Small Cap Value Report (23 Dec 2015) - INB, TRCS, GMD, PTD, PMR

Good morning!

Over the coming Xmas & NY period, If the markets are open, then I will write a report here. Also, sorry to disappoint those readers who have a sense of humour, but I won't be doing my traditional vodka-fuelled special report this year, as my NYE celebrations will be limited to sipping a sweet sherry & nibbling Quality Street with mother, here in Bou'mth, as opposed to my usual partying in London with friends. On reflection, that's probably a good thing!

Yesterday's report was a bit of a rush, as I had to travel back to Hove to pick up some more things & then return to Bou'mth. So re-reading my report on the train, I spotted several typos, so I'll revisit that report later, and correct the errors. My apologies for that.

There's still plenty of news today, despite the proximity to Christmas, so here goes.

Interbulk (LON:INB)

Share price: 8.5p (up 112.5% today)
No. shares: 467.9m
Market cap: £39.8m

Results y/e 30 Sep 2015 - these results are only of passing interest, because the company also today announces an agreed 9p takeover bid.

This is an outstanding outcome for shareholders, because INB has one of the worst balance sheets of any company on the market. It's technically insolvent, with negative net tangible assets of -£34m. The interest cost alone consumed the bulk of profits, and the company was resorting to asset disposals, sale & leasebacks, etc, to reduce debt.

So clearly a distressed company, therefore shareholders should consider themselves extremely lucky that a white knight has come along, and is prepared to pay a substantial premium for the business. I would bite their hand off, if I was reckless enough to have held shares in this company.

So good to see a happy outcome for shareholders.

Tracsis (LON:TRCS)

Share price: 497p (down 2.0% today)
No. shares: 27.2m
Market cap: £135.2m

Disposal of non-core business - this announcement came out yesterday, and I pondered why Tracsis had decided to dispose of an Australian subsidiary which generated £0.25m in profit, for only £0.5m sales proceeds, most of which is deferred.

I try to build good relationships with the CEOs of quality companies, so dropped John McArthur an email querying the logic for this disposal, which on the face of it doesn't appear to be a good deal.

He replied in detail, and has given me permission to reproduce his email below, which explains the rationale for the disposal;

Hi Paul

As you know we are duty bound to insert into the RNS last year's financial numbers of the disposed entity but this does not paint the whole picture.

To put some more meat on the bones:

 We originally came to own this business when we bought Sky High plc but it has always been deemed to carry significant risk by the Tracsis board given it is 10,000 miles away, dependent on a few individuals, has heavy WIP and slow paying debtors.

Profitability has been very variable over recent years:

- It has made a loss or broken even as often as it made a profit. If you took an average profit over the past few years then the multiple changes greatly
- Also, Australian corporation tax at 30% needs factoring in.  We perhaps should have quoted PAT numbers!
- It’s true it made a profit last year but in years gone past it has been breakeven or loss making and had to be supported by the UK business.
- We’ve never actually taken cash out of Australia which tells you a lot about the quality of profits and cash generation.  This always spooked me being frank.

When we offered the MD the chance to buy it from us he was happy to do so provided the price was right.

We considered a lot of different deal structures and consulted external advisors in the UK and Australia.  The structure we have arrived at is the best we feel we could have got - it guarantees a modest return over the next few years whilst eliminating all execution risk and management distraction.

Obviously some shareholders will always think the value should/could have been higher but they will be unaware of the underlying trading wobbles and uncertainty in the past.

Given I'm a big shareholder I'm very happy with the deal and as you know we're certainly not in business of giving away value!  Had the price not been right we always had the option of keeping it on as a going concern.

Hope this helps but a very valid question as couple of our institutions asked the same thing.    Feel free to share the above with your readers.

My opinion - as usual, top marks to John McArthur for great communication, which is very much appreciated. I wish all companies were this open.

The deal's not material to the overall results for Tracsis, and armed with the additional information above, the disposal indeed seems to make sense. I never doubted that it did make sense, but was just curious as to what the rationale was, so now we know.

Game Digital (LON:GMD)

Share price: 128p (down 38% today)
No. shares: 170.0m
Market cap: £217.6m

Profit warning - this company is the reincarnation of the original Game Group, which went bust in Mar 2012. It was bought out of Administration by OpCapita, and amazingly, they managed to re-float it again (after a bit of a sort-out) in Jun 2014.

The new company then warned on profits just under a year ago - which I reported on here on 13 Jan 2015. As I noted at the time, "...it's not a stock I would ever consider investing in, after the debacle last time, and a business model that looks doomed to long term failure, in my opinion."

Anyway, it's warned on profit again. The year end of 25 July is unusual, so today's update covers the 21 weeks to 19 Dec 2015. There is a lot of detail in the announcement, and the company gives guidance of H1 EBITDA of c.£30m.

I'm not up to speed with the figures at this company, as I would never even consider investing in it. So I'm relying on a broker note which hit my inbox today, where current year EPS forecast has been reduced by a massive 60%. Next year's EPS forecast is cut by 42%. Note from the Stockopedia graphic below (which pre-dates today's forecast downgrades) shows that broker estimates had already been declining considerably over the last 12 months;

My opinion - retailers which go bust, and resume trading after a pre-pack administration, as happened here, are given a new lease of life, but are also given an unfair competitive advantage - in that they can ditch all their loss-making shops in one fell swoop, and resume trading just from their profitable shops. So you often see them do well for a while, after the administration.

However, the whole reason the original company went bust, is because its retail format was failing. Therefore, my view is that the most likely outcome in this kind of situation, is that after several years, there is a high probability that the business will go bust again. A good example of that was JJB Sports, which went through either 2, or possibly 3 insolvency processes, before finally dying.

I reckon GAME is probably heading to oblivion in the long run, via the same route. So it's going on the Bargepole List. It could take some time though. Every now and then a new games format comes out, and there's a big boost to sales & profits, then things taper off again, and profit warnings come out.

Do the games developers actually want a retail intermediary? Is it needed, with internet speeds rapidly increasing, and software downloads being the norm now? This business feels to me like a Blockbuster Video a few years before it went bust - a dinosaur. So this is one falling knife that I definitely won't be tempted to catch.

Pittards (LON:PTD)

Share price: 82.5p (down 11.3% today)
No. shares: 10.1m (I have flagged this, as it looks like a data error, I think the correct figure is 13.9m)
Market cap: tbc est. £11.5m (assuming that 13.9m is the correct no. of shares in issue)

Profit warning - oh dear, things are still in the doldrums here;

Pittards plc ("Pittards" or the "Company"), the specialist producer of technically advanced leather and luxury leather goods for sale to retailers, manufacturers and distributors, announces that the suppressed demand that the Company warned it was experiencing in its interim results for the six months ended 30 June 2015 has continued to affect volumes and consequently, while it expects the results for the year overall to show a reasonable level of profit, they will be  materially below current market expectations.

Valuation - tricky, as we don't really know what profit is going to be, but it doesn't sound like a wipe-out by any means.

"Material" usually means 10% or more. 

The house broker has put out an update today, saying that they are withdrawing earnings estimates, until more info is available from the company in Jan 2016, so we're a bit in the dark at the moment.

My opinion - I reviewed the interim results here on 22 Sep 2015, which is worth a read if you're interested in this share. The big problem is that it has a hugely inefficient balance sheet, with inventories of about 9 months's sales.

So a negligible return is being earned from quite a solid balance sheet. Something needs to happen to shake things up here. I'm actually quite tempted to get involved again, on the basis that this could be a nice special situation at some point.

You certainly wouldn't buy the shares on conventional grounds, but we're getting to a point where the valuation is looking so bombed out that the company might attract the attention of an asset stripper activist. So there could be upside, and the risk looks quite limited due to the fairly strong balance sheet (after a fundraising earlier this year at 120p).

Therefore, for people who like value, special situations, this one might be worth a rummage through the numbers. The big risk though, is that the inventories might only be worth a fraction of book value, in a fire sale. So the apparent discount to book value could disappear.

On the upside, the outlook comments today sound mildly encouraging, particularly the bit below about improving margins, so maybe it's not all doom & gloom?

Stephen Boyd, Chairman commented: "Whilst we are disappointed with the slowdown in the current macro environment, Pittards has achieved a great deal in 2015. This includes the strengthening of the balance sheet, purchasing the freehold of the factory at Yeovil, restructuring the Board and the strategically important opening of our second shop in order to build the Pittards consumer brand.

"The continued strength of the US dollar in which over 70 per cent. of Pittards' products are invoiced, together with lower raw material prices are now beginning to be reflected in better margins and the Board considers the Company well placed in the medium term to benefit from a recovery in volumes as the gradual improvement in economic activity in advanced economies gains more traction.

Overall, I remain of the view that there is something potentially interesting here, but the company needs fresh blood - it's the type of company that's crying out for new, dynamic management, with a strategy to transform it into a high end fashion brand. That potential really excites me, but trouble is, there's not the slightest sign that such a strategy is likely to happen at the moment. Therefore buying the shares now runs the risk of it just being dead money, and a continuing drift down in share price. They are very illiquid, so I suspect any rallies will just be sold into by existing stale bulls keen to exit. I'll keep it on my watch list though - at some point, I still suspect that this share could become very interesting. Not yet though.

Sorry if I led anyone down the garden path on this one in the past - my original potential upside case view on the company has so far been proven wrong. Although I never give recommendations, some people do follow me into stocks, hopefully after doing their own research.

It's not one I currently hold, and would need a lot of convincing to buy back in, as you can end up high & dry, in an illiquid share that doesn't pay any divis.

Panmure Gordon & Co (LON:PMR)

Share price: 66.5p (down 20% today)
No. shares: 15.5m
Market cap: £10.3m

Profit warning - I'm really shocked by today's update, which indicates a thumping great loss for this year is imminent;

Difficult market conditions have prevailed in the second half of the year resulting in a decline in capital market transactions leading to lower revenue in 2015 and a number of corporate transactions being deferred into 2016. This will result in an expected loss after tax for the current financial year from normal operations of approximately £4.0m to £4.5m.

However, as a consequence, the pipeline of corporate transactions scheduled to take place in 2016 has continued to build to an encouraging level that is expected, subject to market conditions, to generate much improved revenues. Regulatory capital and cash resources are healthy and supportive of the on-going levels of business activity.

Based on the strength of its mandated and prospective pipeline of corporate transactions, the benefit of the recent acquisition of Charles Stanley Securities and the continued support of its major shareholder, QInvest, the Board remains confident of the future prospects of the Company.

I've bolded quite a lot of the above announcement, and only just noticed that the £4.0m to £4.5m loss quoted for 2015 is after tax - so presumably that's after a negative tax charge, so the pre-tax loss must be, what, something like £5.0m to £5.6m?

It's splitting hairs really, because the figures are horrendous, whether before or after tax.

My opinion - this is a share that I bought (in small size) a while ago, as it looked apparently cheap. Thankfully it dawned on me that something was badly wrong with the whole sector, and I ditched this share before the big falls in share price.

The problems with stockbrokers

What is wrong with the whole sector? Where do we start?! Everything!! Being more specific though, and In no particular order, and please bear in mind this is just a personal view;

• Brokers are businesses which are fundamentally run for the benefit of their staff, not shareholders.
• Massive bonus structures incentivise corporate finance staff to peddle over-priced IPOs and Placings to gullible investors, which of course you can only do for a limited time before the investors walk away, having been fleeced once too often.
• Regulatory changes have largely broken the traditional business models of brokers, who are now almost totally dependent on deal flow - fees from fundraisings - without which they will die, as their fixed costs are too high.
• New, low cost, outsourced business models for broking are coming in, so that competitors don't need all the heavy overheads of existing brokers, so can undercut them.
• Investors have been repeatedly stung by bad IPOs in this cycle (look how many profit warnings happen within 18 months of floats), so many are now refusing to do any more business. So the lucrative fees are drying up for brokers.
• Therefore, widespread personal greed, cynicism, poor ethics, and a blatant disregard for reputational damage, has meant that brokers collectively have killed the golden goose - investors - who now refuse to lay any more golden eggs (i.e. buy crappy and/or over-priced IPOs).

Worse still, I think there is a widespread suspicion amongst investors that companies which are floated in London are (in some cases) dressed up for a float, with the numbers being massaged to present a far more positive picture than is actually the case.

After all, privately owned companies tend to minimise profits, to minimise corporation tax. Whereas public companies try to maximise profits, in order to oil the wheels of the gravy train - so that management can plunder the company for bonuses, share options, or the repugnant "value creation plans" that are now creeping in.

The numbers then inevitably unravel at some point over the next two years. We've seen it happen so many times, especially with PE floats, that you'd have to be incredibly naive now to take new floats at face value. The odd one does well, but it's like searching for the proverbial needle in a haystack.

The overall problem - just a lack of ethics. The city has some good people in it, but there are too many others who put personal greed and ambition far ahead of basic decency, let alone personal honour (a long gone concept in London, sadly).

For this reason, I now consider all broker shares to be uninvestable. The litmus test is this - if the shares were good value, then the employees would be hoovering them up, thus driving the share price up. That's just not happening though. So I think with smaller brokers in particular, the shares have little intrinsic value, but are more a way to secure or retain control. Many look moribund long-term.

The more successful brokers are just sales machines, adept at convincing investors to part with their money for fundraisings. The staff get the big bonuses, and shareholders receive divis in the good years. I think we've had such a lamentable cycle in the last few years of poor quality IPOs, that there could be a number of fairly lean years for these firms going forwards.

They're not sensible investments for outsiders, in my view.