Small Cap Value Report (9 Oct 2014) - GHT, SKP, VNET, SCPA

9th Oct '14 by Paul Scott

3 comments 13905 reads

Good morning! A bit of respite for us today, as the US markets bounced strongly yesterday evening.

Gresham Computing (LON:GHT)

Share price: 66p
No. shares: 63.2m
Market Cap: £41.7m

Profit warning - this software company today says;

However, we now expect that a number of new CTC contracts previously anticipated for 2014 will instead fall into 2015 and as a consequence the Board expects total revenue for 2014 to be 10%-15% lower than current market expectations. As a result, earnings for the full year 2014 are expected to be materially below current market expectations.

Timing of contract wins is usually a big problem for software companies, as they have fixed costs, but lumpy revenues, thus making profits unpredictable & volatile. That is the reason many software companies have instead tried to move to a SaaS model, where instead of paying a large up-front licence fee, customers instead pay smaller, but more regular payments, more like a hire charge than a one-off purchase.

My opinion - I've only mentioned this company once in these reports, on 5 Feb 2013, when I commented that the shares looked too expensive. There has always been a lot of hype around this company's shares, but the financial track record looks lacklustre, and undeserving of a premium rating in my view.

Note that its track record on free cashflow generation is very poor, which probably explains why it doesn't pay any divis. Sure enough if you check its cashflow statements, more than all the cashflow generated is spent on intangible assets (i.e. capitalised internal costs). Therefore it doesn't really make any profit at all.

There are lots of software companies which do this - capitalising a load of internal costs, thus reporting profits which aren't real. The lack of a decent dividend is the big tell. Also, the cashflow statement & Balance Sheet show you what is going on. Caveat emptor! I reckon that sooner or later the penny will drop, and a lot of small software companies that don't generate any cash at all will be heavily marked down in price.

I like software companies, but it's real cashflow, evidenced by a decent dividend, that is the litmus test for me.

SkyePharma (LON:SKP)

Share price: 323.5p
No. shares: 104.8m
Market Cap: £339.0m

Normally I don't go near the pharmaceutical sector, as I don't have the expertise…

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Aislabie

9th Oct '14

Back in June you noted that Hayward Tyler HAYT had "nothing very much to get excited about".
A trading update today suggests that it might be just about to get a little more interesting,
although without a dividend and a reduction in debt it still may not float your boat.
Full year results are,with "full visibility of the years results" and will "at least achieve market expectations" . The full visibility follows contract announcements that will form a substantial part of a years trading.
Interims for 30 Sept will be published 11 November (respectable timing) with an analyst meeting at Finncap on the same day. I like the feel of this.

I very much appreciate your daily work on this site, which I regard as a "must see" part of my daily routine. I want therefore to be sure that I am not abusing the house rules by mentioning another company that was not reviewed today.
Scapa SCPA has given an update today that seems positive and with their pension issues largely dealt with (as far as I can work this out) they would appear to be the sort of company to keep an eye on as a general price fall off in the market reveals a good price point

underscored

Just had a look at SkyePharma SkyePharma (LON:SKP) and have a few suggestions regarding their valuation. They are a "value added" generic manufacturer not a red hot biotech lottery ticket, there is no chance of a multi-billion dollar blockbuster in the foreseeable future. Even if they were involved with such a blockbuster, their business model seems have been to get a partner in to take the risk (and the main chunk of the upside).

That said I like this kind of business model, it takes know-how to achieve and they have attracted in some good partners with excellent in-house expertise of their own, GSK, J&J etc. Some of their developmental products are intriguing and thoughtful. -COPD medicine with theophylline, slow release capsules for insulin dependents. Nice to see people trying to solve real problems with existing technology rather than chasing the latest pathway published in Nature last year.

With regards to Flutiform:
Downsides:
-Possible headwinds moving forward in Europe. The EMA have approved a generic ICS/LABA from Teva at the beginning of this year. Although not the same drug as Flutiform and therefore not substitutable at the pharmacy, it is another cheaper alternative in the same market space.
-They have failed to get US FDA approval for Flutiform, Abbot bailed in 2010. The FDA have requested additional clinical studies to satisfy them, this is an expensive proposition and 4 years later they are still looking for a new partner. This is a shame as 1. the US is the biggest single asthma market, 2. margins in the US are normally higher vs the rest of the world 3. There is no regulatory pathway for generic inhaled ICS' in the US, so a much higher and persistent moat.

Upsides:
-Mundipharma are running a study to gain an indication to treat COPD. If this is can be approved then that is a whole new market.
-Asthma and COPD are growing disease, the total market is likely to continue increasing over time.

Small Cap Value Report (9 Oct 2014) - GHT, SKP, VNET, SCPA

Gresham Computing (LON:GHT)

SkyePharma (LON:SKP)

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Paul Scott

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