Small Cap Value Report (10 Jul 2015) - FCCN, RENE, ZTF, KBT
Good morning!
Thank you for all the responses to our first ever SCVR reader survey yesterday - it was an interesting exercise, so I'll do more of these in future. So {drum roll} here are the results (based on the first 100 responses):
Question 1 : Has the market crash in China affected your confidence in UK shares?
| Yes, a lot | Yes, a little | No |
| 0% | 17% | 83% |
So it looks as if SCVR readers have largely ignored the market gyrations in China's stock market. I think this makes sense - it has very little read across to the UK market, except for the resources sector, as one reader commented.
As alluded to in the fantastic picture above, which the Economist put out on Twitter today, and one reader here commented, "China is not a true market, on the way up & down".
Several readers here commented that they see the Chinese stock market as a domestic market, so regard its gyrations as being self-contained.
Note also since the Chinese Govt banned major shareholders from selling, there has been a spectacular rally in the last two days. This is very much the Chinese way - if a free market gives the wrong result, then rig the market until it does what you want it to do!
Question 2 : Is the Eurozone crisis re Greece affecting your confidence in UK shares?
| Yes, a lot | Yes, a little | No |
| 5% | 52% | 43% |
So clearly the Eurozone's problems are seen as much more of a risk to UK shares than problems in China. A significant level of concern is recorded by our readers here.
This poll is almost immediately out of date, as it looks as if overnight the Greek Govt has capitulated, and now seems ready to accept bail out reform terms from the Eurozone.
Reader comments seemed unconcerned about the impact on UK shares of Greece falling out of the Euro, but more worried about contagion (Spain, Italy, etc), and derivatives.
Several readers commented that it has dragged on so long, it's baked into prices already. Some readers also felt the UK was insulated from Eurozone problems to a large extent.
Question 3 : What is your view of the 2015 Budget - in terms of its overall impact on the country?
| Strongly positive | Mildly positive | Neutral | Mildly negative | Strongly negative |
| 23% | 57% | 13% | 5% | 2% |
Clearly our readers have given an overwhelmingly positive (80%) reaction to the Budget, which is interesting as it was a strange mixture of traditional right-wing, smaller state policies, but also interventionist stuff like the proposal to dramatically raise Minimum Wage for the over 25's by 2020.
Unfortunately I omitted to include a comments field for this question, so the voting numbers will have to speak for themselves.
Thanks again for taking part, I will use Google Forms next time, as that doesn't limit the responses to 100 before charging me a fee. The responses on Google Forms were very consistent with the above, so I haven't included them.
French Connection (LON:FCCN)
(I hold shares in this company)
Finance Director leaves - this doesn't look like a sacking, as the FD is moving on to a similar role at estate agents LSL Property Services (LON:LSL) . This looks to me like a move driven by career progression, as LSL is much bigger & more profitable than FCCN. Although the dominant shareholder/founder at FCCN is notorious for being "difficult", my sources in the rag trade tell me. This is the second FD he has lost in the last couple of years.
Cantors say, intriguingly this morning, that they believe this departure is the precursor to another reorganisation at FCCN.
My opinion - this is one of my slow burn shares. I think there is considerable value in the business, as the wholesale/international & licensing operations are highly profitable. This is negated by a heavily loss-making retailing operation. However, the retail leases only have, on average, about 4 years left to run, so the business should naturally become much more profitable as those problem leases expire.
Having looked up the rental on their flagship Oxford Street store, I reckon that store alone must be haemorraging cash, and could be responsible for a lot of the retail division's losses on its own. Yet it is opposite Selfridges, so there is the possibility FCCN could exit that lease at a profit eventually, who knows? Also note that it is very close to the new Bond Street crossrail station, which is likely to greatly shift the flow of footfall favourably towards FCCN's shop unit there.
I have no idea on the timescales here, but in my view there could be a decent payday for shareholders at some point in the next few years, and of course it will be an instant payday - there won't be any time to react to newsflow and buy the shares - so a case of having to be in it, to win it, I think.
There are obviously no guarantees the bull case will play out. It could just wither on the vine, and shareholders end up with very little, we don't know yet. The balance sheet is very strong still, and the founder will want to maximise his pension fund (i.e. his shares in the company), and life's work, so I'm quietly confident on the long term outlook for this share.
ReNeuron (LON:RENE)
Placing - this is not a value share by any stretch of the imagination, so I wouldn't normally comment on it. However, a large, £68.4m Placing has been announced, and it's noteworthy because Neil Woodford's firm (which already holds 26.2% of the company) is taking 650.75m shares at 5p in the Placing, so £32.5m, or nearly half of the total Placing.
This will take Woodford over the 30% threshold where you have to bid for the company, so they are seeking a whitewash to block the need for a compulsory takeover - shareholders need to agree this, and the Takeover Panel already have agreed it. I'm sure shareholders will be delighted that Woodford is giving the company such a big vote of confidence, so there's not likely to be any problem getting that vote through.
This fundraising is a good example of how things should be done for loss-making blue sky companies. Rather than raising money in dribs & drabs, and running the huge risk of the market not being receptive to another fundraising (Synety (LON:SNTY) and Tungsten (LON:TUNG) have demonstrated this point very well in the last year), instead RENE has gone for it, and raised multi-year financing in one go. This is absolutely the right strategy - don't embark on a blue sky strategy unless you have it funded to breakeven & a substantial safety margin built in too.
I wish we could get this point across to City advisers & brokers, so that they ensure all new market entrants are properly funded from day 1. There are far too many companies floated with inadequate funding, and no reserves for the inevitable delays & cost over-runs, and this needs to be addressed.
Of course, raising more money will also mean advisers generating more fees, so everyone really should all be singing from the same hymn sheet here!
Zotefoams (LON:ZTF)
Trading update - there's too much detail, but not a clear enough overview from this update. The company says sales for H1 (Jan-Jun 2015) will be up 8%, and that order books are "strong".
There are various comments about exchange rates and raw materials prices, but without having a detailed spreadsheet model of the business, it's not possible to understand how this fits together.
The conclusion should give a comment about how trading has been compared with market expectations, but it doesn't, we just get this rather woolly comment:
My opinion - I like this business, but it looks pricey on existing broker forecasts, so you would need to be very confident about future growth to justify paying up over 24 times for this year's forecast earnings.
Of course, if you believe that the company is likely to smash forecasts, then it might be cheap. The tone of today's statement doesn't sound as if they're above forecast though, so it's not for me at this price.
K3 Business Technology (LON:KBT)
Update - the company says "broadly in line" for y/e 30 Jun 2015, so slightly below. This is due to under-performance at their Dutch operation, and the weaker Euro having a negative impact.
Net debt has reduced to £12.1m.
I'll comment more when the results are published in mid-Sep 2015.
Right, I have to dash - another investor lunch to drive to!
Have a smashing weekend, and see you back here as usual on Monday morning.
Regards, Paul.
(of the companies mentioned today, Paul has a long position in FCCN and SNTY, and no short positions. A fund management company with which Paul is associated may also hold positions in companies mentioned.
NB. These reports are just Paul's personal opinions, and never financial advice or recommendations. It's up to you to DYOR, and we very much encourage that).
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23 comments
Market twitchy, eminent rise in rates,trouble in Europe. Big problem with illegal Immigrants, I think I will sit this one out until the big drop.
Just a quick comment on ReNeuron (LON:RENE). I agree; a large fundraising for a loss making share makes a lot of sense as it de-risks it in a large way. However; in reality this partly reflects a different risk appetite of UK institutions vs US. Until two years ago, ReNeuron (LON:RENE) was doing fundraises in dribs and drabs (£5m here, £m there). The board and brokers would have preferred a much larger raise but it required Invesco/Woodford and the Welsh government taking a stake before it could raise a sensible amount. They had wanted to raise much larger chunks of money previously, but couldn't get investor buy-in.
Before this institutions who don't really understand the science (same applies to tech) took part in placing (as far as I can see) to have skin in the game because they don't want to admit they missed out if it become a ten bagger. This means the people with deep pockets only put a toe into the water. What these sectors require IMHO are investors that really learn about the space and sector and can take a view on whether a medicine will work or if a technology, a) works and b) is ahead of the curve compared to what is being developed in Silicon Valley. Once you feel comfortable about the opportunity, only then can you throw millions of pounds at a company and say "go build and conquer". Until that happens, our companies will always be reliant on the odd handout from investors to keep the wolves at bay, which means it is hard for them to invest in the large way required to really make a success of technology or get through all the compliance and regulatory hurdles for a new medicine. I guess a question could be, should these shares be on the market until they get that large backer? But once they are quoted, unfortunately this is the way some of them have to survive.
A company which encourages mindless morons to walk about with FCUK spread across their chests would never have my support. Maybe it is just my age.
Thanks Paul as always. Superb coverage and honest analysis.
The surveys are however useless.
You get like minded people giving you their opinion, which in the best of cases are all biased and quite frankly irrelevant.
People read your (excellent) reports and probably have similar views to you... So a survey will only confirm what you think, not what the overall investor base believes. Good idea, but without value, to be honest.
Hi SingSing,
You're entitled to your opinion of course, but personally I found it useful to survey readers and find out that there was a lot more concern about Greece than I had realised amongst people who are interested in the same sort of shares as me.
Also, it was interesting to hear that there was very little concern about China - which is the opposite of the opinions of 3 investors with whom I had lunch yesterday, who were very concerned about China.
So, a useful exercise for me, sorry you didn't find it useful!
I like the interaction with readers too, so I'll do more surveys in future I think, on relevant & interesting topics.
Regards, Paul.
Hi Paul,
Do you think this maybe related to the Chinese stock market issues, or just coincidence. http://www.ft.com/cms/s/0/8e85675c-2648-11e5-bd83-71cb60e8f08c.html#axzz3fW5xWocZ
Could this impact UK small caps?
Thanks for your detailed response Paul.
I read your SCVR every day :)
Regarding French Connection
“To lose one Finance Director may be regarded as a misfortune; to lose two looks like carelessness.”
? to (mis)quote Oscar Wilde
Hi Paul,
Are French Connection (LON:FCCN) definitely intending to rid themselves of all unprofitable retail leases/?
Thanks
Hi JoeyDisco,
You asked;
"Are French Connection (LON:FCCN) definitely intending to rid themselves of all unprofitable retail leases/?"
Of course! All retailers ditch heavily loss-making shops, if they can. They might hang on to a slightly loss-making shop, and try to turn it around, but bottom line, if a shop is losing money hand over fist (which a lot of FCCN shops must be, as the overall figures for their retail division are so dire), then the retailer cannot wait to hand back the shop to the landlord, once the lease expires.
There will of course be a negotiation between landlord and tenant before the lease ends, whereby the retailer will say at what level of (reduced) rent they would sign a new lease. Quite often for secondary pitches, the landlord will compromise, and agree a lower rent, in order to keep the site occupied.
Also, retailers don't want to throw away all the sunk costs that they've spent on previously fitting out the shop, and don't want to lay off staff, etc. But bottom line, if a shop loses money, then a retailer will want to either turn it around, or hand back the shop to the landlord on lease expiry (or using a break clause, if there is one in the lease).
A third option is to assign the lease to another retailers, which if the rent is excessive, can be very costly - e.g. you might have to give another company (say) a rent-free period of a year or two, to persuade them to take on a lease. Also, the landlord can block a lease assignment if the assignee is a weak covenant - i.e. if their finances are weaker than the existing tenant, then the landlord won't agree to an assignment.
Unfortunately, the current system of rents fixed for 5-year periods, with upward-only rent reviews, on usually 15 year leases, is a system which often causes weaker retailers to go bust in hard times.
A fourth option for a struggling retailer is to do a pre-pack Administration, or a CVA arrangement. JJB Sports did (I think) at least two CVAs to offload loss-making shops, but in my experience these routes are usually just staving off the inevitable - keeping alive a retail format/brand which is past its own sell by date.
Interesting area though. FCCN are actually harmed by their own financial strength - so they can't offload poorly performing shops, because the landlords know they have plenty of cash, and are not likely to go bust, so are happy to keep FCCN as a tenant, and don't care that the shop is loss-making for FCCN. All the landlord wants is his rent each quarter!
Regards, Paul.
Very interesting discussion this morning. Simply put the West has no legs to stand on at all when it comes to manipulating markets. Institutions are made up of people and as long as people see an opportunity in OUR City to make a personal fortune how are they going to "learn the lesson". The lessons that have been learnt in the City is along the lines of what they can get away with rather than remorse or ethical. The removal of the CEO of Barclays was a clear declaration and of course they will deny it but in the end large bonus caps all and a CEO with the job of improving the moral stance of the business is no good to them.
Paul I do appreciate you putting your share analysis in a wider perspective as it is important. And I feel it is also important to tell things how it really is within Uk companies, stock exchanges and the finance industry surrounding them as there is so much complacency especially about issues such as lack of ethics ,corruption, insider dealing and high levels of pay that self interest constantly prevails upon to leave unchanged. There is such a circle of self interested gain among these institutions. Eventually if not dealt with trust will go and the exchanges may collapse along with all our share investments. It is really important to call as you (and other contributors here) do people within companies for how they treat their workers and any excess that takes place. I think you have called 2 shocking examples recently of the proposed share scheme at Vislink. And also the cut taken on the Open Offer at Torotrak at which has been less discussed. I think the greed shown by Charles Stanley and N and I SInger is also extraordinary. If a company is struggling to refinance and to stay afloat you would expect any company working with them to take less rather than more . I think Charles Stanley and N and I Singer are a disgrace. How can £1.3million be a justifiable fee for one deal raising £13.8 million. How many hours work did that take and how much was charged per hour. Disgusting! #greedybastards
In this connection I went to an excellent talk by the economist Stewart Lansley at the Conway Hall Ethical Society a couple of weeks ago on the impact of rising inequality leading to a Divided Britain. He has worked on this subject for a long time including a series called Breadline Britain and some well regarded surveys of low pay going back to the 1980s. He outlined that currently about 22% of UK workers were on low wages of minimum wage or less - up from 20% only a year ago. There is obviously no general consensus among all economists but he felt that the impact of this is to increasingly hold back economic growth. He gave some examples of how growth has been held back including percentages but I regrettably didnt take detailed notes. He also showed that over the same period the rich were getting much richer. His conclusion was that if not checked in time there will be a political response by the lower paid -not specified!. He also said that the trickle down theories are discredited and it does'nt happen! I havent read his books but would be worthwhile judging on his talk. The Tories obviously have now tinkered with this but I dont actually see much difference from the trends he identified happening as the amount of tax credits lost by many low waged workers will IMHO leave most in the same position as before.
The Chinese government's interventions in the Chinese stock market is strange to us who speak of a free economy. But it may well be that China is evolving into a new form of capitalism that will turn out superior to ours. A kind of big brother capitalism that might avoid the excesses that we suffer in the western economies. We do not have grounds to show our superiority in this respect. Just a thought
Fascinating article as always Paul. Didn't see your readers poll before so I haven't voted but it does make for interesting analysis. Just wonder if there's a question to ask regarding the US as well as Grexit and China? I keep hearing quite bullish sentiment from some commentators over the US economy, but you don't have to be a chart expert to know the S&P 500 chart looks pretty dodgy and has looked increasingly so for the last 6 months. Do other readers think if the Grexit problem subsides we'll see a boost in the US or is this the beginning of a bearish trend/correction? After all trends in the US are more likely to be a bigger factor for UK stocks than Greece IMO.
Thanks
James
Hi Paul -
If you didn't have skin in the game, would you be buying French Connection (LON:FCCN) today?
Regards, Ram
Hi Ram,
Yes I would buy French Connection (LON:FCCN) on the dips. They have stemmed the losses very well from previous years, and the Bal Sheet remains strong. So it stacks up still, for me. Although it's not one I would want to go all-in with, as the outcome is quite uncertain, and it's tying up money that could be used for other things, so I can see the bull & bear cases on it.
Other people may not agree though, and the last trading update was poor, so it's not a stock for most people.
Regards, Paul.
"Note also since the Chinese Govt banned major shareholders from selling, there has been a spectacular rally in the last two days. This is very much the Chinese way - if a free market gives the wrong result, then rig the market until it does what you want it to do!"
I had to laugh when I read this. If a free market gives the wrong result, then rig the market? We in the West are experts at this, for the last seven years Western Governments have been propping up the financial elite, markets, house and asset prices with a little trick called QE and any other financially creative interventionist measure they can think of. Perhaps the Chinese are less subtle and they don't have an electorate to worry about voting the wrong way, but "free" markets don't exist except in the dream world of the libertarian right. I mean, if the UK had been a free market in 2008 much of our banking system would have been bust making what is going on in Greece right now look like a tiny squabble by comparison. Heaven knows what would have happened in the US. In the West we like markets to be reasonably free when everything is on the up. On the way down they become less free as politicians fear the electorate response. I don't see this particular interventionist approach ever changing regardless of who gets elected.
Hi SevenPillars,
Haha, yes point taken!
However, I think there is quite a big difference between the West propping up a fractional reserve banking system (which had to be done, whether you like it or not) with State guarantees, QE, and all the rest of it, and the Chinese intervening in a stock market by banning people who want to sell from selling!
The moment you forcibly stop sellers from selling (China), then what you have is no longer a market.
I think that's very different from giving support to financially distressed sellers, so that they no longer need to sell.
Can you imagine if we want to transact online, and there was no sell button, just a buy button?!!!
Regards, Paul.
Paul, it's the banks that were propped up to save the system, that's what sticks in people's throats. They ought to have been nationalised without compensation as part of the saving of the system. The banks have not learned their lesson, you can be sure of that, and there will no doubt be more disasters caused directly by the banks in the future. The point made by SevenPillars is valid and there's a greater point still, that supposedly under capitalism bankruptcy is the price of failure but it just didn't happen because the cost of their failure was shunted on to the taxpayer. We in the West ought to be wary of feeling we have the right to lecture anyone.
Paul,
You must remember this?
The FSA was held by some observers to be weak and inactive in allowing irresponsible banking to precipitate the credit crunch which commenced in 2007, and which has involved the shrinking of the UK housing market, increasing unemployment (especially in the financial and building sectors), the public acquisition of Northern Rock in mid-February 2008, and the takeover of HBOS by Lloyds TSB. On 18 September 2008, the FSA announced a ban on short selling to reduce volatility in difficult markets lasting until 16 January 2009.
https://en.wikipedia.org/wiki/Financial_Services_Authority
A rally in banking shares lifted stock markets in the UK and the rest of Europe on Friday after several European countries introduced short-selling bans.
A row between national regulators erupted after France, Italy, Spain and Belgium imposed bans on the short-selling of financial stocks for 15 days after a week of turmoil in European financial markets. Britain, the Netherlands and Austria refused to follow suit, while Germany is pushing for a Europe-wide ban on naked short-selling of stocks, government bonds and credit default swaps.
http://www.theguardian.com/business/2011/aug/12/short-selling-uk-banks
The Securities and Exchange Commission issued a temporary ban on short sales of 799 financial stocks on Friday, a move against traders who have sought to profit from the financial crisis by betting against bank shares.
http://www.nytimes.com/2008/09/20/business/20sec.html?pagewanted=all&_r=0
China had to learn from someone. They are all playing a similar game of protection.
Short sellers got the blame in 1929 too.
SevenPillars - surely you can see the difference between banning SHORT sellers and banning SELLING ANY SHARES !!
You make a ridiculous comparison !
Of course the bank shares would rally if short selling was banned - other sellers would stop bailing out in the face of shorting pressure from big money, and others who had bailed out would start buying again.
That is completely different from not allowing anyone to sell AT ALL.
Hilarious !!!
Of course I can tell the difference. It's the principle of authorities intervening in what are supposed to be free markets, as I said they play a protection game once things turn a little nasty. China has simply taken it a stage further given the free-fall nature of the current panic selling. They hope for the same end result, that once the ban is lifted the panic will be over and things will have moved on. It seemed to work with the short selling ban in Western markets. Anyway, there is a certain democracy called Greece where no one can trade at all right now, stock market closed for the last two weeks. So China isn't exactly the worst example right now of intervention when the market turns sour.