Small Cap Value Report (14 Jan 2015) - TUNG, GMD

Good morning! Very busy today, lots to absorb & process!

Tungsten (LON:TUNG)

Share price: 237p
No. shares: 103.5m
Market Cap: £245.3m

Interim results - for the six months to 31 Oct 2014 are out this morning. Turnover rose from £0.8m last time to £10.2m this time. The operating loss rose from £5.5m to £14.5m. It's very rare for me to say this, but these figures are almost irrelevant. I say that because during this period Tungsten has been putting in place the building blocks for what could potentially be a spectacular business in a couple of years' time.

What the company has done to date, is to raise £160m in fresh cash from an IPO at 225p per share in Oct 2013. It then used that money to buy an e-invoicing software company, with many large cap clients. It also bought a small bank (yes, really!), and has developed a new invoice discounting service for the supplier base of its clients, whereby those suppliers can receive instant payment for invoices (once they have been approved online) for a small deduction.

The beauty of this is that it's invoice discounting that is seamlessly integrated within invoicing software - so there are no bits of paper flying around, it's all electronic. If the supplier needs cash, they can just press a button to receive instant payment for some or all of their invoices, providing the customer has approved the invoice. This also means there is effectively no credit risk to Tungsten. Or miniscule risk anyway.

The size of the opportunity is simply vast. Tungsten is already processing about $150bn invoices through its software. The invoice discounting has only recently started, on a small scale. However, they are targeting £1 trillion of invoice flow through the system, and 10% penetration for the invoice discounting. So you can do the maths. Tungsten sit in the middle and make an almost risk-free interest rate margin, for this short term lending, and it's all handled electronically.

I absolutely love this business model, and it's not pie in the sky, it's actually happening. The people are key too - normally this type of blue sky, grand scale project would hit the buffers, but in this case myself and other investors are putting our faith in Edi Truell's track record, and substantial personal investment in Tungsten - note that in Sep 2014 Truell bought about £1.8m of shares at 340p in a Placing of £12m. So this guy means business. He currently hodls 15.4m shares, or about £36.5m worth - more than a little skin in the game!

The shares have been volatile, but must admit I am astonished they can now be bought for only a little more than the IPO price, given how much has been achieved in the last year.

Cash seems OK, and if they need to raise a little more in another small Placing, I don't see any issues with that at all - as happened last time, it was done & dusted in 2 days with a few phone calls. There are big hitters backing this company, so top-up funding should not be a problem at all.

Expected value? - I've no idea what the share price will do in the short term (probably yoyo up & down a lot, as it has done in the past!), but I think there is a decent chance this could be a multibagger looking forward say 2-3 years. Probability of success? Who knows, I would say something like this, and this is just my opinion;

25% chance of a poor outcome - beset with problems, delays, etc, failure to reach critical mass, competitive pressures appear, etc. - shares lose say 75%

35% chance of a middling outcome - reasonable take up of the service, but takes longer than expected, and profits disappointing - shares end up largely unchanged, but probably with some nasty dips along the way.

40% chance of a very good outcome - Tungsten becomes highly profitable, and the shares 10-bag or more.

Cynics might say that I'm placing far too much reliance on the very bullish case panning out, but as things stand at the moment, this is my very broadbrush overview of the investment. There is a very strongly positive expected value on the above probabilities & outcomes, hence why I've made this about my 2nd or 3rd largest long position in the market. Of course history might show that I was wildly optimistic, but this is my current thinking.

Webinar today - I listened in to the 1 hour webinar held by the company today, and it provided the red meat about the scale of the opportunity here, which is somewhat lacking from today's results statement.

Click here to watch/listen to the recording of the webinar (thanks to Webpax for providing the link in the comments section below).

The CFO moving on was because he was a dealmaker type of CFO, and the deals have now been done, so they need a more hands on operational CFO going fowards. There's lots of useful detail in the webinar, so I hope they publish a recording of it online.

Perhaps most encouragingly, the company says that take up of invoicing discounting has been 9.9% so far, very close to target. Although I'm not sure to what extent suppliers are using it yet. Oh the big thing I forgot to mention, is that a recent deal has given Tungsten access to unpsecified $billions of financing from Insight, a leading global asset manager, to finance the invoice discounting arrangements. So it's fully funded & is being rolled out.

Tungsten also does invoice spend analytics, and other bells & whistles. Truell indicated that customers are reacting positively to the analytics software, and that a fee of 0.25% of invoices analysed will be charged in future, as free trials convert into proper contracts (which he says is happening).

Overall - we'll just have to wait and see. However, in my view, this is probably the most exciting blue sky-ish companies out there, because it's proven stuff (not really blue sky at all acutally). Plus the customer base for the invoice discounting is already in place - it's a captive supplier base of the large clients that Tungsten processes invoices for.

Nobody really knows what this company is worth currently, it's impossible to value at the moment. All you can do is value the opportunity, and then apply odds of how likely you think it is going to happen.

It's not value, and it's not even GARP, but this is a rare situation where I very much like a more speculative share on the fundamentals of its business model. More important than ever for this type of stock, for everyone to do their own research, and not rely on anyone else's enthusiasm, since this type of share can often go wrong, often badly wrong too. So huge risk warnings need to be at the forefront of our minds with this share.

Game Digital (LON:GMD)

Share price: 235p (down 32% today)
No. shares: 170.0m
Market Cap: £399.5m

Trading update - the company put out a profit warning last night at 5:10pm, which is an irregular move. I don't like that - some investors could easily miss that announcement (if they're not professionals), because people expect trading announcements at 7am each day.

Last night's update refers to competitive pressures, and lower margins, as they had to discount to maintain market share. That's the big problem with a homogenous product which you can buy anywhere, and it's why I wouldn't touch this company. Also, I object to companies re-floating so soon after going bust - it is cynical cashing-in from the people who buy up the good bits for next to nothing from the Administrator, whilst the unsecured creditors are shafted. That's the big problem with our current insolvency law, you see this happening time after time.

I'm not familiar with this company in its current guise, but it looks as if brokers were forecasting quite a big increase in profits compared with last year, which is not now happening.

My opinion - it's not a stock I would ever consider investing in, after the debacle last time, and a business model that looks doomed to long term failure, in my opinion.

Regards, Paul.

(of the companies mentioned today, Paul has a long position in TUNG, and no short positions. A fund management company with which Paul is associated may hold positions in companies mentioned)