Small Cap Value Report (Fri 14 Dec 2018) - GMD, FLK, MANO, CCS

Good morning!

Today we are covering:

• GAME Digital (LON:GMD)
• Fletcher King (LON:FLK)
• Manolete Partners (MANO)
• Crossword Cybersecurity (CCS)

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GAME Digital (LON:GMD)

• Share price: 23.8p (-5%)
• No. of shares: 173 million
• Market cap: £41 million

Proposed admission to trading on AIM

A couple of readers have asked me about GAME Digital (LON:GMD) 's proposed move to AIM from the Main Market. This was announced yesterday, prompting a 5% fall in the share price.

The shares are down by another 5% today, hinting at a delayed reaction to the news from some shareholders.

Let's consider the pros and cons.

Pros

• Saving costs. Comments by BDO in 2015 (PDF) suggested that an AIM listing was £150k/year cheaper than the main market. For a company with a market cap of £40 million, it is sensible to make that kind of saving. In general, companies of that size will find that AIM is more appropriate for them.
• Saving time. On top of the external costs, there are also internal costs to satisfy the more complex corporate governance requirements of a main-market listing. Life will be simpler and easier for Game on AIM.

Cons

• Weaker governance. Some current or prospective shareholders might be unable or unwilling to hold a company listed on AIM, due to the weaker corporate governance requirements. This is hardly going to apply to Mike Ashley (£SPD) or Miton (LON:MGR), though, who are the top two shareholders.
• Signals a lack of ambition? I'm not sure if this is fair criticism, but perhaps the proposed move can be interpreted as a sign that management do not think that their shares are materially undervalued. That they have no ambition to appeal to mainstream and larger investors in the future. That they are content to save a little bit of money in the short-term, and don't expect to return the company to anything like its previous valuation.

My view

Personally, I would view it as a positive that Game is moving to the junior market, from a cost saving point of view.

The negatives wouldn't bother me, as I think that the corporate governance requirements on AIM are adequate for a company of Game's size.

So rather than viewing this news as being symptomatic of a management team that lacks the ambition to justify a main-market listing, I would view it as a realistic acceptance that AIM is a more appropriate venue for the company.

75% of votes will need to be cast in favour of the move, so ultimately it will be for shareholders to decide, and it will happen only if those in opposition represent a small minority.

It's true that changes like this can cause a drag on a share price, as those dissidents who are unhappy with the move can generate a lot of selling pressure in the short-term. But my own view is that the underlying value of the shares has probably increased! So I would view it as a buying opportunity, if Game Digital was on my watchlist.

Would I buy the shares, given the discount to net cash and the average lease length of 0.9 years for its UK business? It's a tempting trade. Indeed, it's one that I've previously made some money from.

The problem is that the company's overall outlook remains highly uncertain, in the face of increasing digital downloads and stiff competition. If I held these shares, I would again be looking for a quick bounce and a profitable exit. In other words, it's definitely not something I'd want to hold for the long-term!

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Fletcher King (LON:FLK)

• Share price: 45.5p (-4%)
• No. of shares: 9 million
• Market cap: £4 million

Half-year Report

We might reasonably ask why this company is listed, given its very small size.

It provides a range of property services and property fund management activities. Revenues (in £ millions) have never made it to double figures.

It has been possible to buy it as a "deep value" investment from time to time - see the work of Glen Arnold.

Some comments on the property market are worth noting:

• no end in sight for the decline of retail property
• online sales fueling demand for industrial space
• large offices in cities (incl. London) still in high demand
• on the other hand, the market for smaller offices is being severely disrupted by serviced office providers such as WeWorks.

This final point makes a lot of sense to me. I rent an office from such a provider and I love it! It's so convenient and it gives you nearly all the benefits of a large office from day one.

For small businesses and start-ups, the smart thing to do is use a serviced office provider, until you are so big that you need a traditional let.

Outlook

FLK is bearish on Brexit and its effect on the property market, saying that it will impact the company's ability to maintain turnover and profits.

My view

Market cap approximately matches up with FLK's book value, and this seems fair to me.

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Manolete Partners (MANO)

• Share price: 211p (+20% vs. 175p placing price)
• No. of shares: 43.6 million
• Market cap: £92 million

Admission to AIM

This is "a leading UK insolvency litigation financing company", so perhaps we can consider it to be a cross between Burford Capital (LON:BUR) and Begbies Traynor (LON:BEG).

Shares have popped up on its first day of trading - a nice bonus for placing participants.

Valuation

According to Jeremy Grime's note this morning, the company's NAV following the placing is £24 million, and it has an HSBC facility to help fund its activities.

As such, today's share price is approximately 3.8x Manolete's book value. For comparison, Burford is trading at 4.1x book value (my own calculations).

Checking last year's annual report, Manolete generated operating profit of £4.1 million, earning a massive return on equity. If it remains highly profitable now that it has a much larger asset base, then I would expect it to trade at a Burford-like multiple of book value. But Burford, as the vastly larger entity, with many years under its belt as a public company, should probably command a premium.

My view

It seems magical to me that litigation financing can generate such high returns.

For example, according to Manolete, it has "achieved IRRs of over 200% on completed cases, on a consistent annual basis, over each of the last seven years".

Perhaps I should suspend my disbelief that such returns are sustainable, and get on board with one of these companies?

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Crossword Cybersecurity (CCS)

• Share price: 270p (-15%)
• No. of shares: 4.7 million
• Market cap: £13 million

Admission to AIM

A new entrant to AIM, although it has been promoted from NEX rather than demoted from the Main Market.

It aims to commercialise academic research into new cybersecurity products, and also provides a range of consulting services.

So far, it is still very small and unprofitable: revenues of £540k in H1 of this year, and a pre-tax loss of £820k.

It's too early-stage for me. Perhaps someone else will find it to be of interest.

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There's nothing else in the RNS that's worth writing about, so I'll leave it there.

Since this SCVR is shorter than usual, let me tell you a story.

On Sunday morning, my dog Frank was suffering. He was flinching in pain, he was walking funny, and he didn't want to eat. One of his eyes was bloodshot. He was trembling. In a word, he was miserable. He had been fine the day before.

(Similar to my dog.)

The vet initially thought it sounded like he was having a vestibular episode. He immediately received a heavy dose of morphine, to ease the pain.

The next day, he received a general anaesthetic so that his mouth could be inspected properly and he could be operated upon, if necessary (he doesn't let anyone inspect his mouth while he's awake!)

Well, it turns out that the answer was very simple. If you're squeamish, you should probably stop reading now.

Poor Frank had tried to eat a sharp sewing needle.

Thankfully, he hadn't swallowed it. Almost as bad as swallowing it, however, was that he had chewed it, and it had become lodged in his head. It had gone vertically upwards, through his mouth behind his back teeth, nearly reaching the top of his skull. It had pierced the fatty tissue behind his eyeball, causing the bloodshot appearance.

No wonder he was unhappy!

While he was unconscious, the vet removed the needle and also performed an operation on his mouth. It took a day or so for the drugs to wear off but I'm pleased to report that he is already back to his usual self.

There's no SCVR-related point to this story, except that you can imagine it caused me quite a lot of worry over the past few days. He has been a good friend of mine for the past 13 years and I'm glad we'll have another Christmas together. It could have been so much worse.

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Ok, that's it for now. Have a good weekend, everyone!

Graham