Small Cap Value Report (5 Dec) - HHR, VNET, QPP

Good morning. I was taken aback by the news this morning from Helphire (LON:HHR) of a large Placing to raise £60m, as the business was already well--financed, having cleared all its bank debt in a refinancing earlier this year. However, they seem to be taking advantage of the amazing willingness of investors to finance IPOs and Placings right now - wave after wave of deals is happening on a daily basis - which has to be good news for the economy, as growth is now being properly financed by the equity market.

I don't think there is any sign of indiscriminate funding for IPOs, but certainly the quality, and valuation, of some deals looks a bit on the iffy side. So a potential warning sign of a market that is getting a bit too frothy in places. A lot of people are buying into IPOs on the basis that many are immediately going to a premium when the shares start trading. However, history shows that a lot of IPOs in buoyant markets go on to be pretty awful investments, as the founders are usually cashing in at a high valuation (why else would they want to sell?!) which probably won't stand the test of time. So it's certainly an area where one should only proceed with caution in my view. Or, for the more risk tolerant, a case can be made for making hay while the sun shines! Whatever floats your boat.

In the case of HelpHire, there's big dilution, with the new shares representing 42.3% of the enlarged share capital. So by my calculations that means that the number of shares in issue (1,677m) is being increased by almost 69%, which is a massive amount to do in one go. So the key issue is what price the new issue is at, and in that regard this deal looks remarkably good - the price is 5.2p, which is no discount at all to the market price before the deal. Therefore existing holders are not being disadvantaged, providing the funds are put to good use.

Cenkos raised the money for HelpHire, and they certainly seem to be one of the key players at the moment in raising money. Funnily enough, I was at their offices yesterday, to have a half hour Q&A session with management of Vianet (LON:VNET), as they were doing a results presentation roadshow to institutions & journalists. I decided to throw it open to investors & hence invited people to submit questions for me to ask management, and I reported back here.

This format worked really well, and was much better than me just listening to a presentation & then regurgitating it. So I'll try to use this format again for future meetings, where possible, although the difficulty is finding the time to write up a report, as it takes a couple of hours - luckily I had 3 hours spare between meetings yesterday afternoon, so was able to find somewhere with wifi & write it up straight away whilst fresh in my mind.

Going back to HelpHire, the market seems to like the deal, with the shares up slightly at 5.25p Bid, 5.34p Offer. So it's moved to a small premium to the 5.2p Placing price. In a bull market it is likely that investor sentiment will concentrate more on the growth potential, than the dilution to EPS and dividends.

Talking of dividends, HelpHire has separately announced that the second interim dividend will be paid earlier than planned, so that only existing shareholders receive it on 10 Jan 2014 (based on the shareholder list on 13 Dec 2013). This dividend is 0.171p, which is a useful 3.3% of the current market Bid price of 5.25p

This snippet from today's announcement outlines their position;

 

Helphire's financial position has improved markedly through its refinancing, which was completed in March 2013, and improved trading. The Group's financial position has been transformed, it has returned to profitability and it has recommenced dividend payments. Helphire is now in a position to grow its business and intends to use the net proceeds of the Placing to fund its strategic growth plans.

 

There is then additional detail, which sounds to me as if HelpHire are jumping on the same bandwagon that Quindell (LON:QPP) have ridden in the last couple of years - i.e. acquiring various companies, and combining them, to get round the Government rules prohibiting referral fees. Quindell seemed to have deliberately obscured their business model, in order to deter or delay others from copying it, see this extract from a research note by Cannacord;

 

Our view is that the company (Quindell) has not necessarily made it easy to grasp how it generates revenues and profits. Part of this has been deliberate, at least in the early phase of its land-grab, so that its competitors do not latch onto Quindell’s strategy and attempt to emulate it.

 

However,  their big profits are driven by personal injury claims - which is essentially whiplash claims, which as everyone knows are very often bogus - since whiplash is an unusual condition that cannot be accurately tested for. So if someone says they have whiplash, then they get compensation. It's an utterly bizarre aspect of British life, that defrauding insurers is considered fair game by the general public.

So I'm very much in two minds about this. On the one hand, competing with Quindell in this space will undoubtedly drive up profits at HelpHire. On the other hand, I really dislike Quindell's business model, and think it will ultimately probably be unsustainable, when eventually the Government/insurers really crack down on bogus whiplash claims.

After all, in modern cars with crumple zones, airbags, head restraints & decent seatbelts, the reality is that genuine whiplash is pretty rare, and only occurs in fairly high impact crashes. Yet people are claiming for whiplash in minor shunts. This happened to me a few years ago, when I was the victim of a set-up accident at a roundabout (it only dawned on me that the accident had been caused deliberately some time later). The repair to my car cost £3k, and the other car (an old Toyota) had no visible damage at all (the impact was no more than 5-10 mph, as I ran into the back of a car which had deliberately done an emergency stop for no reason after joining a roundabout - they time it so that the driver of the car behind is looking to the right as they enter the roundabout, then you run into the back of the car in front, which is now stationary on the roundabout). Yet the total claim cost was £9k - because the other driver made a whiplash claim.

Cannacord also make the following points about whiplash compensation claims in their note;

 

• 550,000 whiplash claims are received by insurers every year, representing 78% of all motor insurance personal injury cases (compared with 48% across Europe) 
• New research by the Institute of Actuaries suggests that as many as nine out of tenwhiplash claims are either fabricated or exaggerated 
• One in four people who have been in a car accident in the last 12 months admit they attempted to exaggerate or feign injuries in order to claim compensation and a quarter of these admit making an injury up entirely 
• The NHS spends around £8m a year treating whiplash yet insurers pay out around £2bn in compensation for whiplash cases 
• Whiplash injuries and a ‘compensation culture’ is costing every motorist an extra £118 on their annual motor insurance, according to a report published by Aviva

 

The other drawback with this business model, apart from unsustainability in the long run, is that personal injury work consumes a lot of working capital - hence the fundraising today, and Quindell's inability to generate any cash (which is why they also recently did a large fundraising, of £200m).

 So it will be very interesting to see how things pan out at HelpHire.

 This is what HelpHire say they are going to do with the money - spend it on acquisitions, and presumably keep some back for the long working capital cycle of personal injury claims (typically about 12 months per claim, I understand);

 

Using ABS licensed entities, the Group intends to develop a top tier UK personal injury legal services business in order to provide a comprehensive range of services to its referral partners. The Group is actively considering acquiring additional businesses in the accident management supply chain, including (but not limited to) legal businesses, in order to build its presence in the market more rapidly and has identified a shortlist of potential targets.

 

I hadn't intended writing so much on this topic, but there's a lot to think about.

The market price has crept up a little higher, and is now 5.3p Bid, 5.35p Offer, so it looks as if this deal is being well received. Certainly a £60m Placing at no discount, makes it very clear that investors with deep pockets like the company's plans.

 

 

I'm just going to listen to the Chancellor of the Exchequor's Autumn Statement, so will sign off for today.

Regards, Paul.

(of the companies mentioned today, Paul has a long position in HHR.

A small caps fund to which Paul provides research also has a long position in HHR)