Small Cap Value Report (18 Nov 2016) - AVS, EYE

Good morning!

I'm still basking in the excitement from the 650p takeover bid for Avesco (LON:AVS) - at a remarkable 125% premium to the previous day's price. That's the benefit of having a founder Chairman who controls nearly 30% of the shares, and is past retirement age. I was expecting a sale of the company, as mentioned in previous SCVRs, including this prophetic one from 30 Sep 2016;

So that looks an excellent outcome, dropping off another non-performing asset, following the sale of freehold land earlier this year.

My view is that Avesco is possibly being prepared to maximise shareholder value, maybe in a trade sale? Its US subsidiary, Creative Technologies, is I think worth considerably more than the current market cap.

Even though this share has risen a lot, it's still not expensive, on forecasts of about 25-27p for this year & next year. It should be debt-free now too. I'm hoping for upside to 400-500p here, in the long run, and it remains one of my core personal holdings. So far, so good!

Yes, you've guessed it, I'm going to be absolutely insufferable for the next few days! Still, it's good to enjoy the victories, as that builds up a buffer (financial as well as emotional) to help us cope with the failures.

Thank you for all the messages from readers who have also gained on this share. We're happy to have been of service.

STOP PRESS!  I've just had David Stredder on the phone, and we're going to have a little celebration of Avesco at Mello Beckenham this coming Monday. Here is the link for more info & details on how to book your place.

David has asked me to give a 5-10 minute talk on why I was so keen on Avesco, and what traits we can identify from it that may be of use in identifying other similar situations. So I'll put together a short talk on that over the weekend.

Also, David will be leading a discussion on stocks with high dollar earnings, which may become targets for takeovers from larger US competitors - as this seems to be emerging as a trend.

So it should be an interesting & enjoyable evening. David has advised me that there are already about a dozen people who say they want to buy me a pint of Peroni. So I've decided that it's half pints only for me, otherwise things could get messy!

Position sizing

Given how confident I was about Avesco, it's a puzzle as to why it was only my 8th largest long position (out of about 40 in total). Really, it should have been in the top 3. Part of the reason is that IG would not allow customers to buy any more - it was closing deals only. As a high proportion of my portfolio is with IG, this blocked me from buying more. Pity.

I forget who it was, but someone clever said that the best stock ideas may already be in your portfolio. So the key is to make sure that position sizes reflect this - i.e. that we put the most money into our best stock ideas.

My favourite Warren Buffett quote is this one;

When it's raining gold, reach for a bucket, not a thimble!

In the case of Avesco, I was holding out a medium sized saucepan, so I collected in a fair bit of gold. However, I really should have been holding out a bucket, because I'd crunched all the numbers properly, knew it was a winner, and was just waiting for the payday.

So an important lesson learned there. This weekend, I will be carefully re-assessing every position in my portfolio, to make sure the money is concentrated into the best stocks. Where everything is lined up perfectly, as it was with Avesco, then position sizes need to be increased. I might have a purge of smaller, low conviction positions too, to free up more cash for my best ideas.

Also, I'll have a trawl through Stockopedia's list of highest StockRank shares, to see if I can find another one like Avesco. It had a very high StockRank (over 90) for a long time, so this bargain was hiding in plain sight!

Eagle Eye Solutions (LON:EYE)

Share price: 130p (down 2.6% today)
No. shares: 22.2m
Market cap: £28.9m

AGM trading update - several readers have messaged me, asking me to look at this one. It's a new one to me, despite having been listed since Apr 2014. The reason I've not looked at it before, is because it's historically loss-making & cash-burning. Things like that usually make hopelessly bad investments, hence why I try to avoid them.

The company describes itself as a;

SaaS technology company that validates and redeems digital promotions in real-time for the grocery, retail and hospitality industries

There are lots of companies like this around, but what I'm impressed with is the client list at Eagle Eye. It's used by Asda, Sainsburys, and lots of other retailers. Also there are some overseas clients too. So the product looks very credible.

Today's update reports strong growth, albeit on small comparatives;

"The year ended 30 June 2016 saw continued progress against the Group's strategic and operational objectives. The significant contracts won and the developments to our software platform mean that we entered FY17 with strong momentum.

During the first quarter of FY17 the Group has accelerated its growth rate, delivering revenue of £2.3 million, an increase from the prior year of 74%. Of the total revenue, £1.9m (Q1 FY16: £0.9m) was contributed from the Eagle Eye AIR platform, representing a 105% year on year increase.

This growth has been driven by the deepening of our Tier 1 relationships in the UK and internationally, as well as increased transactional revenue in both our grocery and hospitality accounts.

Total first quarter redemption volumes increased by 121% to 11.7 million (Q1 FY16: 5.3 million). This was significantly driven by Asda's nationwide roll-out in February 2016 which favourably impacted redemption volumes on the Eagle Eye AIR platform. Eagle Eye has also run several successful digital campaigns through our network with leading brands such as Coca-Cola and Heineken.

That all sounds pretty good to me.

Although my worry is that growth might be stepped - i.e. looking strong when a big new client is signed up, but then perhaps plateauing if more big clients cannot be found? Also it would be necessary to properly analyse the elements of turnover - how much is recurring, and how much are one-off licence fees? I haven't dug down to that level yet.

Profitability - the only comments on this are as follows;

This gives good visibility on delivering half year revenue in line with management's expectations and  further gives confidence on the expectations for the full year."

This is tricky, as it mentions H1 revenue, not profit. So it's ambiguous whether full year expectations also means revenue, or profit, or both? I'm going to assume this is saying they're in line re full year profit expectations.

Forecasts - Stockopedia shows market expectations being £10.7m revenue, and a £3.0m loss this year (ending 30 Jun 2017). Then close to breakeven next year, on a big hike in revenue to £15.4m.

I've asked my broker to dig out some broker notes on the company, to give me more detail to work on. So I'll edit this article later, if he finds anything useful.

Cash - the problem is that the company's almost out of cash;

The Group's net cash position at the end of Q1 FY2017 was in line with Board expectations at £0.2 million (30 June 2016: £1.3 million).

The Company agreed a new banking facility with Barclays Bank plc in June 2016 to support its growth ambitions.

More details are given here on the Barclays facility, which is a £1.5m loan.

The cash burn rate was about £3m in y/e 30 Jun 2016. So it seems to me that the company will need to do another fundraising, as it's already burned through almost all the £4m (before expenses) cash raised in Mar 2015, which was at 200p per share. The price is now 130p.

I suspect another similar-sized fundraising is likely fairly soon (i.e. within 6 months). It's not sensible for loss-making companies to rely on bank borrowings. That said, with strong revenue growth & big name client wins, I imagine it would be fairly straightforward to get another Placing done - there's a good story to tell here, and it's not a million miles away from breakeven.

Capitalising costs into intangibles - the way this company's P&L is presented, the losses look quite small - the operating loss of £4.1m reduces down to a much more reasonable £1.8m EBITDA loss.

However, this is somewhat misleading, because the company capitalised £1.2m into intangibles. So the cash loss is really about £3.0m, which ties in with the reduction in the cash balance for the year.

My opinion - my main concern is that the company clearly has an additional funding requirement. That's not necessarily a problem though, but I'd rather wait for the next placing to be done, to de-risk things.

In terms of the product, I like it - moving rewards & voucher systems into the cloud makes obvious sense. This company is clearly winning big name customers, which validates its product offering. Growth is strong, and if forecasts are met, the company should be getting closer to breakeven next year.

Whether I would want to pay £28.9m market cap for a loss-making business that needs more cash? Probably not. However, I can see that this share might appeal to more adventurous punters. If it becomes the de facto standard for reward schemes, then it could get very interesting indeed.

Actually, I could see myself picking up a few of these for the "fizz" part of my portfolio, once the next Placing has been done & dusted. It looks an interesting, albeit speculative investment idea. Management CVs look impressive too - these seem to be people with experience, not the more usual AIM dreamers.

I didn't want to like this share, but I ended up quite liking it!

I'm popping out now to do some shopping & have a late lunch.

I'll catch up with the backlog either tonight or over the weekend.

Companies I intend covering include;

Tracsis (LON:TRCS)

T Clarke (LON:CTO)

Majestic Wine (LON:WINE)

FW Thorpe (LON:TFW)