Small Cap Value Report (30 Apr 2015) - CCT, OPE, UBI, GBO

30th Apr '15 by Paul Scott

58 comments 36787 reads

Good morning!

I'm on Day 4 of my charity challenge, and apart from a headache & irritability (which someone told me is caffeine withdrawal symptoms, as there was no money in the budget for coffee), it's going alright - I think there will be just about enough food to last today & tomorrow. I posted a video blog last night, for anyone who is sufficiently bored to want to watch it! Donations are rolling in, everyone is being amazingly generous, so thank you all very much indeed! We've already raised £850 online, £175 offline, and with Gift Aid that comes to about £1,200 - pretty awesome stuff, in my opinion!

March and April were so busy that I didn't have time to record any audiocasts. However, the one in early Feb with experienced investor/trader Richard Crow, was so popular that I invited him back for a recap. So here is the link for yesterday's discussion between Richard and I. It's nearly an hour long, so lots of material covered, and plenty of interesting stock ideas.

Character (LON:CCT)

Share price: 410p
No. shares: 20.8m
Market Cap: £85.3m

(at the time of writing, I hold a long position in this share)

Interim results - covering the six months to 28 Feb 2015 are out today. I nearly fell off my chair when I read the headline figures, which are fantastic, as shown in the table below. They haven't put in the % gains, but as you can see they are massive - PBT is up 178%!

Broker forecast for the current year is 40p EPS, so as you can see, by achieving 35.66p EPS just in H1, they look set to absolutely smash full year forecast.

Clearly, from the flurry of early trades, quite a few people rushed to buy more shares. The trouble is, the headline figures are very misleading, and the company and its advisers deserve a serious ticking off for this. You have to scroll down a considerable way through the narrative to come across this vitally important clarification;

So underlying profit before tax wasn't up 178%, it was actually up 17%!

Isn't it funny how companies are so keen to highlight underlying profits when it goes in their favour, but they bury the bad news deep in the narrative when it goes against…

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Roger Lawson

7th May '15

The sunk cost of software development is a good starting point as a measure of the amount of research and development that has been put in, and hence is a useful measure to anyone who is trading the shares in a public market. Yes a trade buyer will do more due diligence on the prospects and likely future revenues that will result but the intrinsic value of the R&D put in will not be totally ignored. In any case you are ignoring the key point I was making that folks knowledgeable in the software sector, or trade buyers therein, will not simply be looking at the accounting data and will likely take very little notice of the balance sheet figures, or even profits. If I was running Globo at this point in time I would be wanting to pay more attention to revenue and its growth than short term profits. And how much they spend on R&D (capitalised or otherwise) is more a function of what they need to spend to develop the products and their strategic product position than anything else.

And really you should not be saying things like "screaming red flags" and "real nasties in the accounts" without some sound evidence. Doing so just annoys people like me. It's just malicious garbage. And your comments on cash are most peculiar - cash is cash and adjusting the cash figure is nonsense.

If you compare Globo with one of your favourites, Synety, which has yet to show they have a business model that can generate any real profits, then I know which one I would prefer to invest in at this point in time.

shipoffrogs

8th May '15

Roger

"But the key issues with Globo are: 1) the involvement in Greece, which is becoming less and less with GO!Enterprise taking off "

Moving away from the financial reporting, googling Go!Enterprise suggests anything but it taking off: it's profile there could barely be more negligible.

Shipoffrogs: Not sure how you are measuring it from simply googling the name. It is not a retail product. Need to look at the revenue the company is gaining from it, and industry reviews. Incidentally Investors Chronicle just rated the company a "buy" this morning. P.S. It might help you if you searched "go enterprise byod" or "globo byod", versus their competitors like "Good".

rmillaree

9th May '15

Per Roger
"I am a small holder of Globo and your comment about deferred income in software companies being "unbilled" revenue is probably also wrong because most software companies charge 20% per annum for support which is billed up front, but provided over the year and hence is in the books as a liability when in reality it will never be crystalised."

To be fair to Paul here his point is 100% correct albeit he has used the term "deferred income" rather than "accrued income" - he clearly states though this amounts involved and that the item is a debtor on the balance sheet and not a liability.

Accrued income is definitely (i am sure you would agree) the "Ugly Sister" of the sleeping beauty that is deferred income. Accrued income is always worth mentioning when its material as a potential red flag as there is the double whammy that (a) it needs to be converted to sales and (b) the cash still needs to be collected after its converted to sales - we all know how easy it is too mess around with an accrued income figure if one wants too.

I see way more positives than negatives in Globo but imho there are plenty of red flags in the figures that could be a plausible cause for worry if the integrity of the management turns not to be as good as we hope. Lets be honest here this company looks like its the Costis show most of the time - so i would expect he has a direct hand in dictating the figures we are presented with.So although i see no reason to presume the figures aren't 100% legit i am absolutely fine with someone like Paul highlighting some salient points that would be an issue if "this company turned out to be a bad un" - again to be fair to Paul he pretty much takes this approach to all company balance sheets he looks at so i for one don't particularly see this article as a hatchet job on Globo and thank Paul for his honest analysis and opinions.

You are right in that this company has significant accrued income on long term contract work that is not yet billed. That might certainly be a concern if it became excessive or unexplainable.

Hopefully the accrued income bears doesn't head the way it did at Geong where its up to the point where there is an effective debtor days of probably 3 years in the accrued income alone !!!

mineralwasser

Hi Paul Scott,

I have a question regarding the additions to the intangible assets and the statement that they are "(...) mainly just payroll costs (...)". This is something I have always been confused about after reading the Report for 2013 and maybe you can help me with the confusion I have.

Note 16 states that "Additions to internally generated intangible assets totalled €14,577,000 (2012: €11,206,000)", while Note 10 states that "The Group has capitalised wages and social security costs of €1,090,653 in the year ended 31 December 2013". To me it seems like only a small percentage (less than 10%) of the additional intangible assets are actually staff costs.

Can you give any explanation for this?

Hello Mineralwasser

Globo have reasonably high "third party" costs - 18 mill of Direct costs were third party in 2013 compared to only 1.2 mill of staff wages in direct costs.

In summary they presumably simply subcontract out the majority of development and direct cost of sales work out to third party entities. How this works i know not but it may be as simple as most IT bods being engaged on a self employed basis. Or perhaps its cheaper to get a fixed fee via quotes from software development firms for particular assignments.

Whether these are on the books payroll costs or third parties is probably irrelevant as its likely to be the same thing with a different badge on.

The mention of licence costs being capitalised though leads me to believe there may simply be licence fees paid for multi year use of some other bods IP If say they paid Microsoft £5 mil for multi year licence for an import part of the Go Enterprise suite that's a reasonably safe accounting treatment. However they could equally have paid a small Greek subcontractor a large licence fee to use their product rather than a specific development fee, in which case the use of the term licence does not mean the expense may much different from that of development costs.

If one were being devious perhaps one would want to use the term licences to make the expense sound more pukka :)

Note i don't really have any specific knowledge of this industry so my guesswork/presumptions may be completely wrong.

cig

1. Send money to mate as "licence fees"
2. Mate buys new hat
3. Mate buys faux product with money from #1 wearing hat from #2 so that auditor doesn't recognise them

(This comment is a work of fiction. Any resemblance to real business models, living or dead, is purely coincidental.)

Paul Scott

12th May '15

Hi mineralwasser,

You asked;

Note 16 states that "Additions to internally generated intangible assets totalled €14,577,000 (2012: €11,206,000)", while Note 10 states that "The Group has capitalised wages and social security costs of €1,090,653 in the year ended 31 December 2013". To me it seems like only a small percentage (less than 10%) of the additional intangible assets are actually staff costs.

And could I shed any light on this.

Unfortunately not, I don't think the company gives a breakdown of exactly what it capitalises into intangible assets. However, from talking to other software companies, I have found that what they usually capitalise into intangibles (for development spending) is overwhelmingly the cost of getting people to do work - whether its programmers making code, designers, etc, all that kind of thing, and the associated overheads - so it might include some office occupancy costs, etc.

I can only imagine that Globo might use external contractors, which whilst not strictly its own payroll, is just another form of people cost.

I expect most investors could accept a moderate amount of costs being capitalised into development spend on the balance sheet. However, Globo (LON:GBO) takes it to a whole new level - they are capitalising an enormous proportion of their costs.

The IC has a track record of being extremely naive about this type of issue - remember that they remained steadfastly bullish on China frauds like Naibu Global International Co (LON:NBU) and Camkids (LON:CAMK) until the bitter end, seemingly oblivious to the reality that a PER of 1 or 2 is the market telling you something - namely that the figures are highly suspect!

I believe that there's certainly an element of that with Globo too - the forward PER of 6, for a supposedly exciting growth tech company is the market telling you, through a megaphone, that a lot of people think there's something not right here. It's then up to you whether you ignore the warnings, as Roger likes to do, or whether you have a careful think about the very explicit red flags being highlighted by me in the main article.

I don't mind what people do with their own money, but when I see red flags, I report on them.

Regards, Paul.

Roger,

And really you should not be saying things like "screaming red flags" and "real nasties in the accounts" without some sound evidence. Doing so just annoys people like me. It's just malicious garbage. And your comments on cash are most peculiar - cash is cash and adjusting the cash figure is nonsense.

I couldn't care less if you get annoyed by my articles, which are anything but "malicious nonsense" - I think your comments have actually stepped well over that line!

Your problem is that you pick lousy shares, and then get emotionally attached to them, and turn on anyone who flags up all the things that are wrong with them!

You did it with Blinkx (LON:BLNX) and are now doing it again with Globo (LON:GBO).

My article was very, very specific about some of the red flags I see at Globo. You've chosen to ignore those red flags, and shoot the messenger. Whereas practically all other bulls in Globo have accepted that I have raised some very valid points.

Paul.

Paul:

Re Globo. Where are the real nasties? Where are the red flags? If you let the facts speak for themselves that would be sufficient, but you make comments based on ill-informed views. For example, apparently one of your red flags was the change of auditors. But that was explained at the time and perfectly satisfactorily so far as I was concerned. As was the case with Blinkx, there have been lots of ill-informed comments on Globo from people who have not taken the time to study the company and the sector in which it operates in any detail. But mud unfortunately sticks and has done serious damage to these businesses, particularly Blinkx. Who are the bulls in Globo who have accepted your bullshit? It's all very amusing bullshit but it does not reflect the underlying facts. Neither of those businesses are perfect in many regards, but that's true of a lot of software businesses which are often complex and where you need to understand the business model that underlies the accounting data.

Globo has particular problems in that it is a Greek company (and that has a significant impact on the share price alone) and a lot of its revenue historically comes from Greece and other Mediterranean countries where collecting debtors takes time, but that is changing rapidly.

As regards capitalisation of costs they did provide a breakdown in the last accounts. Total was Euro 11.2 m split between software and licenses. As their revenue last year was 71.5m that does not look exceptional to me in any way for such a business.

Oh and incidentally if I had fallen in love with these companies, I would have a lot bigger holding than I do. Again you are making allegations without any evidence! And I can think of a lot of improvements I could make in Blinkx, such as having a CEO who could communicate better what the business does and stand up more strongly to the attacks on it. But no business is perfect and if you gave me a list of your holdings I could no doubt think of several reasons not to invest in any of them.

If you are going to make public prognostications based on weak evidence, you are bound to get some flak. Those who can't stand the heat....

You are of course free to take whatever views you like of any company, but hurling abuse at me doesn't exactly strengthen your case, and I'm surprised at you taking that tone.

Just to reiterate my SPECIFIC concerns about the accounts of Globo (and this is not exhaustive);

1) Change of auditors TWICE, and one was a highly unusual, unplanned change after the year-end. If you believe the explanations given by the company, then good luck to you! Many years experience of investing in small caps has taught me to be very careful about unexpected changed in auditors. I trained with PWC, and these things don't happen without good reason, in my experience. So I was right to flag this as a red flag to my readers.

2) Debtors - far too high, as set out in the main article above. Again, in my experience, people who explain away excessive debtors nearly always end up with egg on their face. Excessive debtors is nearly always a sign of problems ahead. So it's a red flag - and just to clarify what red flag means - it's a potential warning sign. Not a definite problem, just a sign that there may be a problem. It's my job to report what I see, so that readers can make up their own minds.

3) The 51% partial disposal of a Greek subsidiary to its own management, which was given away with a cash dowry that is being recycled back to Globo on deferred terms, was a ridiculous transaction in my view. Think it through. How could there possibly be any reason for that transaction, other than to get problems off balance sheet?

4) As mentioned in the main article, why did the company have net cash, yet pay a staggering E4.1m in interest payments on bank debt in 2014? Why did it further increase bank debt, when it has a big cash pile??? I'd love to hear an explanation for this, which nobody has yet come up with. With no explanation from the company, It's a massive red flag.

Re Blinkx (LON:BLNX) - profits have collapsed! But everything is still fine according to you? That pesky Professor Edelman scared away all the customers did he? Come off it Roger! Were you born yesterday?!!

As with any business, if customers are happy with the product or service, then they continue buying it, regardless of what is said at some investor show across the pond, or in a blog.

Paul, no I wasn't born yesterday - actually long before you I think. We could argue a long time about Globo and the Annual Report for 2014 when it is available will certainly be worth reading. And I'll try and ensure I go to the AGM and cover some of the issues you have raised. But issues such as the change of auditors are history.

Roger,

Thanks, I would be interested to hear back from your trip to the AGM, if you manage to ask the company about the specific issues I've flagged.

You may view the two changes of auditor as history, but I certainly don't. It's a very clear warning sign to me, that there were probably issues that the auditors refused to accept.

I look for a pattern of red flags, which usually come together. As demonstrated above, Globo has at least five red flags which concern me greatly. You are happy to disregard them. Fine, that's what makes a market.

Paul.

TheWatchmaker

13th May '15

Re: 'But issues such as the change of auditors are history'

True, these auditor changes are history in that they have happened, but that does not mean that we should ignore them. Auditor changes can be benign but they are often an indication that there is something amiss with the accounting practices.

Paul has a history of identifying 'red flags' and I choose not to ignore his historic ability as I anticipate that he is likely to continue to demonstrate this ability. History is important in some cases.

As regards the change of auditor I said this was "history" because it was discussed at length at last year's AGM, as were also some of the other issues Paul has raised. There is a full report of that meeting by me on the ShareSoc Members Network. In addition I had talked to the CFO about it at a presentation they gave to investors - and where the new auditors also happened to be present so I talked to them also. For those reasons I did not consider the change of auditors to be suspicious. Perhaps this is a case of DYOR - do your own research if there are apparent concerns.

Experience has taught me that if you seek assurances from a company, you will always get them. I remember Sean Nutley of Silverdell lying through his teeth to us at a meeting, saying everything was fine, just a few weeks before the group went bust. I could tell from his body language and demeanor that everything was not fine, so I sold my shares immediately.

I'd go further and say that many, maybe even most, Directors of companies on AIM are polished liars. Or at the very least they know how to create a falsely positive impression.

This is a game of cat & mouse between investors, and often quite dodgy companies on AIM.

So, as far as I'm concerned, two unexpected changes of auditor is not something that can be explained away, it's a massive red flag. You take a different view, which is fine.

Paul, well we can agree at least on Silverdell which I never invested in because I did not like it at all when I saw them present. But many were taken in by what seemed a good story.

rhomboid1

22nd Jun '15

I see the Globo Annual Report is on their website, p61 looks interesting, I'm not a holder or short but I have to say the accounts look odd to me.

In essence it borrowed an additional c.20m euros during the year and burnt through c.20m euros of cash and cash equivalents by year end.

I think I can see why it needs a bond issue..

PS and it pays very little tax

Small Cap Value Report (30 Apr 2015) - CCT, OPE, UBI, GBO

Character (LON:CCT)

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Paul Scott

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