Small Cap Value Report (Fri 1 July 2022) - UBG, MYSL, REAT, XPF

Good evening/morning, it's just Paul here for Friday (Graham does Mon-Thu). Today's report is now finished. Enjoy the weekend everyone!

Congratulations to Simon Thompson for winning Journalist of the Year at the Small Cap Awards last night (run by Master Investor). He normally wins it most years. Still, it was nice that I was included as one of the 5 nominees.

 I had a good chat with Unbound (LON:UBG) (I hold) yesterday afternoon, and have typed up the key points below.

Agenda -

From yesterday - my notes from a call with the Unbound (LON:UBG) (I hold), to clarify some reader questions & misunderstandings.

UPDATE at 11:22 - There wasn't anything interesting on the RNS today, so I've had a lazy morning, and will now look back at React (LON:REAT) ad XP Factory (LON:XPF) updates from earlier this week. Sections should be up by 3pm.

Mysale (LON:MYSL) [No section below] - this has come up on the top % risers today, up almost 200% (from a very low base of 1.25p). The excitement seems to be due to Mike Ashley's Frasers (LON:FRAS) emerging with a new 28.5% stake. He must have taken several of the major shareholders, maybe including Philip Green's 16.3% stake? Or if it's someone else, then Green, Ashley, and Schroders would together hold a controlling 59.7%. We saw what happened at Studio Retail when Ashley & Schroders teamed up - they bought it for a quid, and other shareholders got wiped out. For that reason, I wouldn't touch MYSL. It's a rubbish business too, which never lived up to the promises, and is now in decline & loss-making. I wouldn't bank on the founding Jackson brothers being able to hold off the vultures. Still, if it all goes wrong for them, the Jacksons could just blame it on the boogie! ;-)

React (LON:REAT) - Interims look uninspiring (around breakeven), but a recent acquisition should transform future results, as it's a high margin window-cleaning business. I was expecting to dismiss this share again, but on closer inspection there might be some potential here, if more good acquisitions can be made. The problem is that equity is on a low rating, so each acquisition is likely to require considerable further dilution - so EPS could remain depressed.

XP Factory (LON:XPF) - an interesting concept, which looks tons better since the acquisition of Boom Battle Bars. The share price is coming down nicely, and starting to look interesting as a long-term buy & hold. Sites are being rolled out quickly now, some owned, some franchised. I think this share looks interesting, but there's probably no rush to buy just yet.

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Unbound (LON:UBG)

Q&A with the company, yesterday

How does this marketplace concept work, and what is it?

It’s a new website, UnboundGroup.com and we’ll drive traffic there from Hotter Shoes database.

It’s a way to leverage more products to our existing database of 4.6m consumers.

Will not use a single penny of working capital - it’s a drop ship model, as you correctly said.

Products & services will be curated, specific for our target audience - e.g. if a customer buys walking boots from Hotter, then we’ll target outdoor clothing to her, from partner Rohan, which has a strong store presence, but wants to grow their online sales.

Other existing sales channels include 17 standalone stores, and 8 garden centre concessions.

I asked to discuss the garden centres more - low cost to set up, they do have to be staffed. CFO has previously said on a webinar that all 8 sites are profitable.

Looking to roll out more garden centre concessions. How many? Not saying at the moment, as scoping out an expansion plan. Payback time is quick from new sites.

Garden centres are perfect demographic for Hotter, and many customers will know the brand already, as lapsed customers of shops since closed. Use 3D scanners to get exact size & shape of customers feet, reduces returns. Have full range, but not necessarily every size option, so some orders despatched from the distribution centre.

Returns rate is low compared with online fashion, in the low 20%’s. Combined with high gross margin of 68%, this is good business.

How about posting out traditional catalogues? Yes we do this, about 800k per month sent out. Can add third-party products into catalogues very easily, for minimal extra spend - a couple more pages in a brochure that’s already being sent out, is very little extra cost.

Very sophisticated marketing analysis is done in house.

The whole strategy can be summed up as “leverage” - little extra cost, to leverage existing marketing spend to drive extra sales, from curated third party products/services.

Hotter Shoes factory has 3x capacity, was doing £100m revenues before shops were closed in restructuring during pandemic. Hence want to recover those lost customers through online, concessions, etc. So have the capacity to scale up.

Everything being done is low risk, and low cost.

Results for FY 1/2022 showed £52m revenues, and £5.6m EBITDA, so current share price is 2x EBITDA. I pushed back against this, saying many private investors don’t like EBITDA (that’s useful feedback they replied), especially after IFRS 16 has made the numbers nonsense. CFO clarified EBITDA was £3.8m pre-IFRS 16. Also that doesn’t take into account net debt. But I think we agreed the shares are cheap for a profitable, growing company.

How many of 4.6m people on database are active customers? We’ve not disclosed that, but over 1m respond, and have bought something in the past. Some dormant customers might not want to switch to digital channels, so that’s where garden centre expansion could unlock those customers - cheap, and profitable way to do a low risk retail roll out.

We’ve taken on board feedback from your readers today, and have learned that we need to be clearer in future RNSs. We should have said specifically that we’re using a drop ship model, with little to no costs or working capital.

My opinion - it seems obvious to me that, being a new listing, the company has not yet got its message, business model, strategy out there to the private investor community. At £11m market cap, we are the buyers of the shares, instis are not going to be interested in something this small. Hence the change of brokers is a good move, that was an obvious mismatch, inherited from Electra.

I think the reader comments in yesterday's SCVR reinforced that UBG has just not explained its business model to the investing community. So I urge people to take a look at existing webinar recordings out there - on InvestorMeetCompany from 3 Dec 2021, and a Capital Markets Day webinar from 15 Sept 2021 on Unbound's own website. Maybe it would be better to check out this information before condemning the business model on your own invented, alternative facts?!!  There again, as the company accepts, it should have explained everything more clearly in the RNS, and not just assumed that we all understood the business model.

Overall, I think UBG shares look cheap at £11m market cap. It's a good brand, with a high gross margin, profitable, and growing. In a bull market, this would possibly be valued at 2-3 times the current price, in my opinion.

Downside risk? I don't like the bank debt, so there's a possibility of dilution, if the economy really craters. There again, as with Saga (LON:SAGA) (I hold), supplying niche product/services to affluent pensioners, is probably one of the best places to be currently.

Would I want to hold if the market cap was £30m+? No. But it's £11m, and that's too cheap, I reckon.

The marketplace platform is a sound idea I think, and involves little to no risk. 

Some reader comments yesterday were inaccurate, so I hope its been useful clarifying the facts here.

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React (LON:REAT)

1.0p

Market cap £11m

Half-year Report

Very small, but I know some readers like it, so I glanced through the interims last night.

It’s an acquisition vehicle for specialist cleaning companies. Which just doesn’t interest me at all, as these companies are two a penny, usually run privately (owner-managed), and being so competitive, margins are thin. So why would you want to focus on building a sector consolidator, in this sector? I don’t see the logic for that at all. What are the scope for synergies? I don’t see any, maybe discounts for bulk-buying cleaning fluids? Although my view does change somewhat further down, so keep reading!

Here are my notes -

H1 Revenue doubled to £5.1m

Big drop in gross margin, from 41% H1 last year (LY), to 23% H1 this year (TY)

Trading around breakeven.

Big fundraise, about half the market cap, in April 2022, raising £5.5m

Bought Laddersfree post period end, for up to £8.5m - highly material to the company’s future, given that the group market cap is £11m. Laddersfree is a commercial window cleaning business.

Balance sheet - nothing, once intangibles are eliminated.

Current trading in line.

Laddersfree - is said to have revenues of £3.0m (flat vs LY) in FY 11/2021, and a very high profit before tax of £1.4m. Normalised adj EBITDA was £1.2m (these figures are from the acquisition announcement of 12 May 2022).

I’ve looked at Laddersfree’s accounts at companies house, and it does indeed look a highly profitable & cash generative little business. Who knew that window cleaning could be so lucrative? Maybe I’ve missed my calling in life! Where did I put that bucket…

Another thing to bear in mind, is that Directors of private companies often pay themselves a low salary, instead being paid mainly with divis, as that reduces NIC charges. This inflates profit numbers. So when consolidated into a listed company, the Directors have to be paid proper salaries, which can reduce profits a lot. It’s not clear if that has been done in the “normalised” figure given above.

My opinion - the Laddersfree acquisition does look transformative, in that REAT should now start making meaningful profits. Funds were last raised at 1.2p (a deep discount at the time, which upset existing holders), causing a lot of dilution. REAT will clearly have to keep raising more fresh equity, to do more acquisitions. The last acquisition almost doubled the share count, to over a billion. It needs to do a 100:1 consolidation I think, to stop the share price looking mickey mouse, at just 1p. My worry is that the Directors have shown they are happy to issue lots of new shares, at a deep discount, in order to get deals done. Directors don't seem to hold much skin in the game themselves, which again is a worry.

On broker consensus, the forward PER is about 6.5, which looks reasonable.

This share is a straightforward punt on Mark Braund’s acquisition skills. He’s got to buy good businesses on very cheap earnings multiples, since his own paper is on a very low multiple. The trick with successful acquisition vehicles, is to get your own paper highly rated, say a PER of >20, then make acquisitions on a PER of something like 6 or 7, maybe half funded with debt. That allows EPS to rise rapidly, and creates shareholder value, which is the strategy executed so brilliantly by David Cicurel of Judges Scientific (LON:JDG) . He identified a sector where many small, highly profitable companies could be consolidated, e.g. when owner-managers of specialist scientific instruments companies wanted to retire. I remain to be convinced that there’s such a good opportunity in the contract cleaning sector, but who knows - the numbers from Laddersfree do look impressive, and there’s also the chance of organic growth, to expand it nationally.

Overall then, with a fresh look today, this is actually looking better than my preconception. It could be an interesting punt, but likely to be plagued with continuous dilution, to fund more acquisitions, which could prevent the share price from achieving take off velocity. It’s difficult to see now how a low-multiple share, is a good method to consolidate a cheap sector. So I expect to see management constantly doing the rounds, trying to generate buying interest so that this share re-rates to a higher margin, with shareholders then being clobbered with more dilution for each new acquisition. It’s possible that might work, so I’ll keep an eye on it.

I think this share got a bit rampy around the time of the pandemic, with people chasing it too high. Although the valuation now looks a lot more sensible -

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XP Factory (LON:XPF)

17p

Market cap £26m

I last covered this escape rooms/bars group here in May, and was starting to warm to the concept, although high valuation was the deal-breaker for me at 26p per share (£39m mkt cap, for an essentially unproven business model).The escape rooms don’t really interest me as a concept, but the acquisition of Boom Battle Bars looks a lot more significant - competitive socialising, a very popular concept for bars these days.

Revolution Bars (LON:RBG) (I hold) have successfully trialled a similar concept, so expect to hear more of these gaming themed bars coming to a High Street near you! Landlords like them too - RBG’s CEO recently said in a webinar that they had lost out on a couple of good new sites, to a competitor whose gaming format was preferred by the landlord, to a conventional cocktail bar format from RBG.

Stockopedia subscriber, Fiddlesticks posted an excellent comment here, which helpfully provided the financial model for the roll-out via franchisees of the Boom Battle sites. It looks a cracking set up, with XPD receiving a 10% revenue share. That’s so good actually, that I suspect franchisees are likely to become disillusioned, once they realise that most or even all of the profit is going to be siphoned off by XPF - possible risk there?

Anyway, with the shares now down from 26p to just 17p, (mkt cap £26m) is it cheap enough to get me interested now? Let’s have a look at the latest

AGM Statement - from 2 days ago, 29 June 2022.

XP Factory (AIM: XPF.), a group of leading UK experiential leisure businesses operating under the Escape Hunt™ and Boom Battle Bar™ ("Boom") brands, is pleased to provide an update on trading …

This builds on the update in May, so it’s only really 1 month (June) additional info.

2 new Boom sites have opened. Total is now 17 (4 operated by the company, 13 franchised)

6 new sites being built (3 company, 3 franchised)

Pipeline is for a further 20 sites, of which 8 are at an advanced stage - so this is quite a rapid roll-out underway - interesting.

On track to have 27 Boom sites open by end Dec 2022.

Confident that site dynamics previously forecast will be achieved.

Franchised sites performing in line with expectations. Although it’s strange this was not specifically stated above for the company managed sites.

Inflationary pressures on fit out costs, but return on capital “remains highly attractive”. This is badly worded & confusing -

The return on capital expected from Boom owner operated sites remains highly attractive, notwithstanding inflationary pressures to fit out costs, with target cash on cash returns in excess of 50% still achievable taking account of landlord contributions and rent-free periods

Escape Hunt sites - performing well, ahead of expectations in Q1, in line in Q2 (for company operated sites).

More sites being opened.

Cash of £6.8m at end May 2022 (why not give the end June, current figure?)

Some site openings delayed a few months, which I don’t think matters really.

My opinion - do check out my notes on the FY 12/2021 results here, as there are some important points, e.g. potential dilution from contingent consideration relating to the Boom acquisition.

Today's announcement reads as a bit vague, and over-PR'd in places. Which arouses suspicion, more than glossing over potential negatives.

As we know, hospitality is a really tough area right now, with consumer incomes squeezed by inflation, and high gross margins in the sector meaning that there’s a leveraged impact on profit when demand softens.

That said, the best operators do fine, even in recessions.

XPF has a novel format in the Boom bars, being rolled out rapidly, partly funded by franchisees, in a property market where very attractive deals are available.

I’m increasingly drawn to this share, and think it could make a decent long-term purchase, once the economy/stock market are on a firmer footing.

I don’t think there’s any solvency risk, helped by some sites being franchised, a nice mixture actually.

It’s interesting to compare the charts of RBG (I hold) and XPF. It depends where you set the starting point, but I’ve based the below on just before the pandemic started. As you can see, the higher line is XP Factory, which had a big boom, starting in Oct 2020 (when a major stock market rally started on the vaccines being launched). XPF then got way ahead of events, in the summer of 2021, and it’s been downhill ever since.

This chart suggests there might still be some newness premium in XPF shares, compared with the (unjustified) staleness in RBG shares, despite RBG trading well, and refurbishing its stores, and with 2 new formats ready to roll out.

So for me, RBG remains far better value, but at some point, I could be tempted to supplement that with a small starter position in XPF. I’d want it cheaper than the current price though - why pay up, when markets are throwing bargains at us every day?

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