Small Cap Value Report (14 Mar 2014) - FUTR, SOG, TAN, CAP

Good morning! Slightly late today, so I pressed "snooze" a few times.

I have to mention today's IPO of BooHoo.com. The ticker is BOO, and that also describes the impact the shares had when they burst onto the market today! The valuation looked eye-watering at 50p per share, which valued this online fashion retailer at £560m. Of the £300m raised in the Placing organised by Zeus Capital, £240m is being withdrawn by the existing owners, and £50m ie being retained by the company to buy the freehold of its warehouse, and finance further expansion.

The shares are currently 75p, just over one hour into their life on the market, so that now takes the market cap to £840m, which is nearly as much as the value of Debenhams (£966m mkt cap at 77p per share)! Looking through the AIM Admission Document on their website, 2013 results shown are for 10 months to 31 Dec 2013, and show turnover of £92m and operating profit of £9m. So it's a proper business, and showing strong growth, with international expansion planned. But £840m market cap already?!! That's paying up-front for many years' expansion that has't yet been done.

I suppose investors are looking at this as the next ASOS, so are throwing valuation out of the window. All very reminiscent of the 1999 tech shares boom, although at least the companies now achieving sky-high valuations are mostly profitable. In my view, by far the cheapest way to buy successful online retailers, is to buy shares like Tesco or Debenhams, which have online operations that dwarf many of the fashionable dot.com shares.

 

 

 

Future (LON:FUTR)

Last time I reported on this publisher of magazines, was when they warned on profit on 18 Jul 2013.

They've done it again today, with another profit warning today. The shares are down 23% to 10p at the time of writing. With about 333.6m shares in issue, that makes the market cap currently £33.4m.

The key part of today's profit warning says;

 

Following our update to the market on 3 February, the downturn in trading we saw in the latter part of the first quarter has continued in January and February. This has led the Board to conclude that the EBITDAE out-turn for the full year is anticipated to be below normalised FY13 and therefore significantly below market forecasts for FY14.

 

Stockopedia shows consensus broker forecast at 0.91p EPS for 2014, so being "significantly below" that must mean at least 10% below, and probably nearer to 30% maybe? So to be on the safe side we should probably be thinking about EPS of around 0.6p for this year.

They have already embarked on cost cutting, so that might give scope for earnings to recover in future? It is also likely to incur exceptional costs I would imagine.

Actually, I've been looking back at the last set of results, for the year ended 30 Sep 2013, and normalised EPS was 0.6p then. So as this year is likely to be below that figure, as stated in today's update, then we might be looking at 0.5p EPS or even lower for this year? That would put the shares on a current year PER of perhaps 20? So the 25% drop in share price today might not be enough to price the shares prudently perhaps?

The problem with this company, and the reason I won't be investing, is that it has a very weak Balance Sheet. Net assets were last reported (at 30 Sep 2013) at £67.4m, but that includes £86.3m of Goodwill (which arises when acquisitions of other companies are done, Goodwill is the accounting book entry that shows the premium over net asset value paid at the time of the acquisition. It has no resale value as such, so in my view should always be written off to nil).

With £3.5m in other intangible assets also to be written off, this brings net tangible asset value to a significant negative figure of £22.4m. That makes it uninvestable to me - I never invest in companies with negative net tangible assets, unless there is a very compelling reason to break that rule (nothing should be set in stone).

I also find their working capital position to be weak. Current assets were £28.3m, with current liabilities of £44.2m, so that leaves a yawning deficit there, where I would normally like to see a surplus. A further £9.4m in long term liabilities is also owed to creditors. A £5.2m Corporation Tax liability suddenly appeared in 2013, which struck me as odd, because the company did not make anywhere near enough profit to have triggered such a large tax bill. Doing a little digging, note 5 to the accounts reveals the following rather unpleasant information;

 

During the year the Group reached agreement with HMRC relating to the tax treatment of certain one off transactions which took place in 2003. Part of that agreement will result in the Group paying tax of £6.2m plus interest (comprising instalments of £85,000 per month over five years from July 2013 and a final instalment of £2m). The tax payable was fully provided for in prior year accounts. The liability in the balance sheet has been split based on this agreement between current liabilities and non-current liabilities.

 

So whilst it was already provided for, this is a nasty cash outflow over the next five years, and that is money that could otherwise be paid in dividends, so it should be factored into the valuation.

I've seen enough here to have realised that for me, this is a baregpole job. There are too many negatives, so risk:reward looks unfavourable to me.

 

 

 

 

StatPro (LON:SOG)

Every now and then I get a call or email from companies, or their broker or PR company, saying that they didn't like something in my morning reports here. I value good relationships with these advisers, as they provide me with a lot of useful information, and access to management. I usually stand my ground on matters of opinion, unless they are very persuasive! However, I will happily correct any factual errors, as it's important to make these reports as accurate as possible.

I've had an amicable discussion with a StatPro shareholder who is close to the company, and they have asked me to point out that the company's Deferred Income on the Balance Sheet, which although it is technically a liability, is not repayable in any circumstances. It represents money that customers have paid up-front, typically for annual software licences and/or support revenues, but is parked on the Balance Sheet temporarily, then fed into turnover the following year. So deferred income is exactly what it is - income for next year (and sometimes beyond) that is temporarily being held on the Balance Sheet, since the customer has paid the cash up-front.

Investors regard deferred income differently, and that's a matter of judgement. I take a very conservative view on it, and treat it as net debt when calculating Enterprise Value, but I recognise that this is an ultra-conservative view. Most investors largely ignore deferred income, which I would argue is too aggressive, but each to their own!

It's really the pattern of deferred income throughout the year that matters most. E.g. hypothetically if a company charges its customers annually up-front, and most customers pay in November, then the December year end will show a large cash balance, and a large deferred income credit on the Balance Sheet. However, througout the next year, cash will deplete, as will deferred income, until the company might well be overdrawn for a lot of the year. So valuing the company on its year-end net cash would be a big mistake, as you would be overvaluing the company for cash that isn't really its own. They just happen to have timed the year end to reflect a seasonal spike in cash.

Another point which has been flagged up to me, is that the Deferred Income line on the Balance Sheet can be seen positively - in that it indicates how much future revenue is underpinned. Also, if you see Deferred Income rising, then that means contracts are being won that will feed through into future years turnover (although one has to be careful that it's not just extending the contract lengths). From my point of view, I like to see companies with a lot of deferred income also have that money mainly still in the bank, rather than having spent it already.

In the case of SOG, which gets the bulk of its revenues from annual contracts, paid up-front, customers renew throughout the year. There is a slight seasonal bias towards Q4, but the company has confirmed to me that it holds net cash throughout the year. So my assumption that the interest charge on the P&L reflected an overdrawn bank balance during the year, was incorrect.

What the company has said, is that they pay for a bank facility which they rarely use, so the amounts charged to interest in the P&L are arrangement fees charged by the Bank, rather than interest on overdrawn balances. So I'm happy to clarify that point, and will amend the original article as my next job this morning.

 

 

 

 

Tanfield (LON:TAN)

It looks as if the wheel nuts are loosening at Tanfield, although the wheels haven't come off completely yet. They disposed of the loss-making aerial lifting equipment business some time ago, and were pinning some hopes of unlocking shareholder value from their stake in Smiths Electric Vehicles. The dreams of it becoming another Tesla seem to be slipping away, and instead I am picturing a 1970s milk float in my mind's eye.

Today's update makes it clear that Smiths is struggling to raise financing, and if it does that Tanfield might be greatly diluted. So my last, very bearish comments on Tanfield back in 30 Sep 2013, are looking correct. I hope no readers are still holding.

 

 

 

 

Clean Air Power (LON:CAP)

This is the developer of dual-fuel (diesel & natural gas) conversions for HGVs. Market enthusiasm for the stock ebbs and flows, but their calendar 2013 results published today show some progress at least in turnover, which has risen 25% to £9.9m. Operating profit has only marginally improved, from a loss of £2.2m in 2012 to a loss of £2.0m in 2013.

Growth companies often lose money in the early days, and providing they have enough cash in the bank, and a credible route to profitability, then it's not necessarily a problem. Following a fundraising, that was underwritten by Roman Abramovich, CAP has net cash of £ 4m, so that should be enough for two years' more cash burn, which looks OK to me.

Note that there is a £326k R&D tax rebate this year, so that helps moderate the cash burn.

I haven't read all the narrative yet, but from an initial look at the outlook section, and what I already know about the company (in that it's launching in key markets of USA and Russia later this year or 2015), then I think it's certainly worth me continuing to hold my shares in this. The market cap is around £22m at 9.5p per share, which seems fair to me considering the upside potential.

As usual, my comments are never recommendations or advice, but are just my personal opinion, which will sometimes turn out to be right, and sometimes will be wrong. It's more often right than wrong, otherwise I wouldn't be able to make my living from the market! However, as usual I must stress the importance of readers Doing Your Own Reserch (DYOR), which is the whole ethos of Stockopedia, especially with more speculative shares such as CAP which often end up disapointing in the long run.

 

 

 

I'll sign off now, as a Webinar is starting at 1pm for Fairpoint (LON:FRP), being organised by Equity Development. A really good initiative, more of these please!

Have a lovely weekend, and see you back here on Monday.

Regards, Paul.

(of the companies mentioned today, Paul has a long position in CAP, and no short positions)