Hunting For Compounders - Spectra Systems

23rd Oct '20 by Jack Brumby

33 comments 5426 reads

Spectra Systems (LON:SPSY) is a fascinating company but summarising its operations is a challenge. That’s because there’s just so much going on at this industrious, innovative small cap.

Maybe we can crowdsource some additional insight in the comments… I’m keen to see what people make of this one.

It’s been on the research list for a while - possibly as a future Investment Club pitch - but while I’ve been taking a closer look, the shares have gone up 10% or so this past week due to a promising contract announcement (covered below).

For those companies with substantial upside though, a 10% rise should be loose change in the grand scheme of things.

Spectra is a profitable, innovative, cash generative technology business with no debt, stable long-term income streams, and some fantastic growth opportunities. The high StockRank is no surprise:

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The group has pumped millions of pounds into research and development in order to get to its current position, and it has the proprietary tech and materials to show for it.

It also faces into some substantial markets for a £90m small cap:

Banknotes - over 150 billion banknotes manufactured annually vs. 45 billion banknotes with Spectra security features worldwide,
Global lotteries - estimated at over $300bn, per MarketWatch,
Tobacco manufacturing - Spectra TruBrand ™ materials on 6m packs of cigarettes in FY19, with billions more likely to come,
Keurig coffee machines - optical materials used in disposable coffee K-cups.

With all this activity and potential, if you take a step back then a 10% move doesn’t mean you’ve missed the boat.

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So let’s take the contract announcement and strong share price as a sign that we might be onto something here, and continue with the research…

What does it do?

Spectra’s core profit and cash engine is longer term contracts providing products and services to help authenticate and process banknotes.

It makes the fancy bits in banknotes and passports that shift and shimmer under the light among other things.

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Company accounts

That’s the simplified version, of course - there’s plenty more going on at Spectra. It’s clearly a smart, ambitious firm with its sights set on multiple ways of providing product quality and security services.

And you might think that banknotes are on the way out given the widespread adoption…

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FREng

23rd Oct '20

... and Spectra Systems (LON:SPSC) offer is currently 2p below Spectra Systems (LON:SPSY) bid.

Fishing

No problem with AJBell which is interesting as Barclays use AJBell!

Sully8786

24th Oct '20

Hi FREng,

Just wondering what the difference is between the two classes of shares? Is it a similar position to Schroders (LON:SDR) and Schroders (LON:SDRC) ?

Rob Swift

All set for strong growth over next five yrs. A good income stream will give the company plenty of scope for development. A strong management team in place, bodes well for the future.

gari en desti

Hi Freng. Can I ask, what is the difference between (LON:SPSC) & (LON:SPSY). I notice they are both listed in the UK, however, there are a couple of comments here saying the share price is in USD, but appears to be in GBP. I'm confused. thanks

timarr

The thing about Spectra Systems (LON:SPSY) is that you have to take their technology advantages on trust. I worked in the ID card / passport industry for a while and the security features that those rely on are kept secret - for obvious reasons. There are overt features, covert features and trick features, all designed to make counterfeiting difficult. Banknotes and asset protection features have similar properties.

They could be winning business because they have the best technology or the best pricing or the best contacts with central banks and governments or even the best supply channels. It's hellishly complex. In terms of valuation it's a black box which I wouldn't want to waste any time trying to unpick.

That said, the addressable market across all of the assets they could possibly help protect is huge. Against that, there's a lot of competition and as we can't assess their IP advantages it's difficult to make any kind of forecast or assess their moat, if they have one.

Anyway, I bought a few in the June dip and will continue to hold on financial progress. There's a possibility of a takeover too, although those are dependent on continued goodwill as maintaining relationships with central banks, regulators and government departments are critical.

Note that the Spectra Systems (LON:SPSC) line are US Regulation S restricted shares, which can't be held by US citizens, which goes back to the IPO I believe. They can be converted into Spectra Systems (LON:SPSY) which is more easily tradeable on request to the company. The last time I looked, back in June, there were only about half a million SPSC left in issue compared to over 45 million SPSY. Unless you have a very good reason the SPSY line is the one to buy due to liquidity.

racthompson

This company looks too good to be true. it's difficult to understand exactly what it does, and who are its competitors? It's a concern that AGMs appear to be inaccessible. The stock turn is extremely low.

mort1980

Jack,

What do you think the realistic Target Price is for you?

The chart looks uptrend, but the fact that Directors been selling recently is not a good sign, what do you think

abtan

Thank you for sharing this, it is much appreciated!

ajcajc

25th Oct '20

A great article, thanks - one to watch for me.

One quick question - is the information on customer concentration you've used available on Stockopedia?

Jeffvshepherd

Able to buy it through HL.

OldSchool05

Thank you Timarr.

Do you know who their main competitors would be please?
Regards

James

26th Oct '20

Hi James

Do you know who their main competitors would be please?

That's dependent on the exact sector - but if you're looking at banknote security features then the likes of G&D, Oberthur, De La Rue, Toppan can all supply them. It's a complex supply chain, and different players fit different parts of it some will produce the banknotes, some will provide security features, some will provide the authentication methods, etc, etc.

When you extend the range of solutions as Spectra Systems (LON:SPSY) have done into banknote cleaning, security features for other industries and even Internal Control Systems for lotteries it becomes more than usually impossible to analyse what the company is doing. On the plus side the contracts tend to be long, so there's a reasonable certainty of ongoing revenue.

Based on the financials they seem to be doing a good job, but I wouldn't want to waste my own time analysing any detail here. Way too complicated.

WarrantStar

27th Oct '20

I have tried buying Spectra Systems (LON:SPSY) in my ISA with Interactive Investor. But I can't because they think it's a US security and would need a W8BEN form. I have asked them to sort it out. So we'll see what happens.

pieRsquared

It would be interesting to know their thoughts / approaches to the likely advent of central bank digital currencies and whether they are deploying any R&D in that direction.

Rusty2

I can buy in my ISA but I need to fill a W8BEN form out for any US shares, this is to do with the dividend and witholding tax.

There's nothing in the public domain about Spectra having any interest in this area.

In any case CBDCs are unlikely to replace physical banknotes any faster than electronic payments and the range of options that Central Banks are considering are really varied, so it's probably wise to hold off spending money in this area at the moment. Most Central Banks seem to view them as a way of getting parachute money directly to citizens and businesses without having to rely on the banks to manage the process (which they do badly, in general).

But realistically there's not much overlap between physical banknote production / authentication and CBDCs which will be based on a mixture of blockchain and traditional payment technologies and probably mediated via the existing banking systems to ensure you don't get agency issues where everyone sticks their cash in the Central Bank as soon as a crisis looms.

The only real overlap is in terms of contacts at Central Banks - and possibly the relationships could be levered in this area. Possibly.

It's a fascinating area, but at the moment real-world CBDCs are years off and they're not likely to impact physical cash very much. And as the BoE points out there's nearly twice as much cash in circulation now than there was a decade ago:

https://www.bankofengland.co.u...

For Spectra's immediate future CBDCs aren't very relevant as far as I can tell.

28th Oct '20

Herbie Thank you for your reply. It looks like I can put Spectra Systems (LON:SPSY) in my ISA at Interactive Investor. But I won't be bothering due to the time I would have to waste on admin,

smilingmickey

29th Oct '20

Excellent article Jack. You expanded my knowledge re Spectra's activities! Please keep following this Company.

I have been following Spectra Systems for around 2 years holding the stock in an ii Isa. I completed a WBen80 form (via ii where I hold both an ISA and Trading Account) when I purchased Somero Enterprises (another US based stock listed in the UK) a while ago. One needs to renew (after 3 years?) but the procedure is not too challenging with the help of a knowledgable broker.

The Company has only become highly profitable in recent years following (IHMO) development of a considerable level of IP. It is led by a well qualified founder who leads a similarly well qualified small team of scientists who remain in close contact with former US University colleagues.

Information about their activities is hard to come by, maybe driven partly by their customers' wish to keep jointly developed technology under wraps, so if you are unhappy with this I would not bother to own the share.

It intrigues me that this year, Spectra put out 2 RNS advising news of their bidding for and losing out on a large contract because of failure to match the price of a competitor, who was offering a lower quality product!

The Company has been generating cash from its operations in recent years, pays an attractive well covered rising annual dividend and maintains a positive cash balance. Not great for ROCE but helps one sleep at night!

Martin VT

10th Feb '21

AJBell have got the WBEN80 thing sorted, it comes up pre-completed when you try to buy a US stock and took all of 10 seconds to complete and then allowed me to buy Spectra straightaway.

Hunting for compounders - Spectra Systems

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Jack Brumby

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