Small Cap Value Report (6 Nov 2015) - TCM

Good morning!

Extremely quiet for small cap results/trading updates today, which is handy as I have a lunch appointment with the "Sheriff of AIM", Tom Winnifrith, so that should be entertaining!

Whilst I sometimes cringe at the things he says, and the way he says them, there's no denying that he has become a huge asset to the investor community in the last year or two - single-handedly cleaning up a big section of the market, by shining a bright light on wrongdoing, dodgy companies, management & advisers. As well as the occasional misfire, when the wrong target is shot at.

Also, I think it's incredibly useful to have someone fighting for better standards who isn't frightened by the libel laws, indeed who seems to positively relish court appearances. Only this week, I became aware of a company which responded to legitimate investor concerns by firstly issuing a threat to sue them for libel! So the UK libel laws seem to be providing refuge against criticism in less than perfect situations.

We discussed this at the ShareSoc event earlier this week, with Roger Lawson briefing us on the current state of play with the law. This is the reason why shorting dossiers are issued in the US, where there is greater freedom of expression than here. Bear in mind that Tom Winnifrith was the only UK journalist who was prepared to publish the shorting dossier which brought down the Globo fraud. It's surely worrying for our freedom & democracy where the mainstream press are scared of publishing such controversial material, through fear of legal action?

Telit Communications (LON:TCM)

Share price: 232p (down 14% today)
No. shares: 115.1m
Market cap: £267.0m

Swisscom contract - this announcement reads positively, although as no financial details are given, I'm viewing it more as a marketing communication than anything else. It's not clear why the shares are down 14% today, perhaps there has been some other news which I've not spotted?

Why mention it then? Well, several readers have recently asked me to look at this company and give a view, so I've had a quick whiz through the most recent interim figures.

The balance sheet looks generally OK, although there is some debt. It seems odd to run about $36m in cash simultaneously with roughly the same amount of debt. This was a big red flag at another company recently, so that needs looking into.

My main issue however is the cashflow statement. The company is reporting profits on the P&L by capitalising costs into intangible assets. The amounts being capitalised are far higher than the amortisation charge. If you adjust the accounts to expense all development spending (which is how I like to look at things, to ascertain the real cash profits), then it pretty much wipes out profit completely.

For example, in the full year to 31 Dec 2014, the company reported $13.9m in profit before tax. However, if you look at the cashflow statement, it capitalised $26.1m of development spending, but amortised only $10.4m through the P&L, thus boosting profit by $15.7m. So the way I look at it, the company actually made a loss of $1.8m.

The company's accounting treatment is perfectly legitimate, so I'm not saying they have broken any rules. However, investors need to be aware that the profits are all coming from fairly aggressive capitalisation of costs into intangible assets.

Note that it doesn't appear to have paid any dividends in recent years either.

My opinion - I don't like it, for the reasons given above.

There's literally nothing else of interest today, which is handy as I've also run out of time!

Have a great weekend, and see you back here on Monday morning.

Regards, Paul.

(Paul has no long or short positions in the companies mentioned today.

A fund management company with which Paul is associated may hold positions in companies mentioned.

NB. These reports are just personal opinion, and never financial advice or recommendations)