Small Cap Value Report (27 Apr 2016) - SEPU, PRES, BLUR, OUT

Good morning!

Another busy day today for announcements, I'll cover as many as I can this morning, as am busy working with a private company this afternoon, with my FD hat on.

Sepura (LON:SEPU)

Share price: 64.25p (down 30.9% today)
No. shares: 184.4m
Market cap: £118.5m

Trading update & financial position - in my report of 4 Apr 2016 I covered Sepura's profit warning, and warned that a discounted fundraising looked inevitable, therefore the shares were much too high risk to consider catching the falling knife at 120p. The price has nearly halved since then, as my fears over its weak capital structure have been confirmed.

The company today says:

The Company's current net debt and consequential leverage position is largely the result of the working capital expansion referred to above. The working capital position is expected to significantly ease during this financial year. However, the Company is subject to short term cash constraints which the board expects will require an extension of its banking facilities and a waiver of a possible covenant breach at 30 June 2016.

Discussions with the Company's debt providers regarding the Company's liquidity requirements and the possibility of covenant breaches are ongoing.  The Company has also commenced discussions with major shareholders regarding an equity capital raise of up to £50 million to reduce leverage and provide the working capital to support the development of the business.  

So a substantial equity raise is on the cards, as I expected. We're now in the realms of the unknown. It all depends whether existing shareholders are keen to support the company, or not. To a certain extent they have to support it, otherwise the value of their existing shares could be destroyed if a deeply discounted Placing occurs.

If major shareholders are indeed supportive, then the discount on the new equity fundraising might be quite modest. Or it might be quite large, we simply don't know.

There's a risk that private shareholders may not be allowed to participate in the fundraising. Therefore for us, buying shares now would be little more than a gamble.

The rest of the information given in today's statement sounds reasonably alright - i.e. in line with the trading update given on 4 Apr 2016. Although note that the more precise revenue & adj. EBITDA figures given today (for y/e 1 Apr 2016) are near the bottom of the previously indicated range, as follows:

Revenues - range previously given: E190-200m.   Today: E191m

Adj. EBITDA - range previously given: E16-20m.   Today: E17m

Outlook - for the current year (ending 3/2017) is maintained:

The Board maintains its expectations for adjusted EBITDA for FY17. This is supported by the additional contribution from the delayed orders together with a full year of synergy benefits which will drive lower operating costs for the combined business in FY17 and a recovery in product margins now that the Saudi contract has completed. These factors offset the lower expectations for Applications and DMR. With the growing momentum for the TETRA business, particularly in North America, the Company will be increasing its focus on this over other areas such as DMR.

My opinion - once the £50m equity fundraising has been done, then this share could be an interesting recovery situation. The trouble is, at this stage, we don't know what the structure of the fundraising will be, nor the appetite of institutions to support it.

Therefore, these factors make it too risky for me to consider taking a punt now. The big danger is that a deeply discounted Placing might be necessary, which of course would heavily dilute existing holders. Private investors don't have access to Placings usually, so we become the lambs to the slaughter. Effectively, a deeply discounted Placing steals part of the company from existing holders, and gives part of that to the new shareholders. It's a deeply unsatisfactory method of fundraising. However, in emergency situations it can be unavoidable.

I'm not sure whether this is an emergency situation or not, that depends on the attitude of the banks. It's certainly a stressed situation though, whenever covenant breaches are involved. The survival of the business is then entirely dependent on the bank being co-operative. They are likely to be co-operative, as they want to protect their own interests. The best way of doing that is insisting that the company raises fresh equity from its shareholders. So shareholders will effectively get the bank off the hook - which is one of the reasons that banks like lending to listed companies.

Looking forward, once the equity fundraising has been done, and if working capital does indeed unwind as anticipated, then Sepura should recover quite nicely. Therefore I shall follow it closely. At some point, I think there might be a good buying opportunity here. Although personally I would only invest once the balance sheet has been repaired with an equity fundraising. My hunch is that existing shareholders are likely to be supportive - because the problems here look fixable.

Pressure Technologies (LON:PRES)

Share price: 130p (down 24.6% today)
No. shares: 14.4m
Market cap: £18.7m

Update on recent trading (profit warning) - yet another profit warning from this engineering group, which is heavily reliant on the oil & gas sector. Trading has deteriorated further:

As highlighted at the AGM in mid-February, the difficult trading conditions in the oil and gas market continued into the first quarter of 2016. Whilst the Board indicated that no significant pick up was expected this year, the Group's businesses dependent on the industry have since experienced a further, substantial decline in orders in quarter two, which has been complicated by unpredictable demand and very short lead times.

Despite cost-cutting measures, the impact sounds nasty:

Reflecting the Board's continued caution, we therefore now anticipate that the result for the year ending 1 October 2016 will be substantially below current market expectations.  

It sounds as if FY16 is likely to be perhaps just above breakeven. One broker has said today that it sees profit before tax of £0.6m for FY16, and a recovery to £2.1m for FY17. My feeling is that forecasts are little more than guesswork right now.

Solvency - the key issue is whether or not this group is likely to go bust. If it's not, then there's a good case for just taking the plunge by buying a few shares, and riding out any further downturns. The long-term upside could then be considerable, once the oil sector recovers. Nobody knows the timing of when that will happen of course. With oil inventories apparently at all-time highs, and Chinese speculators driving up the price of commodities in the short-term, it seems to me that we could perhaps see another lurch down in the price of oil perhaps? Nobody really knows for sure though.

This bit sounds reassuring:

The Board has continued to take measures to ensure the Group remains cash positive, including a further significant reduction in headcount, alongside a commitment to productivity efficiencies that are already yielding improvements.  The preservation of our key core skills remains paramount; consequently we have seen gains in market share, as a result of market pressures on some of our competitors and our dependability and reputation for delivering quality products on time and in full.

Note the market share comments - perhaps PRES could emerge from the current industry crisis in a better competitive position, being one of the last men standing, and leaner & more efficient?

My opinion - I'm tempted to have a dabble here. However, it's the balance sheet which puts me off. There is a £10m bank loan within long term creditors. This is partially offset with cash, and as working capital unwinds then perhaps the cash pile might be growing? However, having any bank debt at all makes me very nervous, given the sector in which PRES operates.

I'll hold fire until the next balance sheet is published, to gauge the overall financial position. I'm worried that bank covenants might become an issue, although that hasn't been mentioned in today's update.

Note that there is a more detailed divisional performance report in today's statement. I haven't read that, as I've already decided that the overall picture is too risky for me to consider a purchase here.

At some point though, this share might become a good buying opportunity, as in normal circumstances its businesses are decently profitable. Right now though, it's almost impossible to value.

Blur (LON:BLUR)

Share price: 10.75p (down 21.8% today)
No. shares: 47.1m
Market cap: £5.1m

Results y/e 31 Dec 2015 - absolutely diabolical figures for 2015.

Revenue fell from $4.7m in 2014, to just $2.7m in 2015.

The loss from operations, has barely reduced from 2014, and was a staggering $10.7m in 2015.

The cash pile reduced rapidly, from $17.4m a year earlier, to $7.1m at 31 Dec 2015. Since the year end this has fallen again to $5.8m, so it's likely to run out of cash later in 2016, or perhaps early 2017. I very much doubt that anyone will put fresh funding in again, so my view is that this company is highly likely to go bust in 2017.

Cash burn is reducing though. Perhaps it's sunk in with management that they're in the last chance saloon?

·      Operating costs down 25% in Q1 2016 compared to Q4 2015 as platform maturity and higher quality revenue streams drive further operational efficiencies.

·      Underlying cash burn (excluding Foreign Exchange movements) reduced by 33% to $1.0 million in Q1 2016 from $1.5 million in Q4 2015.

·      2014 R&D tax credit of $0.5 million received in Q1 2016.

·      Cash at end of Q1 2016 was $5.8 million.

My opinion - I think management at this company are delusional, and irresponsible - squandering so much shareholder cash on a project which is obviously not likely to reach commercial viability.

Maybe they can pull something out of the hat, but in my view the shares are very likely to end up worth nothing.

Anyone buying or holding these shares is out of their mind, in my view. Or maybe an insuppressible optimist with a relentlessly declining portfolio. It's these jam tomorrow stocks which really did the damage to my portfolio, when I used to dabble in this kind of thing. Even now, with my strict investing rules, I occasionally get suckered into a good story, and end up losing money (e.g. Tungsten).

Outsourcery (LON:OUT)

Share price: 6.2p (up 72% today)
No. shares: 55.6m
Market cap: £3.4m

Although its market cap is well below my usual lower limit, I'm drawn to reporting on this share, as it's fascinating to see how these disastrous situations play out - so we can spot the warning signs in future at other similar companies.

Update - I was very surprised to see this share jump over 90% earlier this morning. It's still up 75%, and I think this could be a spurious move from people who might have misunderstood the RNS, which says:

Outsourcery plc (AIM: OUT, 'Outsourcery' or 'the Company'), confirms that it has reached agreement with its principal secured lender, Vodafone, as to the terms of a new conditional drawdown working capital facility ('New Facility').

The New Facility has been structured to provide sufficient additional funding such that the Company can seek to undertake a realisation of the principal assets of the Company in the immediate term. The New Facility will be subject to a number of key terms and conditions including the appointment of a proposed Non-Executive Director.

The way I read that, it sounds like a temporary lifeline to enable the company to raise enough cash to repay the main lender. How is that good news?

It depends what the "principal assets" are, and how much they're worth?

I've looked at the last balance sheet, at 30 Jun 2015, and it was insolvent - with negative net assets. Continued trading losses (in excess of the small Placing done later last year) mean that the situation can only have got worse since then. Perhaps customer contracts could be sold on, to unlock value?

This comment today is very surprising. An unqualified audit report suggests that the auditors have somehow been convinced that the company can survive another 12 months. I find that very difficult to regard as credible.

As a result of the New Facility, proposed asset realisations and previously announced restructuring, the Board expects to announce its unqualified audited financial results for the year ended 31 December 2015 by 30 June 2016. 

My opinion - based on the published figures, this company looks bust to me. I think shareholders are likely to end up with nothing, and that this company's days are now very much numbered. However, the comments today about an unqualified audit report are surprising. So perhaps it might be able to stagger on for a little longer before bowing to the inevitable?

In any case, there is not likely to be any value remaining in the shares, because the company has failed to create a viable business model.

Sorry, I'm out of time again.

See comments section below, where I've listed the shares that I do want to catch up on, and report here when I've got more time.

Regards, Paul,.

(usual disclaimers apply)