Small Cap Value Report (22 Dec 2015) - CHA, FJET, KOOV

Good morning!

Things are winding down for Christmas now, with only a few micro caps reporting today. Personally I still like to pay attention to the markets over the holiday period, because in thin trading, some unusual price movements can occur, and I usually manage one or two profitable trades at this time of year, which pays for the mince pies.

There's also less competition - with many/most investors/traders/brokers sozzled over long lunches at this time of year, then unexpected trading updates can present opportunities that might last an hour or more, whereas in normal markets the opportunity would disappear in a minute or two as people bought or sold more rapidly.

It's amazing how many rubbish AIM companies have unravelled this year. If the oil price stays this low, then I think dozens more rubbish companies will be leaving the market next year too, thank goodness - AIM really is cluttered with complete junk, which makes it far more time-consuming to plough through lists of risers & fallers for example, so I very much welcome the (hopefully) forthcoming clear-out.

Let's hope that the LSE also has a clear-out, of the clowns who currently run AIM, who have allowed it to fall into such disrepute, by creating the structure & ineffective governance which positively encourages fraudsters to flock to the market and rip-off UK investors.

Story stocks

Above all, this year has taught me to stop chasing stories. If you ignore the figures, and instead just chase a promising-sounding story, then it's a virtually guaranteed way to lose money. True, money can be made in the initial surge of excitement (if you buy and sell at the right time), but the money-making opportunity is to do a very quick (days) in and out. The longer you hold story stocks, the more likely you are to lose money. Stories go stale, and in almost every case, actual results fall a long way short of forecast performance.

Look at all the hyped up stuff that crashed back down to earth this year - e.g. Audioboom (LON:BOOM) (which has just changed broker to Liberum, so clearly work has started on the next discounted Placing), Fitbug Holdings (LON:FITB) (which went from 0.4p to 20p, and is now back down to 0.8p), Concha (LON:CHA) (which was just a cash shell with £5m in it, yet soared to a mkt cap of nearly £100m on pure hype, but is now back down to c.£8m mkt cap). There are numerous others too - Tungsten (LON:TUNG) (has been a disaster, despite highfalutin big name management), Rightster (LON:RSTR) , Torotrak (LON:TRK) , the list just goes on and on - story stocks that have failed to deliver, and need repeated fundraisings, which are usually done at a discount via a Placing, thus shafting existing shareholders, who are little more than lambs to the slaughter.

StockRanks

This is a good time to mention StockRanks. Although I'm paid to write these articles, as a freelance writer at Stockopedia, I've looked objectively at the StockRank system here, and am becoming more & more impressed with it. Clearly no system can accurately predict the future in every case, but it does (proven, statistically) skew the odds in your favour if you generally pick stocks with high StockRanks.

Therefore I tend to use StockRanks as a confirmation signal for my main shareholdings, although I do occasionally deviate from it when I find a really promising GARP stock (such as Boohoo.Com (LON:BOO) for example). Indeed, as it works on historical data, you can get ahead of StockRanks by interpreting trading updates, to anticipate an improving StockRank before it actually happens.

Going back to story stocks, a quick look at the lowest scored stocks demonstrates the point - what a lot of (mostly) junk!

Overseas AIM stocks

My policy of avoiding all overseas AIM stocks, especially Chinese ones, has served me (and hopefully readers) very well this year. Although I will make the very occasional exception - but usually only if the company has been listed on the market for a long time (5+ year), and consistently paid dividends. That is usually enough to screen out rubbish, and let through the occasional good overseas AIM stock (e.g. Somero Enterprises Inc (LON:SOM) ).

I broke my own rule with SKIL Ports & Logistics (LON:SPL) though, which is a risky Indian stock I hold, as thorough research by friends has convinced me that the project to build a new port in India is actually real, is happening, and that management have a track record of having delivered on similar projects in the past - that bit is crucial generally for AIM stocks - track record of mgt. But it could easily go wrong, so I have mentally prepared for it crapping out at some point. However, I see this being a good multibagger if it works out alright. So it's high risk, but potentially high reward.

Position sizing is critical too. Personally if I'm dabbling in something really risky (like the Indian port), then I factor in the possibility of a 100% loss, and limit my position size to a level where it wouldn't kill me to lose the full amount. That way, even a wipe-out on one stock won't hurt my portfolio by more than say 2-3%, which is my personal limit for anything high risk.

Spotting frauds

The signs that a company is a fraud are often amazingly obvious. Globo (GBO) was of course a stock that I repeatedly & consistently warned about for 3 years before it finally went under. My archive of Globo posts is here, in one easy-to-read 29 page document, and one of my projects for January is to make a video running through all the warning signs that I spotted, to help investors look out for & avoid similar issues at other AIM companies.

Last night I watched a video of Gabriel Grego, the US fund manager whose dossier (published by ShareProphets) delivered the final knockout blow to Globo, which led to its CEO admitting to fraudulently misstating the accounts. It is compulsive viewing, so I highly recommend you watch this at some point - here is the YouTube link. This video is a reminder that often you just need to engage a little common sense, and question whether things make sense.

With Globo, its attempt to raise c.£100m in a high yield bond issue, whilst simultaneously supposedly holding large cash balances, just didn't make any sense at all. You didn't need to be an accountant, or any kind of expert, to see what nonsense this was. Clearly something was wrong, you just had to use a little common sense to see it. I made it clear in my articles of mid-2015 here that I thought management had probably stolen the cash, but didn't dare say so directly, in case we got sued! And in any case, you can't say something as fact, unless and until you have firm evidence.

What amazes me more than anything, is how delusional we can all become once we own shares in a company. We start to block out opposing views, and even shout them down. This is a terrible trait in all of us, which must be countered. I make a point of having lunch with bears every now and then, and on several occasions in 2015 they jolted me out of my complacency, and convinced me that I was wrong on several speculative, jam tomorrow stocks, which saved me tens of thousands of pounds (because I sold them soon afterwards), thus avoiding the subsequent collapse in price. So my thanks go to Lucien Mears, and Matt Earl (for jolting me out of my delusion re Tungsten (LON:TUNG) ) and Was Shakoor for putting me right on Audioboom (LON:BOOM) when the share price was in the teens.

So my key lessons from 2015 are;

• Avoid jam tomorrow shares - they nearly always go wrong.
• Listen to opposing views  - serious bears are more often right than wrong, in the long run.
• Don't touch overseas stocks on AIM.
• Position-sizing is key - the riskier it is, the smaller the position size should be.
• Pay attention to Stockopedia StockRanks - I try to keep over 90% (by value) of my portfolio in shares with a StockRank of over 60.

Re-rating of growth stocks

A lot of people are patting themselves on the back for having run winners in 2015. However, this is dangerous, because 2015 has seen a (probably one-off) re-rating of growth stocks. Whereas a PER of say 15+ would have been seen as quite pricey a year or two ago, this changed in 2015.

Good growth stocks are now on PERs of 20-30, sometimes more. That's a one-off re-rating, and thus it doesn't follow that such rises will continue. In fact, it's now more likely that such a move could reverse, or at best stabilise.

Therefore one of my themes for 2016 is to avoid anything that is on a stretched PER, as the winners of 2015 could easily turn out to be the banana skins of 2016, in some cases anyway. So I'm thinking about mean reversion very closely.

Concha (LON:CHA)

Share price: 0.54p (down 13% today)
No. shares: 1,552.7m
Market cap: £8.4m

Results y/e 30 Jun 2015 - firstly I note that the accounts are already nearly 6 months out of date. That a cash shell (hence ultra-simple accounts) takes this long to file its accounts, doesn't exactly give confidence in management.

It's got about £5.5m in cash, so the shares are still at a significant premium to cash - presumably on the expectation that management who presided over a gigantic ramp in the share price to 14 times the current level on little more than hot air, might be able to repeat the trick.

The reason I think this was a managed ramp, is because the issue of shares at an over-valuation (at 4p) and warrants priced at 8p, didn't make any sense, since there was nothing much of any value in the company. It was, I believe, a cynical attempt to inflate the share price, and it worked for a while.

As I reported on, in my report of 31 Mar 2015, issuing shares in a cash shell at 4p, when a previous fundraise just a few months earlier had been at 0.6p, when nothing factual had changed, really did smell of share price manipulation. A similar sort of thing was attempted recently with Daniel Stewart, once the conman Rob Terry got involved.

Such share price manipulations never work in the long run, but in the short run it provides a very profitable exit for the promoters, and gullible punters end up nursing the losses. Same thing happened with many of the Chinese AIM stocks - they were just cynical promotions, designed to separate mug punters from their savings.

It really is a minefield out there. Which is a pity, because AIM also has several hundred really decent companies on it, and I worry that the quality is being tainted by association with all the spivvy rubbish like Concha that clutters up AIM.

Fastjet (LON:FJET)

Share price: 43.6p (down 7.6% today)
No. shares: 66.4m
Market cap: £29.0m

Operational & trading update - the theme of today's report is low quality shares, so it's fitting that African low-cost, high-losses airline FastJet is reporting.

I was amazed that it got away a decent-sized fundraising (£50m before costs) in Apr 2015, at 100p per share, so the people who backed that are already 66% down.

The historic figures are absolutely terrifying - huge losses. The company has also been beset with problems, and been a bit unlucky too.

So very much a bargepole stock, however, there is one interesting comment in today's results, saying;

fastjet is proactively taking steps to manage its operating costs and overheads, and fully align its growth strategy with demand. As such, despite the current challenging market conditions and currency headwinds, which are expected to lead to lower than anticipated revenues in 2015 and 2016, the Company remains confident that these actions will ensure it continues to be well placed to capture the significant growth potential in the African aviation market. The Board believes 2016 will be a year of network growth and that the Group is expected to be cash flow positive for the next financial year.  

The last sentence intrigues me. If it's now going to be cashflow positive, then it might be worth a fresh look perhaps? The trouble is, how much can we rely on that expectation from management?

My opinion - if I can get some comfort that it genuinely is likely to be cashflow positive in 2016, then it might actually be worth a look, for a very small, speculative position.

Certainly the historic track record is so dire that I would take a lot of convincing, and would need hard evidence, that things are set to improve enough to make it a viable business. It's worth keeping an open mind though.

It can sometimes be very profitable to nip in and buy a share at the first signs of a turnaround, once other people have refinanced it at a much higher price, and are despondently selling at too low a price. I'm not yet sure if this is such a situation or not, but I'll do a bit more digging & report back if it looks interesting. Although I'm very unlikely to actually buy any shares in this, as every time I've looked at the numbers before, it looked a total disaster.

Koovs (LON:KOOV)

Share price: 26.75p
No. shares: 27.1m
Market cap: £7.2m

Interim results to 30 Sep 2015 - here's another absolutely terrible stock. It's meant to be the Asos of India, indeed the Chairman of Koovs, Waheed Alli, was involved with Asos for many years, so the story was that he was going to replicate its success in India - a very nice story, but as with nearly all story stocks on AIM, it's been a dismal failure to date.

In H1 the company achieved turnover of only £2m, yet generated an operating loss of £6m!

The business model reminds me of something that one of Lord Sugar's Apprentices (or an unsuccessful candidate anyway) would have dreamed up. They raised loads of money, and are burning through it at a rapid rate, in the hope of creating enough scale to do a repeat fundraise.

The cash pile has fallen from £16.7m to £6.3m in the last year, so a burn rate of an average of £867k per month. Therefore, even if we're generous and assume that has tapered down to say £750k per month now (to allow for growth in sales), then this means the cash pile would be down to only £4.1m by the end of this month. So that gives it about to the end of May 2016 before it goes bust.

Funding - so we can clearly see it needs more cash, and lots of it. To make matters worse still, the company telegraphed to the market a few months ago that it was seeking to raise £35m over the next three years. So that's an invitation for investors to short your shares, and then close the short through participation in a discounted Placing. Just a schoolboy error, what were they thinking?

So far, of the £35m needed, only £1.1m has been raised in Oct 2015, from management. Positive comments are made in the narrative about discussions with investors, but show me the money. Talk is cheap.

Going concern - note 2.2 in today's results is an eye-opener, which I reproduce in full below, with my bolding of certain key remarks. This sounds very ominous to me;

Going Concern

This Interim Report has been prepared on the assumption that the business is a going concern.The Group is in the early stages of its aim to build a significant business in India.  The business plan envisages a period of development and investment for which funding was initially secured through the public offering of shares completed on 10 March 2014.

  During the period since March 2014 revenue has grown dramatically as demonstrated in the Consolidated Income Statement and Koovs has built a strong initial market position from which to develop further.  In building to this point the investment required in advertising and marketing has been higher than originally anticipated. The e-commerce market in India is growing extremely quickly and is attracting significant investment from a number of major players who aim to claim leading brand recognition.  With this level of noise in the market and the inevitable upward pressure on marketing costs, particularly for biddable search terms, we have found it necessary to increase our investment in marketing in order to secure sufficient share of voice in the market to maintain a healthy growth in revenue.

Further, we recognise that in order to achieve our goals, the brand requires to achieve significantly higher brand awareness in the short term.  We have therefore developed a detailed plan to raise the awareness of the Koovs brand and to generate significantly higher revenues.  A detailed marketing plan has been built with the objective of making Koovs "famous" and achieving significantly higher brand awareness in our target market of affluent fashion focused youth in the major metropolitan areas of India.  The campaigns have been designed to be as cost-effective as possible, but will represent a major investment.

For these reasons the Board, in conjunction with its advisors, has been making arrangements to raise additional capital of up to £35m over the next three years.

At the date of publication of these accounts an initial tranche of £1.1 million has been raised through the issue of new ordinary shares of Koovs plc and, subject to the approval of shareholders, further shares will be issued early in the new year.

This situation has created the following material uncertainties:

·      The Group's ability to access sufficient further funding in order to support the business over the next 12 months; and
·      The Group's ability to meet its forecasts, manage its expenses in order to extend the period when the Group is expected to have sufficient liquidity and to predict the impact of any change in marketing expenditure.

These circumstances represent material uncertainties that cast significant doubt upon the Company's ability to continue as a going concern.

Although the funding process has not yet concluded, discussions with a number of potential investors have been encouraging.  Based on this the Directors have a reasonable expectation that the on-going efforts will be successful and that therefore the Group and Company will have adequate resources to continue in operational existence for the foreseeable future.

The Directors therefore consider it appropriate for this interim statement to be prepared on a going concern basis.  This statement does not include any potential impairment to intangible assets based on the above material uncertainties nor include the adjustments that would result if the Group was unable to continue as a going concern and the accounts were prepared on a break-up basis.

My opinion - fashion ecommerce is an area that fascinates me, due to my background in finance of a fashion chain. A lot of people mistakenly think that it's easy to replicate fashion websites, and that there are no barriers to entry.

This is true to the extent that anybody could create a fashion website, buy a bit of stock, and has thus entered the market. However, they won't actually sell anything, because you have to spend serious money on marketing, just to get noticed by customers, let alone actually sell them anything. Multiple millions, as an ongoing marketing spend.

There are lots of people trying to succeed in this space, but only a relatively small number are likely to make it big. Once you have got to scale, e.g. Boohoo.Com (LON:BOO) then, providing your margins are high enough (BOO makes a pre-marketing profit margin of over 20% of revenues, which is outstanding), then you can simply drown out competition by out-spending them on marketing.

Koovs seems to be suffering in this regard - as it (and its auditors) allude to in the going concern note above. Koovs is now in the nightmare scenario where it has used up nearly all its cash pile, but achieved very little in terms of sales. The only solution to this is spending even more on marketing! So who is going to stump up the £35m cash needed to do this? It looks as if there is little appetite so far, as no funding deal has been done.

If a second round of funding is successful (which I doubt), then the investor(s) will be able to name their price, and value the existing equity at virtually nil.

Therefore I see 3 likely possible outcomes here, which are all disastrous for existing shareholders;

1) The company goes bust in 2016 (quite likely)

2) The company limps along with a smallish fundraising, at a deep discount, and then goes bust in 2017 (very likely)

3) A larger fundraising is achieved, but valuing the existing equity at virtually nothing - so this could involve taking the company private.

Overall then the existing shares are clearly a total bargepole job - again, it's one that I forgot to put on my Bargepole List, but I've rectified that today. The existing shares only have value if someone rich comes along and decides to take a punt on refinancing it, and for whatever reason decides to smile kindly on existing shareholders. That's possible, but unlikely in my view.

So this is yet another jam tomorrow stock that has dismally failed to live up to its initial promise, despite having management that supposedly knew what they were doing, and had been involved in Asos (although maybe they were just along for the ride there, more through luck than judgement? Just because someone worked somewhere that was a successful business, doesn't necessarily mean they played any particular part in causing that success).

Regards, Paul.

(of the companies mentioned today, I hold long positions in BOO, SOM & SPL. I hold no short positions in any of the companies mentioned today, but probably should do!

A fund management company with which I am associated may also hold positions in companies mentioned, which I may or may not be aware of.

These reports are my personal opinions only, which are subject to change without notice. Nothing in these reports should ever be mistaken for advice or recommendations. Happy Christmas!)