Small Cap Value Report (15 Mar 2016) - FCCN, ZTF, PEG, SAT, BGO

Sunday, Mar 20 2016 by

Good evening. I am writing this on Sunday 20 Mar 2016, and it's the last article from last week to catch up on, then we'll be fully up-to-date. So my apologies for the delay.

French Connection (LON:FCCN)

Share price: 45p
No. shares: 96.3m
Market cap: £43.3m

(at the time of writing, I hold a long position in this share)

Results y/e 31 Jan 2016 - looking back through the archive here, I've written about this share 19 times! It's a fascinating special situation in my view - an international fashion brand which is doing well in licensing & wholesale, but which has a disastrously loss-making retail division.

The investment opportunity, as I've said many times before here, is that the retail stores are gradually disposed of, hence shrinking the retail losses, which in the end should result in a decently profitable business.

So the only question really is whether the cash pile will see the company through the roughly 4-5 year process of disposal of loss-making shops (the average lease length is now 4 years). A couple of years ago, things were looking touch & go on that front, as losses were mounting, but I'm fairly comfortable that the cash should last until the group overall becomes profitable.

Interim results were dreadful - a loss of £ 7.9m (£ 4m worse than prior year H1) in the quieter 6 months of the year gave investors a fright, and you could have picked up stock as cheap as 23p last autumn (I know, because I did!). There's often a good trade on FCCN shares each autumn, as often people panic sell after poor interims, forgetting the seasonality of the business, where H2 is usefully stronger.

This year the seasonality was particularly pronounced, because the company had a poor spring/summer season, with clothing ranges not working well. Better performance ensued in H2. So the H1 underlying operating loss was - £ 7.9m, but H2 produced an equivalent profit of £ 3.2m, giving a total loss for the year of - £ 4.7m. That's not too bad, given that we already knew H1 had been a disaster. Although it's still a step in the wrong direction compared with a near breakeven result of - £ 0.8m in 2014/15.

This table shows the key breakdown of profitability, over the 3 activities of the group (retailing, wholesaling, and…

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French Connection Group PLC designs and supplies branded fashion clothing and accessories for men and women. The Company operates retail stores and concessions in the United Kingdom, Europe, the United States and Canada and also operates e-commerce businesses in each of those territories. Its principal brand is French Connection, which designs, produces and distributes branded fashion clothing, accessories, such as toiletries and fragrances, shoes, watches, jewelry, eyewear, furniture and homeware through its distribution channels: retail stores, e-commerce, wholesale and licensing. Its other brands include, Great Plains and YMC. The Company operates in approximately 50 countries around the world. The Company's subsidiaries include French Connection Limited, French Connection UK Limited, French Connection (London) Limited, Contracts Limited, French Connection Group Inc., French Connection (Hong Kong) Limited, French Connection (Canada) Limited and YMC Limited. more »

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Zotefoams plc is a United Kingdom-based cellular material technology company. The Company is engaged in the manufacture and sale of cross-linked block foams. The Company's segments include Polyolefins, High-Performance Products (HPP) and MuCell Extrusion LLC (MEL). Polyolefins foams are made from olefinic homopolymer and copolymer resin. HPP foams include ZOTEK F foams and T-Tubes insulation, made from polyvinylidene fluoride (PVDF) fluoropolymer. Other products include foams made from polyamide (nylon) and PEBA. MEL licenses microcellular foam technology and sells related machinery. The Company offers a range of categories of products, such as AZOTE, including PLASTAZOTE, EVAZOTE and SUPAZOTE; ZOTEK, including ZOTEK F, ZOTEK N and ZOTEK PEBA, and T-FIT. Its products are used in a range of markets, including sports and leisure, packaging, transport, medical, Industrial, building and medical other construction, and other. more »

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Bango PLC (Bango) offers the Bango mobile payment platform. The Company's principal activity is the development, marketing and sale of technology to enable mobile phone users to make payments for digital content and media on smartphones and tablets. The Company's segments include End user activity and Platform fees. The End user activity segment includes the content access fees paid by end users for accessing chargeable content provided by digital merchants, adjusted to take account of whether Bango is agent or principal in the transactions. The Platform fees segment includes the amounts paid to Bango by digital merchants and others for package fees and other services, including analytics and operator connections. Bango Grid is a resource for Bango application store partners to plan their payments strategy. Bango Grid enables partners to find the statistics of every mobile operator globally, and a range of other payment methods. more »

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  Is LON:FCCN fundamentally strong or weak? Find out More »

13 Comments on this Article show/hide all

gus 1065 20th Mar '16 1 of 13

Hi Paul - many thanks for the excellent commentary and opinion. As has been picked up on a couple of other threads, Will Adderley's, (son of the Dunelm family) WA Capital has taken its holding in French Connection (LON:FCCN) up to 7% this week. If this is tied in with the new director appointments, there may be more further developments on the horizon. Could there be a tie in with Dunelm over acquiring stores leases/licensing/franchising etc?


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Paul Scott 20th Mar '16 2 of 13

In reply to post #124486

Hi Gus,

I'd say it's very unlikely that there would be any tie-up between FCCN and Dunelm.
Although it is encouraging that someone is stake-building, and that it's someone with retail knowledge.

Regards, Paul.

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herbie47 21st Mar '16 3 of 13

Good morning Paul, many thanks for the very thorough report on French Connection (LON:FCCN). I'm still not sure about FCCN I have taken a small holding, could be an interesting ride. Closing the retail stores is key and clearing the debt.

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Paul Burkitt 21st Mar '16 4 of 13

Zotefoams - they have obviously been investing heavily in the last few years - impacting cashflows. - see below.

Capex ps p 9.17 7.07 7.81 9.42 10.6 18.4 14.6 +14.9%
Free Cashflow ps p 6.35 9.25 4.92 3.80 3.47 -6.10 1.01

I asume this investment will start to pay off - but they say
"We believe certain of our longer term developments are now reaching the point where market success is much more likely and we plan to further increase resources to support these opportunities"

sounds like they are not finished yet.

I held this stock for a long time - did OK but it was a bit jam tomorrow and input prices were all over the place.

Maybe the jam will start to arrive. Definately one to watch

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Brackendale 21st Mar '16 5 of 13

Hi Paul - a couple of real nuggets in FCCN analysis (autumnal buying opportunities and the £2.4m payment being included in debtors) - thanks. I panicked last week and sold half my holding, when I saw the cash burn, inventory size and continued retail loss. I really had expected significant progress on the latter two. Any worries that the inventory includes significant old stuff they cannot sell?
Whenever I go into an FC store it is empty - it is bizarre that the brand is clearly sought after but not in their own shops! I cannot see they are doing much different to other retailers.
I try and write down my expectations for results before they arrive - and what actions I will take under various scenarios - to try and take the emotion out of it when they arrive. Not sure if it worked very well this time - anyone else do anything similar?

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Effortless Cool 21st Mar '16 6 of 13

PEG convertible terms are at 8p per share, so very material dilution is in the pipeline, albeit somewhat offset by saving ~£150k per annum on interest/amortisation. Even allowing for the dilution, PEG is very clearly underpriced on any conventional valuation basis. The problem is that it is difficult to see what might cause this to change - they don't seem to be able to establish reliable revenue growth from the existing businesses and the possible acquisitions talked of in the latest results would be small and introduce a new element of risk. My preference would be for PEG to put themselves up for sale; the company is surely worth more as an add-on to a bigger business than it is on a stand-alone basis.

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rhomboid1 21st Mar '16 7 of 13

In reply to post #124592


I think the catalyst for a rerating is either;

A)the point when it becomes a dividend payer, they've got the High Court approval required to allow for distributions and this should be the year unless a corporate action occurs

B) a continuation of improved trading and any meaningful contract wins should do the trick.

CheersIn the meantime I'm happy to invest alongside Andrew Perloff who is an extremely shrewd operator IMHO . I'm not sure whether there is a property play here as generally that is what piques Mr Perloff's interest?

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Effortless Cool 21st Mar '16 8 of 13

I hope you are right but: (A) any dividend is likely to be tiddly, given the volatility of earnings and the potential 20m+ converted shares in the pipeline; and (B) revenue is moving sideways and the order book is shrinking (albeit still substantial) . Whilst their remedial work on the business seems to have succeeded, the management do not seem able to generate any meaningful momentum to revenues.
There is no freehold property on the books, so some other aspect must have caught Mr Perloff's interest. Hopefully, he can see a route to value here.

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Paul Scott 22nd Mar '16 9 of 13

In reply to post #124556

Hi Brackendale,

Re French Connection (LON:FCCN) - inventories - forget it - the auditors have to write down slow moving stock to net realisable value.

FCUK stores always empty - yes, that's why they lose so much money in the retail division! HOWEVER, it's high avg selling price, so when they do occasionally sell something, it's high margin. They need to sell maybe 10 items, and it's a good day. Whereas New Look have to sell 1,000 items at £9 each to breakeven!

Bottom line, forget it. We all know FCCN shops lose money hand over fist. The miracle is that the group makes so much profit on wholesale & licensing that it's been able to support such a gigantic millstone for years - don't you see the opportunity? With retail leases averaging 4 years to expiry, the value here is so ####ing obvious, that you'd have to be brain dead not to see it! And it's cash backed too! Trouble is, we might have to wait 4-5 years for our upside.

Regards, Paul.

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Brackendale 22nd Mar '16 10 of 13

In reply to post #124784

Thanks Paul,
Yes I think I do qualify as brain dead most of the time! Taking your points above, now I am glad I only sold half.
The inventories point is a big relief, I thought there was some danger there. My point on the stores being empty was that I cannot work out why - they do not seem any different in layout and broad content to Next, for example.
An interesting wobble from me - reflecting on it this morning maybe I was being impatient, expecting quicker progress from a value situation when of course there is no reason that the turnaround would happen according to the timing I would have liked. And I had too much money in it as a percentage of portolio which put irrational pressure on me. A couple of useful lessons!

Thanks for the response,

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Yantomawr 22nd Mar '16 11 of 13

And now a very positive Simon Thompson commentary regarding French Connection in his Investors Chronicle report just published today.

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Paul Scott 22nd Mar '16 12 of 13

In reply to post #124843

Hi Graham,

Ooops, I had enjoyed a bit too much of Mello's sublime Peroni when posting the above reply at 3:28am, so my apologies for probably over-stating the case!

Regards, Paul.

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gus 1065 29th Jul '16 13 of 13

In reply to post #124784

Evening Paul.

I appreciate we're well after hours and your original comment was something of a footnote, but I wondered if you had any views on today's two RNS announcements coming out of Satellite Solutions Worldwide (LON:SAT) in light of the 13% fall in the share price today.

The reason for the mark down was a substantial discounted equity placement with friends and family (including the directors) equivalent to 65% of the company's share capital at 6p against a previous share price of about 7.5p (i.e. a 20% discount). The placement proceeds are being used to fund two "transformational" acquisitions in Australia and Norway as per the two links below.

Notwithstanding the huge (for a small company) share issuance, the shares ended above the placement price at 6.5p by close today. Although I am not too chuffed about the discounted dilution, the acquisitions more than double SAT's existing subscriber base, give an immediate boost to revenues and profits, open up two new high growth potential markets (AUS and Norway have a lot of "remote" homesteads and SMEs wanting Broadband connection) and increase the company's product offering.

Seems the company is on a roll and is rapidly gathering critical mass in a previously fragmented market that seems to have massive potential. Management certainly doesn't seem to be letting the grass grow under its feet and the success of both the placement and the previous substantial fundraisings through the Business Growth Fund suggests they have the necessary financial backing to be successful.

Any views?



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About Paul Scott

Paul Scott

I trained as an accountant with a Top 5 firm, but that was so boring that I spent too much time in the 1990s being a disco bunny, and busting moves on the dancefloor, and chilling out with mates back at either my house or theirs, and having a lot of fun!Then spent 8 years as FD for a ladieswear retail chain called "Pilot", leaving on great terms in 2002 - having been a key player in growing the business 10 fold. If the truth be told, I partied pretty hard at the weekends too, so bank reconciliations on Monday mornings were more luck than judgement!! But they were always correct.I got bored with that and decided to become a professional small caps investor in 2002. I made millions, but got too cocky, and lost the lot in 2008, due to excessive gearing. A miserable, wilderness period occurred from 2008-2012.Since then, the sun has begun to shine again! I am now utterly briliant again, and immerse myself in small caps, and am a walking encyclopedia on the subject. I love writing a daily report for on most weekday mornings, constantly researching daily results & trading updates for small caps. Cheese! more »


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