Small Cap Value Report (21 Aug 2014) - TNG, OFF, SKP, CBUY

Thursday, Aug 21 2014 by

Good morning!

Tangent Communications (LON:TNG)

Share price: 7.5p
No. shares: 277.1m
Market Cap: £20.8m

From what I can make out, this is basically a company that prints marketing material, through its websites. Today's announcement has derailed the bull case, with the shares currently down about 20% on the day.

General comments on profit warnings - Profit warnings are fairly frequent with small caps - it's an occupational hazard unfortunately, as small companies are usually reliant on a small number of key clients, contracts, products & staff. Whereas larger caps have a more diversified spread of business, which smooths out bumps in the road at any individual part of the group.

This high risk of profit warnings is why it's such a bad idea for investors to use gearing, or to over-concentrate one's portfolio with small caps. Been there, done that. In my view, little to no gearing, and a reasonable degree of diversification is the only way to go with small caps investing. Together with a focus on strong Balance Sheets of investee companies (so that they can survive & recover from profit warnings).

Therefore I always look at profit warnings as potential opportunities - especially in a bull market this can often be your only chance to buy into a good company at a reasonable price. Also, profit warnings tend to be forgiven much more quickly in a bull market - in a few weeks the share price can be recovering again.

However, it all hinges on separating out the good companies from the bad. Also, the old adage that profit warnings come in threes has to be borne in mind - i.e. management usually don't give the full picture at the first profit warning, there is very often more bad news to come.

So weighing up all these factors is just as much an art as a science - interpreting the wording, and assessing how open & honest management are, matters just as much as the figures. I will usually only buy if the valuation still stacks up if another 20% fall in earnings (beyond what has been reported at the current profit warning) can be comfortably absorbed.

Profit warning from Tangent - today's trading update covers the six months to 28 Aug 2014, so it's a week early, as presumably the company has tried to recoup the shortfall but now realise it's too late. The key part says;


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12 Comments on this Article show/hide all

IGC WHITE 21st Aug '14 1 of 12

Excellent piece Paul re TNG ,just the sort of insight that is really valuable.

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intuitive6191 21st Aug '14 2 of 12

I agree - a very comprehensive piece of analysis. It is all the more impressive in that it tries to decipher the statements phrase by phrase.

If there is a problem it invariably means that there is a conflict in the wording of these statements somewhere. For this reason it’s probably a good idea to briefly check what the company has said in previous announcements and check these for discrepancies as well.

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clarea 21st Aug '14 3 of 12

Any chance getting your views on qpp Paul don't hold but love ot hear from take on it

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ACounsell 21st Aug '14 4 of 12

Hi Paul, It is interesting that one of the best performing small cap equity fund in 2014 (PFS Downing Active Management Fund - Manager, Judith McKenzie), according to their most recent factsheets, either purchased or increased their holding to 4.93% in Office2Office in June (taking Office2Office into their top 5 holdings) and topped this up in July to 5.76%. Given that this company's financials were, as you noted pretty terrible, and that a cash offer has now materialised at an 85% premium to last nights closing price this is either fantastic stock picking or a large degree of inside knowledge (I know where my view lies but then I am a cynic!) - perhaps we should be looking at other 'bombed out' small cap stocks PFS Downing hold in their portfolio!!

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ACounsell 21st Aug '14 5 of 12

Sorry posted on wrong tab - will correct!

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evoh_1 21st Aug '14 6 of 12

Regarding SkyePharma,

Your love of recurring revenue will enjoy the fact that a most of the co's products are not easy to move to another supplier due to regulatory requirements. This mean the revenues for products should be stably related to the % of their global sales with the client pharmaceutical firm.

This isn't really a pharma business per se, it is more of a play on the business as they service customers within the sector. Though a quick look on their website suggests they have developmental projects in the pipeline that they will look to partner or sell on to a larger clinically focused firm.

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cig 21st Aug '14 7 of 12

Was the risk:reward that bad for Office2office (LON:OFF) ? While you certainly don't want to buy precarious balance sheets when fully or overpriced, as they usually are, in that case it was sufficiently discounted in my view.

In general if a recovered valuation is N times current price, you can afford N-1/N chance of bankruptcy and still break even (give or take time discounting). Here let's do a back of the envelope valuation: we have a stable turnover of £200m. If they get their act together and return to an unimpressive 5% margin (or equivalently downsize with more decent margins on the remainder), we have £ 10m post-recovery income, worth £100m EV on an unchallenging 10 times earnings, less £30m debt, £70m final equity which is 7 times the market cap yesterday, so we could say the priced implied a 85% (6/7) risk of bankruptcy, which seems overly pessimistic.

So in that context I don't think the private equity offer is particularly good value (as expected from PE!), they probably just paid a premium big enough to shut up the opposition. They do seem to have a half decent business plan with the combination with Vasanta, deep enough pockets to restore the balance sheet, and a new name (who the hell came up with "office2office"?!) so looks like a good deal for the company, but a so-so deal for shareholders.

(No holding but got close to buying earlier this year and it was still on the shortlist.)

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davidtalbo 21st Aug '14 8 of 12

Hi Paul

I am a little disappointed you didn't give your view concerning the continuing Quindell saga, following its interims today. Any chance of an opinion tomorrow?

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Paul Scott 21st Aug '14 9 of 12

In reply to post #85547

Hi David,

I've made my views on Quindell (LON:QPP) very clear in the past - click here for the archive on it (scroll down for my articles from 2013, repeatedly warning of the issues).

As I currently hold a short position on QPP, I am barred from commenting on it on Stockopedia.

However, I'm not barred from commenting anywhere else, so see my Tweets @paulypilot

Regards, Paul.

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davidtalbo 21st Aug '14 10 of 12

In reply to post #85548

Thank you Paul - I am now off to consult paulypilot

Best wishes

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NigeA 21st Aug '14 11 of 12

Hello Paul

Being a fugitive from Forex trading, I am reasonably strong on technicals but a beginner on fundamental analysis. I recently subscribed to Stockopedia in order to try to learn more about fundamentals and convert from being a 'dabbler' into taking stock investment more seriously.

I just want to say how much I appreciate your posts, I find your analysis extremely interesting. Please keep it up and thank you!

Kind regards


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fernandesb 17th Sep '14 12 of 12

Paul I cannot comment at the moment,as at present I am very much involved with forex trading,however in the past I was very much involved with Equities,maybe in the future i will be able to comment

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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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