Small Cap Value Report (Mon 26 July 2021) - SAG, CNIC, XLM, SUP, ATQT

Good morning, it's Paul & Jack here with the SCVR for Monday.

Timing - TBC

Explanatory notes -

A quick reminder that we don’t recommend any stocks. We aim to cover trading updates & results of the day and offer our opinions on them as possible candidates for further research if they interest you. Our opinions will sometimes turn out to be right, and sometimes wrong, because it's anybody's guess what direction market sentiment will take & nobody can predict the future with certainty.

We stick to companies that have issued news on the day, with market caps up to about £700m. We avoid the smallest, and most speculative companies, and also avoid a few specialist sectors (e.g. natural resources, pharma/biotech).

A key assumption is that readers DYOR (do your own research) - don't blame us if you buy something that doesn't work out. Reader comments are welcomed - please be civil, rational, and include the company name/ticker.

Agenda -

Paul's Section:

Science (LON:SAG) - decent H1 results out today, with profit about 4% ahead of recently raised guidance. Looks a very nice company, trading well, and still reasonably priced.

Supreme (LON:SUP) - This is an interesting recent float, with the high energy CEO with a 57% stake certainly coming across as an effective entrrepreneur, very much what I look for.

Attraqt (LON:ATQT) - Half year trading update. Seems to be slightly below expectations, which looks to be a little below breakeven. Not sure why it commands a valuation of £81m.

Sunday papers - a few interesting stories with relevance to investing caught my eye.

Jack's Section:

Centralnic (LON:CNIC) - revenue ahead of forecasts but profits to remain 'comfortably in line' due to ongoing investment. There have been a lot of acquisitions here, along with equity dilution, but the group is growing and its valuation is becoming more attractive.

Xlmedia (LON:XLM) - in line update. Casino vertical continues to suffer but registering growth in European and US sport. There's execution and integration risk in the turnaround strategy, as well as business model risk (responsible for previous setbacks in share price), so I'm happy to sit back and wait for more detailed results and management commentary.

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Paul’s Section

Science (LON:SAG)

420p (Friday’s close) - mkt cap £173m

Interim Results

Science Group is an international, science-led services and product development organisation with a significant freehold property asset base. Following the Frontier acquisition in 2019 and the natural evolution of the services operations, the Group now comprises three divisions: R&D Consultancy; Regulatory & Compliance; and Frontier Smart Technologies ('Frontier').

[Paul: extracted from final results statement, issued 9 March 2021]

We last looked at Science Group here on 12 July 2021, when it issued a positive trading update, with H1 guidance raised to >£40m revenues, and adj operating profit >£7m.

Today’s interim results are slightly ahead of guidance, with H1 revenues of £40.7m (up 10% on H1 LY, or up 16% at constant currency, quite a big difference).

H1 adj operating profit is £7.25m (up 48% vs H1 LY), and nearly 4% of previous recent guidance.

Adj basic EPS is up 51% at 13.3p. Double that for a full year (assuming no seasonality), and that’s 26.6p, a PER of 15.8 - doesn’t seem expensive, given the good track record.

Many thanks to Liberum’s analyst Janardan Menon, who’s crunched the numbers, and is forecasting 25.9p for FY 12/2021, very close to my simplistic doubling of the interim actual results. He points out that Frontier has been turned around, and is now profitable, since acquisition by SAG.

Freehold property - an unusual positive feature, today we are updated as follows -

Science Group owns two freehold properties, Harston Mill near Cambridge and Great Burgh in Epsom. The Group's triennial freehold property valuations were undertaken in March 2021. Despite the timing in the midst of the Covid pandemic, there were only minor changes to the valuations with a range between £23 million and £35 million, the latter being a sale & leaseback model. The properties are held on the balance sheet on a cost basis at £21.1 million (30 June 2020: £21.3 million).

Acquisitions - it sounds like more could be in the pipeline -

With a strong balance sheet including significant cash resources, the Board continues to explore both add-on acquisitions and larger opportunities to increase the scale of the Group...

Balance sheet - NAV is £44.9m, less intangible assets of £22.8m, results in NTAV of £22.1m - which looks fairly strong.

Note that the cash pile of £29.0m, is partially offset by £15.9m borrowings. Although we could allocate the borrowings against the £21.1m freehold property.

Cashflow statement - looks as I would expect it to, so nothing of concern.

Outlook - nothing specific that hasn’t already been covered above.

My opinion - we like Science Group here at the SCVR, and have reported positively on it several times already this year.

It’s trading well, and has sound finances, and the valuation looks reasonable (assuming that increased profitability is sustainable). Hence another thumbs up for this share. Stockopedia is also very positive, with a high StockRank of 92.

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Attraqt (LON:ATQT)

41p (down c.2%, at 11:09) - mkt cap £81m

I remember visiting this company shortly after it floated on AIM, in 2014 or 2015. I was struck by its swanky London high rise offices (which turned out to be free, as a favour from a friend), and having a chat about the business with the CEO. It sounded quite interesting, and was a plugin to eCommerce websites, which delivered better product selections when customers searched for something, resulting in higher conversion rates. It had some big name clients, but it struck me as a bit small & niche.

Since then, the share count has exploded, from c.22m, to 196m, and the financial performance has been poor - rising revenues, but losses every year, as you can see. It’s expanded by acquisition. Given this track record, there are clearly much more positive expectations built into the share price. Let’s take a fresh look.

Consideration shares - more shares have been issued, in an announcement this morning, to do with a technology transfer. So the share count is now 201.3m.

Trading Update -

Attraqt Group plc (AIM: ATQT), a leading provider of online search, merchandising and personalization solutions for ecommerce, is pleased to provide the following trading update covering the six-month period to 30 June 2021 (H1 FY21).

Financial performance for H1 was in line with management's expectations, with revenues of c.£11.1m delivered in the half.

Nothing is said about profitability though, although I suppose the above implies that profitability is in line with expectations, but it’s ambiguously worded. Although further down it seems to be saying performance is running a little behind full year expectations -

The ongoing pandemic related uncertainty has continued to result in the delay of some customer decisions, impacting new bookings and thus revenue outlook for the full year, which nevertheless remains broadly in line.

The StockReport is showing FY 12/2021 forecast of £23.8m revenues, and a small post-tax loss of £(0.2)m. That’s all I’ve got to work on, as no broker research is coming up on Research Tree.

Annual recurring revenues up 40% on last year, but it doesn’t say how much of that growth is organic, and how much from acquisitions. It talks about new contract wins, but without giving any context (size of deals, etc).

Diary date - late September, for interim results to 30th June.

My opinion - there’s more positive-sounding commentary in today’s update, but it’s too general to help me come to any conclusions on the numbers.

Overall then, the company has grown, seems to be operating just below breakeven, and is valued at £81m. That doesn’t make a lot of sense to me, so let’s move on. Mind you, technology company valuations generally don’t make a lot of sense to me. Valuations seem to be more based on multiples of revenue, rather than profits. I wouldn't invest on that basis myself, because it completely ignores profitability & cash generation. we're old fashioned here at the SCVR, we like profits.

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Sunday papers

Several very interesting articles caught my eye in the Sunday Times, which I thought might be interesting to discuss. Please don't post comments saying can't you discuss this somewhere else on a different thread, because that actually causes more disruption than the discussion itself!

“Virus infections halve in a week” - the most upbeat story on the pandemic that I’ve read for a while. A professor of medicine from the University of East Anglia is quoted saying that the drop in case numbers is “remarkable”. Although it warns the impact of so-called freedom day may not be fully in the numbers yet.

So I wonder if the recent market sell-off of re-opening type companies (hospitality, leisure & travel) might turn positive again? That looks to have already happened to some extent. The market really can’t make up its mind about what the most likely outcome is, and nobody knows, despite so many people having apparently certain & often strident views on this topic. The only honest answer, is that nobody really knows how this will pan out. However, I’m feeling a bit more confident about my positions in Revolution Bars (LON:RBG) (double jab requirement for entry directed by Govt from September? Why not do it now?), and Saga (LON:SAGA) which has been on a bizarre rollercoaster ride of late!

Another covid article in the News Review section tells the fascinating story of a Russian flu outbreak in 1890-1900, which came & went in waves, and apparently killed 125k people in the UK. I’ve heard of the 1918 Spanish flu, but not this one. The article argues that this time around in 2021, vaccines are greatly accelerating herd immunity, therefore covid-19 should rapidly turn into a relatively harmless disease, not requiring any further lockdowns. Let’s hope so.

The most important point in the article is some data about hospitalisations of people who have been double vaccinated in the UK: 29k people who had been double jabbed have tested positive in the UK for covid, and only 1,656 of those needed hospital treatment, only half of those needing an overnight stay in hospital (about 800 people).

Deaths in England of people who had received both jabs, are described as extremely low, at 224, of which only 4 have been under 50 (it’s not stated what other medical conditions they might have had).

Assuming that the S.Times data is accurate (no source is indicated), then this makes re-opening look sensible rather than reckless. It also strikes me that the doom laden tone of the TV news appears to have been wildly inaccurate in recent weeks, terrifying us with case numbers, but not mentioning that deaths of double vaccinated people have been extremely low. All deaths are a tragedy for a family of course, but we need to see this in the context of the enormous damage done to peoples’ lives by the lockdown measures. The damage to mental health in particular is enormous, and many people I know (including myself actually) have really struggled this year to keep our heads above water.

The reason I’m mentioning this, is not because I have any particular axe to grind, or any political stance on things, it’s more that the above leads me to believe the outlook for shares might be looking a lot better, particularly what’s been called the reopening trade. Hence I’m thinking about increasing some of my position sizes in shares that are likely to benefit from restrictions lifting, some of which came into buying range (i.e. fell in price to a more reasonable level) last week. A week or two I was very worried about the risk of yet another lockdown. That risk could now be easing? Maybe? We don't know for sure of course.

Everything could still change again, so I’m keeping an eye on the data and the newsflow.

Freight problems - some interesting short articles in the sunday papers about the cost & delays of shipping goods from the far east. Things seem to be getting worse, and it seems to me fairly likely that we’re heading for profit warnings in many sectors that rely on importing large amounts of bulky, low value items. $20k per container is talked about, if you can find one at all, and delays, as ships are re-routed to take advantage of more lucrative routes. Shipping companies must be coining it in, maybe that’s an area to look at investing in?

Loads of companies that we report on here are flagging up delays & increased cost of shipping, and raw materials. Where does it all end? Logically, demand and supply should eventually rebalance, but not before it could do some nasty damage to our portfolios maybe?

Let’s hope we see more on-shoring. I don’t think it’s a good idea to become so dependent on extended & vulnerable supply chains, particularly from a one-party dictatorship which is becoming increasingly hostile. As the CEO of Supreme (LON:SUP) pointed out in the video mentioned above, if the labour content is 10% or less (which can be achieved using automation), then it’s feasible to make things in the UK. It’s also worth thinking about the environmental damage of all these ships moving things around from high polluting countries, to consumer markets in the West. We’ve not only exported many jobs since the 1980s, but we’ve also exported the pollution, and made it worse by using huge, polluting container ships. Everything needs a re-think, if you ask me.

Finally, the other issue is the pingdemic, which has caused large numbers of people to self-isolate, and hence impacted their employers. This should be a fairly short-lived phenomenon, because so many people are now deleting the app apparently, and work arounds are being found (e.g. daily testing). But I reckon we could see some profit warnings from this issue too, at weaker companies where the CFO doesn’t have some fat on the balance sheet to use up when something bad happens (all good CFOs have a bottom drawer account, with some excess provisions squirelled away in a good year, to absorb any unexpected costs later, it’s just good financial management).

Overall then , I’m not expecting a smooth ride over the rest of 2021, but the longer term picture does seem to be more positive, possibly?

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Jack’s section

Centralnic (LON:CNIC)

Share price: 89p (pre-open)

Shares in issue: 251,160,084

Market cap: £223.5m

Centralnic is a domain name and web services provider focusing on the corporate market, with a 25-year track record in the space. The group has developed its own proprietary software platforms for the global distribution of domain names.

Revenue has grown at pace since listing in 2013.

This growth has been at least in part due to acquisitions however and it looks as though net income growth has failed to keep up.

Meanwhile shares in issue have consistently increased, so all in all this is not the kind of profile that typically catches my eye.

Centralnic has certainly been active though. It has annually doubled in size six out of the past seven years through a combination of organic growth, winning new clients, and by acquisitions.

Here’s a brief rundown of the company’s activity so far:

• December 2013 - acquired DomiNIC Software (Germany) - domain management platform used by Telcos and large corporations to manage sales of domain names,
• June 2014 - acquired Internet.bs (Bahamas) - a Top 20 global domain name registrar with customers in nearly 200 countries,
• September 2014 - acquired 10% Accent Media Ltd (UK)
• July 2015 - Acquired dnsXperts (Germany) - a German software development company specialising in domain name management platforms for Telcos and large corporations,
• January 2016 - Acquired Instra (Australia / New Zealand) - ICANN accredited registrar and supplier of associated services to small businesses and corporations,
• December 2017 - Acquired SK-NIC (Slovakia) - the domain name registry for the Slovakian domain extension .SK,
• August 2018 - Acquired KeyDrive (Luxembourg / Germany) - a global technology business and leading domain registrar which managed nearly 6 million domain names,
• September 2018 - Acquired GlobeHosting Inc. (USA)
• July 2019 - Acquired TPP Wholesale (Australia) - Australasia’s leading reseller platform,
• August 2019 - Acquired HEXONET (Germany / Canada) - a global market leader in services for thousands of reseller clients,
• August 2019 - Acquired Ideegeo (New Zealand)
• December 2019 - Acquired Team Internet (Germany) - operates the popular domain parking service ParkingCrew that monetizes more than 20 million domains,
• November 2020 - Acquired Codewise (Poland) - including the monetization platform ZeroPark, the online marketing software Voluum tracker and the associated Media Buying platform Voluum DSP,
• January 2021 - Acquired SafeBrands (France) - manages the domain portfolios of leading French and Swiss brands,
• February 2021 - Acquired Wando Internet Solutions (Germany) - online marketing firm.

Q2 trading update

The company expects to deliver revenue for the year well ahead of market expectations through our significant investment in resources, restructuring and new business, resulting in profits we expect to be comfortably in line with market expectations.

Following its ‘significant investment programme’, the group recorded $90m of revenue, representing a 63% increase of reported revenue and a record organic growth of c.25% during the three months ended 30 June 2021.

As a result, Centralnic expects to report revenue of c $174m and adjusted EBITDA of c $20m for the first half of 2021, reflecting growth across all business lines. This would be a 56% and 32% increase respectively over the $111.3m and $15.1m results for the same period last year.

That suggests full year results comfortably ahead of the forecast $312m of revenue, so it could be worth a closer look here in case broker forecasts are too conservative.

Cash increased to $39.5m from $28.7m as at 31 December 2020, whilst net debt was broadly the same at $84m (compared to $85m at 31 December 2020) despite $13m spent on the acquisitions of Safebrands and Wando and the final deferred consideration payment for Team Internet.

Adjusted operating cash conversion was well in excess of 100%.

Ben Crawford, CEO of CentralNic, said:

CentralNic has enjoyed a very strong second quarter across both our digital subscriptions products and our privacy enabled online marketing technologies - achieving record organic growth of 25%, following 16% organic growth for the first quarter 2021 and 9% for the full year 2020… As our investment levels plateau, we expect future periods to benefit from increasing operational leverage.

Conclusion

The public markets are littered with empire-building companies that have grown in scale, diluted shareholders over time, and ultimately destroyed value. That would be my concern here. The company has undoubtedly expanded, but has this benefitted equity owners?

But then, on the other hand, it looks like there is a fair chance of continuing to surprise to the upside given the gap between broker forecasts and the company’s own guidance. Talk of operational leverage is important. Is Centralnic at a point where ongoing expansion will see a rapid swing from net losses to profitability?

Through the recent years of losses, operational cash generation has been more robust - but then it spends a lot on capex, so free cash flow to shareholders has been depressed.

The group notes a ‘significant investment programme’ that will plateau. This should hopefully drive organic growth in future and should also see profits rise over the next couple of years as the programme winds down.

I’m neutral on the stock for now but this update suggests Centralnic warrants a closer look. There have been a lot of acquisitions here, so digging into those acquisitions and the capital allocation skills of the management team is required.

But trading momentum is strong and the price to sales ratio has fallen dramatically over time due to the static share price. Brokers forecast an uptick in profitability on what look to be prudent revenue estimates. So on valuation grounds it is far more interesting now than it has been in the past.

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Xlmedia (LON:XLM)

Share price: 54.1p (-0.73%)

Shares in issue: 262,586,405

Market cap: £142.1m

XLMedia is a global digital performance publisher, with verticals including online gambling, personal finance, sports and technology. It uses proprietary tools and methodologies to identify and target high value clients for platform operators.

Its informational websites earn commission payments by generating signups for advertisers. XLMedia was focused on the online gaming sector, but more than 100 of the firm’s casino sites were hit by a Google penalty early in 2020. It is re-focusing on North American sports as a result.

We can see the share price took a tumble in 2018, and again in 2019/20. Shares in issue are up since then, from 219m to 262.6m.

The group has an ambitious transformation strategy, which will enable it to ‘shape the future of the performance publishing industry’. It has two fundamental priorities:

1. Create a balanced portfolio of websites to cover a range of attractive geographies with greater exposure to regulated markets. This means North American sports, primarily through targeted acquisition.
2. Consolidate the online portfolio, concentrating on a much smaller number of publishing assets, and focusing its resources on optimising this core set of premium sites for its chosen markets.

XLM hopes that fewer, higher-quality websites focused on sports will enable it to build more enduring relationships with consumers.

Trading update

… The company therefore reaffirms guidance as previously stated on 27th May 2021 of revenue for full year 2021 of between $65m and $70m.

For the six months ended 30 June 2021, XLMedia expects to report :

• Revenue of approximately $32m (H1 2020: $27.7m), and
• EBITDA of approximately $2.9m (H1 2020: $3.5m) and Adjusted EBITDA of approximately $7.0m (H1 2020: $5.1m).

Adjusted EBITDA is defined as ‘EBITDA adjusted for Share Based Payments and Transformation costs’. There’s not much guidance in this update on exactly what will be included in transformation costs.

Cash balances at the end of June 2021 were approximately $38m (30 June 2020: $24.8m).

XLM notes the consistent performance in the Personal Finance vertical, record organic growth in the European Sport vertical, and a positive impact from the recently acquired US Sports vertical. Marketing initiatives across its US sports assets continue, with increased levels of traffic reported across all sites since their acquisition.

However, this progress is partially offset by Casino's performance, where tail revenues continue to deteriorate and new revenue is being built from a smaller existing asset base.

This continues the narrative from recent trading updates of good sports verticals and a weak casino. Management is accelerating the move to reorganise XLM by vertical markets. Increased visibility on the performance of these various verticals will be a positive step.

The workforce is to be reduced by up to 15% and XLM continues to evaluate acquisition opportunities.

Conclusion

Casino was 63% of FY20 revenue while Sports was just 22%, so it looks like further acquisitions and organic growth are required to fuel this turnaround.

There is business risk here as well in that small changes in algorithms from internet giants like Google can cause a lot of disruption.

It could all change quite quickly in this space and I have some reservations regarding the longer term durability of profits. For now at least it looks like good money can be made if the new management team can execute this shift towards the US sports market. The jettisoning of non-core sites to focus on fewer, higher quality assets sounds like a smart step.

The profits and cash generation at XLM have at times been eye-catching - but are they sustainable? This is an important consideration as the company has had setbacks before.

Furthermore, total assets of $92.2m on the balance sheet are dominated by $63.9m of goodwill. It could all work out, but there's a fair amount of risk here. In order to fund more acquisitions, we’ll likely need to see evidence of strong cash generation or additional placings.

Revenue should be up this year to between $65m-$70m but this is on the back of two recent acquisitions. It’s quite possible that the strategy will come good, but in my view there’s still a lot to prove and I’d prefer to wait for more detailed accounts (rather than relying on today’s measure of adjusted EBITDA before transformation costs, for example).