Small Cap Value Report (12 May 2016) - DRV, WSG, XLM
Good day!
This is a catch-up report, being written on Sun 15 May, as I missed one report last week, whilst on holiday in Abu Dhabi.
Firstly though, a profit warning from a building consultancy which warned on profits a couple of days earlier:
Driver (LON:DRV)
Share price: 46p (down 30% on the week)
No. shares: 31.1m
Market cap: £14.3m
Trading update (profit warning) - firstly, the company explains what it does:
Driver provides disputes, programme and project management and other consulting services to construction, engineering and industrial markets around the world
The group reminds investors what it has previously reported:
As previously reported, the delay of contracts in the AMEA region led to a significant softening of revenues in December, January and February. At the time of the AGM in March, bearing in mind the short term nature of much of the company's revenues, it had been assumed that much of the lost profit in those months would be recovered over the remainder of the year. March and April revenues were strong and the current workload / pipeline indicates that the Group will deliver revenues for the year ending 30 September 2016 at least in line with current market expectations.
Note the emphasis on revenues, and not profit! The above sounds reasonable though, so why have the shares fallen 30% this week?
However, following the appointment of a new CEO in March, Driver commenced a detailed review of all aspects of the business and the board taking into account the findings of the ongoing review believes that profit for the current year will be significantly short of market expectations. In addition, a review of the bad debt provision has led to a more prudent approach and an increase of an additional £460,000 has been implemented, primarily due to a small number of outstanding debts in the AMEA region.
This is an interesting example of how a change in CEO can often lead to the new incumbent "kitchen-sinking" the figures. Any skeletons in the cupboard are cleared out, conservative provisions made, and the new CEO then has a clean sheet to start with. Previous management can therefore be blamed for legacy issues, in the honeymoon period for new management.
Costs have been cut, which should help improve future profits (providing the costs taken out are unproductive overheads):
The business has addressed its cost base and this has resulted in the removal of costs totalling £2.4 million in a full year so as to better position itself for future profitable growth.
It doesn't say what exceptional costs have been incurred in this overhead reduction. Given that it's a people business, then I imagine there will be redundancy costs involved in making the above cuts.
Bank facilities - rather more concerning is the necessity to increase the group's overdraft, and it sounds as if this is not yet finalised:
Driver has agreed in principle an additional £2 million revolving on-demand credit facility with HSBC which will when finalised provide the Group with working capital flexibility.
My opinion - I've had a quick look at the last set of full year results, and the y/e 30 Sep 2015 was poor, with a loss incurred, after exceptionals.
Also, the balance sheet worries me, in that receivables stands out as being particularly large. I'm not keen on businesses which struggle to collect in cash, as a large receivables (i.e. debtors) figure can often contain disputed amounts.
This concern is confirmed by the need for an additional bad debt provision in the most recent trading update.
Overall then, it doesn't appeal to me, particularly with the banking situation looking uncertain at the moment. The risk is that another big write-off to receivables might be necessary at some point, which could trigger the need for an equity fundraising.
Westminster (LON:WSG)
Share price: 7.5p
No. shares: 69.6m
Market cap: £5.2m
Financing & trading update - this company seems amazingly accident-prone. I last reported on it last August, concluding that at 17p the shares were a perpetual under-performer, and wondering why on earth anyone would buy shares in a company like this?
Since then, the share price has more than halved, on continuing woes.
Worse still, the company now says it needs to raise more money:
While these delays have in part been offset by an improving performance of the Group's airport security operation, the Group will need to put in place additional financing in the near term.
The Board is currently exploring a number of potential financing options, which include directors' support and investment by strategic investors including a substantial strategic investment fund which is interested in joint venture arrangements relating to Westminster's aviation security business, Westminster Aviation Security Services Ltd (WASS).
Also, in order to provide additional financing flexibility and due to the Company's share price recently trading around or below its nominal share price of 10p, the Company is currently finalising plans for a capital reconstruction to reduce its nominal share capital to 1p. The Company will shortly issue a circular to shareholders with full details. The proposed change in nominal value will be subject to the passing of certain resolutions at a General Meeting.
That's not good.
Who knows what discount will be demanded by people putting in fresh funds?
My opinion - If I held this share, my inclination would be to get out, and await news of a fundraising having been completed. One can always buy back in later, of course. The danger is, with a serial under-performer like this, that new investors may demand terms which are brutal to existing holders, causing heavy dilution.
Existing small shareholders don't usually get a chance to participate in discounted fundraisings, so we're very much lambs to the slaughter in this type of situation.
Fundamentally, the key question is whether this is actually a viable business? It doesn't look like one to me.
XLMedia (LON:XLM)
Share price: 65.5p
No. shares: 200.4m
Market cap: £131.3m
Conclusion of strategic review & trading update - it seems strange to be doing a strategic review, considering XLM has only been listed on AIM for just over 2 years.
Looking back, the company effectively put itself up for sale here on 26 Jan 2016. Although that announcement included various other potential actions, an offer period commenced under the takeover code.
Anyway, it looks as if there wasn't any interest from potential buyers at a price premium, since the company now says:
XLMedia (AIM: XLM), a leading provider of digital performance marketing services, today announces that further to the initiation of a Strategic Review announced on 26 January 2016, the Board has concluded that the best way of maximising value for shareholders is by remaining listed in London as an independent company on AIM.
As regards current trading, everything sounds good:
XLMedia has maintained its excellent start to 2016 with strong demand for services reported across the Group's geographic footprint. The Group believes that the combination of scale and diversification will continue to support its growth. The Board confirms that during the first four months of the year, the Group continued to progress according to its plan in existing and new verticals. Furthermore, developments in technology continue to progress well and as planned. Therefore, the Board is pleased to report that current trading remains in line with management's expectations.
Valuation - there's no denying that this company has performed very well on fundamentals since listing. The shares look good value on PER, PEG, and divi yield bases.
However, there are big drawbacks which have tempered investor enthusiasm:
1) It's an Israeli company, listed on AIM. That puts off a lot of investors, who've been stung by overseas frauds & semi-frauds coming to AIM because it's effectively unregulated.
2) Concerns over the sustainability of earnings. Look how the ad-tech sector blew up last year.
3) The company itself has been coy about explaining where its profits actually come from, and (I am told) has refused to give any examples of the 2,000 websites which it operates to attract customers to other businesses.
My opinion - the profits & cashflow look genuine to me. However, as we found with Plus500 (LON:PLUS) another "too good to be true" Israeli company, there can be hidden problems with companies like this. That said, PLUS seems to have recovered well, and apparently got its house in order.
On the upside, there's no denying that Israeli companies are often highly innovative, and for such a small country, it has done disproportionately well in technology sectors. Also, I very much like that XLM pays divis. Plenty of companies fiddle the figures to show big profits, but don't pay meaningful divis. If the cashflow is real, then companies usually pay generous divis, as this company indeed does.
I can't find any current forecasts, but as the historic PER is 10, and trading is good, then we must be looking at a PER in high single digits. The cash pile is significant relative to the valuation also.
On the downside, note that the company seems to capitalise a lot into intangible assets, so that helps boost profits.
Overall, it's not for me. There are still too many amber flags around this company. Putting yourself up for sale, and having no takers, as has happened with the recent strategic review here, raises more questions than it answers.
Having said the above, I might be tempted to take a very small punt on this share at some point, as the price lowly valuation does seem to discount a lot of the issues.
The company's main activity seems to be driving traffic to gambling websites, and taking a share of the profits, as explained by the CEO in this video.
Disclaimer
This is not financial advice. Our content is intended to be used and must be used for information and education purposes only. Please read our disclaimer and terms and conditions to understand our obligations.
4 comments
XL Media still gets a significant amount of its income (41%) from the Nordic countries. The following comments were in the prospectus regarding these which suggest to me that they operate on the edge of the law in these areas.
" The Group’s primary markets are Finland, Sweden, Norway and, increasingly, the US, which is a key
target market for the Group. The Group previously operated in Turkey but has now ceased direct
operations there. Set out below is a summary of the position in each of these jurisdictions as well as:
Finland
Finland has laws in place that restrict gambling activities from within the country to the national
lottery operator. Although there are laws that seek to limit the marketing of gambling (which are
technologically neutral and so apply equally to offline and online marketing), they are not (and have
not been) enforced outside of Finland. It is not a criminal offence for Finnish customers to
participate in online gambling offered by operators outside of Finland and, therefore, while marketing
to such customers may be considered to infringe Finnish marketing laws, the risk of enforcement is
regarded as low.
The Group seeks to minimise its risk by conducting all its marketing activities with respect to Finnish
customers from outside of the jurisdiction. The laws in Finland have not been tested to date as to
whether or not conducting marketing activities from websites based outside of the jurisdiction (albeit
in the Finnish language) would be considered to fall within the prohibition against directing
marketing targeting Finnish customers but given the low risk of enforcement activity to date (both
against gambling operators, the more likely targets – and affiliate marketing companies) the Group
considers that its operations with respect to Finnish customers are not high risk.
Sweden
As with Finland, Sweden has in force laws that seek to restrict the provision of gambling services
only to companies based and licensed in Sweden and in turn, the only licensed operator is the
national monopoly operator, Svenska Spel. While enforcement action has been taken against
companies promoting foreign gambling operators (such as newspapers), the action has only been
against Swedish established businesses (which is determined by reference to the place of residence of a
business’ organisation and management as well as the residence of management, board members and
employees). The Directors are not aware of any enforcement action having been taken against either
gambling operators or marketing companies based outside of Sweden and there are restrictions under
Swedish law that prevent the Swedish authorities from doing so.
It is not a criminal offence for Swedish citizens to participate in online gambling products offered by
foreign operators. Nor is it an offence for Swedish operators such as Betsson and Unibet to be based
in Sweden provided that the servers making their gambling services available are based outside of
Sweden.
The Group considers that the enforcement risk for providing its marketing services targeting Swedish
customers is low.
Norway
Norway has a more restrictive regime than either Finland or Sweden as it seeks, in addition to
prohibitions against foreign operated gambling and marketing, to restrict the payment processing of
bets and wagers taken from Norwegian customers. Although the laws have been in place since 2010
this has seen little restriction on Norwegian customers placing bets and wagers and the Directors are
not aware of any enforcement action having been taken against operators outside of Norway.
24
c109234pu020 Proof 10: 17.3.14_09:49 B/L Revision: 0 Operator YouG
Although there are restrictions on marketing to Norwegian customers, these have not been enforced
outside of Norway. The Group bases all of its operations outside of Norway (albeit that it operates
using a Norwegian language website) and on the basis that the Norwegian authorities have
demonstrated no inclination to enforce the restrictions against non-Norwegian entities, the Directors
consider the risk of its Norwegian operations to be low.
The actions of the player in Norway are not criminalised, further evidence that the risk of marketing
to Norwegian customers is low."
Some time ago I tried to find examples of XLMedia's work and failed. I can only guess as to where they put their links . Any how, I'm not going to buy a pig in a poke no matter how good the figures look.
Interesting how the Driver results do seem to be isolated and haven't affected many others in a similar sector (such as Waterman) on the read across. It goes back to fundamentals as always.
You can however not ignore the Macro. I am convinced that if the Country votes Remain next month, we will see a bounce of confidence in these sectors. On the flip side, a Brexit vote could be very nasty for them.
I thought Driver was about dispute resolution in construction ?, so not related to Waterman, in fact arguably disputes occur more often when construction sector is in the toilet so Driver might be a very rough and ready hedge for $wtm holders!