's start with the three biggest % fallers today, which are all struggling to find buyers or refinancing;

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Proactis Holdings (LON:PHD)

Share price: 32.5p (down 31%, at 10:26)
No. shares: 95.5m
Market cap: £31.0m

Conclusion of Formal Sale Process (FSP)

Proactis Holdings PLC ("Proactis", the "Group" or the "Company"), the global spend management solution provider, announces the conclusion of the formal sale process ("FSP") announced on 29 July 2019.

No firm proposals have been received. That's clearly bad news - I tend to stay away from any share where the company has conducted a lengthy sale process and nothing has come of it. What does that tell us? That potential buyers have had a look, and don't think much of it. There's no other possible conclusion, in my view.

I last reviewed its accounts here in Oct 2019, which I found very poor - in particular the weak balance sheet, loaded up with too much debt, from poor acquisition(s).

Today's update tries to sound positive, with some figures on new business wins. However, there is no clear statement about performance versus market expectations. It does say this though, which some people might think is positive (I don't, because it side-steps the key issue, of how they're trading versus market expectations)

As communicated within our recent trading update, we have delivered a significant improvement in new business and dramatically improved retention rates and we expect a return to revenue growth in the second half of this financial year. Our progress in the short-term has been encouraging and we are confident that the long-term prospects are significant."

My opinion - nothing's really changed. It's still an over-indebted software group, with patchy performance. The fact that nobody wants to buy it, confirms my negative view of this one. Maybe it might recover, who knows? There are some positive noises made today. The strategy of abandoning the sale process, and concentrating on cost-cutting, and driving sales up, sound sensible.

Given the wording used in today's update, I imagine that the risk is very much to the downside, as regards existing forecasts.

I'll have another look when the results come out, but this is likely to be a difficult year for many/most companies (as we discussed yesterday), so highly indebted companies like this are really best avoided in my view.

As you can see, the speculative takeover surge that started when it put itself up for sale in July 2019, has now evaporated completely;

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Intu Properties (LON:INTU)

Share price: 7.7p (down 28% today, at 11:51)
No. shares: 1,355.0m
Market cap: £104.3m

Update on strategy to fix the balance sheet

This is a large, complex business, which owns some of the best retail shopping centres in the UK.

The problem is that it has been overwhelmed by debt, with asset values reducing due to some of its tenants struggling to pay rents which are now unaffordable.

Today's update is blunt;

intu has, over the past several months, engaged in extensive discussions with its shareholders and potential new investors regarding a possible equity raise of between

£1 billion and £1.5 billion. Following these discussions intu has concluded it is unable to proceed with an equity raise at this point.

Therefore, I think we have to (continue to) work on the basis that existing equity is probably worth nothing.

Alternatives are being looked at, but this sounds to me like people wanting to cherry-pick the best bits, and probably at fire-sale prices now that coronavirus is likely to further hit retailers;

However, during this process, intu received several expressions of interest to explore alternative capital structures and asset disposals.

My opinion - reading through all the detail, it seems that the crunch point re covenants could come in July 2020.

The debt to assets ratio of 68% mentioned today (after a £2bn valuation markdown in 2019) doesn't sound so bad, if the banks were prepared to maintain support, and equity holders prepared to stump up more cash. The trouble is, that does anyone actually believe the valuations? With retail conditions getting worse each year, and more tenants going under, then it seems likely that more large asset write-downs are in the pipeline. Coronavirus couldn't have come at a worse time for intu.

It looks far too risky to catch this falling knife. I think we have to work on the basis that the most likely outcome would be for a refinancing that largely, or completely, wipes out existing equity.

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Nanoco (LON:NANO)

Share price: 13.45p (down 46% today, at 13:36)
No. shares: 286.2m
Market cap: £38.5m

Update on Formal Sale Process

This company makes tiny dots, which apparently can be used to make display monitors. It's a rather stale story, having been around for years, and not really getting very far, despite burning through a lot of cash.

Today it says -

On 20 December 2019, Nanoco announced that it had engaged with multiple interested parties as part of a formal sale process, as referred to in Note 2 on Rule 6 of the City Code on Takeovers and Mergers (the "Code"), and that certain of those parties were being invited to enter into further due diligence and detailed discussions about the sale of the Company.

Nanoco confirms that it has not to date received any firm proposals that, in light of the current market environment, it believes would lead to an offer for the Company from such parties and discussions with certain of them have now been terminated.

The Company is continuing to engage with a number of parties to establish whether they are prepared to make such a proposal.

Which doesn't sound very promising to me. Similar to Proactis above, it looks as if potential buyers have looked over the books, and walked away. Although in this case, there are still parties involved, but as time goes on the likelihood of a deal tends to reduce. Potential buyers have had 2 months to do their due diligence, so I think anyone with a serious interest would have expressed it by now.

Strategy update -

As announced in February, Nanoco is pursuing a patent infringement lawsuit against Samsung. In addition, the Board continues to review all the strategic options available to the Company as part of the Group's strategic review, including possible sources of additional funding for the Company which include some short term commercial opportunities, with contingency plans in place if needed.

That all sounds a little scary - an expensive lawsuit, and by the sounds of it, a need for more funding (discounted placing, possibly?).

I've had a look at the last published accounts FY 07/2019, and to be fair, the company does seem to have made some commercial progress. Revenues more than doubled to £7.123m, at very high gross margins of almost 91%, achieving £6.458m gross profit. Costs were still very high, so the loss before tax was £5.5m. On the basis of these numbers, if the company is able to increase revenues, and reduce costs, then profitability could be achieved.

Although the narrative talks about a single customer, and expiry date of end 2019, so more work would be needed to ascertain what future sales might be like?

The legal case against Samsung is obviously a worry. Maybe Samsung might bid for NANO, to shut down the problem? On the other hand, given that NANO's finances are weak, then it might not be able to continue funding the legal action, which being in USA, would presumably be very expensive. I wonder if they should contact Burford, to do a deal on funding for the case?!

My opinion - on a cursory glance, I was expecting to conclude that this would be a basket case. However, whilst clearly cash must be becoming a problem, if it's able to refinance again, then the shares might be worth a fun money punt. In current market conditions, it might struggle to not only find a buyer, but to refinance again. So it must be seen as high risk. Although speculative upside does seem possible. I haven't done enough research on it to be able to gauge risk:reward. It could go either way, so I'm neutral.

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Mpac (LON:MPAC)

Share price: 307.5p (up 1% today, at 11:45)
No. shares: 20.2m
Market cap: £62.1m

Full year results

I was bowled over by the trading update from this company a little while ago, here on 8 Jan 2020. The most striking thing was repeated, and very substantial upgrades to forecast earnings - tripling in one year! You don't see that very often. I've been looking forward to having a proper look at it, so today is my opportunity. This might take some time to prepare, so please bear with me.

Here are my notes from reviewing the results announcement -

• 2019 was clearly a very good year, as has been previously flagged by the company
• Revenues up 52% to £88.8m, of which 24% growth was organic
• Acquisition of Lambert is described as a "strategic milestone", in May 2019
• Healthcare-orientated customer base - sounds good, growing sectors
• Underlying EPS 39.5p (LY: 4.5p!) - adjustment for pension costs not necessarily justified, as it is an ongoing & repeat cost
• Statutory EPS 29.7p - more conservative measure that some people may be more comfortable with - which is still showing impressive growth
• Divis re-starting, with a modest 1.5p final divi - so not an income stock yet
• 2020 has started well, in line with expectations
• 2020 opening order book flat vs last year at £52.2m (not clear if this is LFL, or including Lambert) - possibly slightly disappointing? Has the growth surge paused for now I wonder?
• Coronavirus - currently doesn't expect delay to parts. China is small element of supply chain. But, could be knock on effect if other suppliers impacted by China.
• Huge pension schemes - £423.6m assets, £403.2m liabilities, on an accounting basis - technically a surplus, but since deficit overpayments are calculated on the actuarial numbers, then I would delete the £20.4m pension asset from the balance sheet. Investors here do need to properly understand the pension fund situation.
• Annual pension recovery payments of c.£3m - are material cash outflows, and help explain why divis are so small. Not to be ignored!
• Tax charge - NB note the P&L tax charge is negative at +£0.3m - this significantly boosts EPS, so needs to be adjusted to a normalised tax charge to properly value this share
• Balance sheet - overall looks fine, even after adjusting out the pension scheme asset, and intangible assets. Cash position is fine.

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My opinion - the figures look good. Although I think it's important to adjust the EPS figures down by normalising the tax charge, and possibly reversing back in some of the adjustments (especially pension fund related costs).

My big question, is how did the company achieve such a surge in performance, and is it sustainable? It could have been a one-off surge in orders, or it could be the beginning of a run of strong performance. I don't feel able to judge that, given no knowledge of the sector, nor its competitors. I think finding out about that should be the key focus of investors research. Remember that, when competitors find out how a company is achieving strong results, then they copy it!

Overall though, I think this looks interesting & worth a closer look.

If we're going into a global recession, which strikes me as likely due to coronavirus, then orders could be delayed, or dry up. Therefore, I'm not sure this is necessarily a good time to buy the shares. But it's on my watchlist for a possible purchase later on, when the situation becomes clearer re coronavirus.

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I have to leave it there for today. See you tomorrow.

Regards, Paul.