Good morning!
Small-cap news today from our universe of stocks is limited:
- 600 (LON:SIXH) (trading update)
- IQE (LON:IQE) (grants share options to CEO/CFO)
- Checkit (LON:CKT) (concert party increases stake)
- AdEPT Technology (LON:ADT) (placing and subscription)
After I've covered these, I might say a few words on the recent deal by Volvere (LON:VLE).
Timings: finished at 2.30pm.
China Supply Chains & Coronavirus - Paul asked me to provide a link to the interview he published yesterday on his website, on a timely topic. Here's the link to the interview with the MD of UP Global Sourcing Holdings (LON:UPGS).
600 (LON:SIXH)
- Share price: 11.25p (-20%)
- No. of shares: 117.5 million
- Market cap: £13 million
This industrial group already issued a profit warning in December, triggered by "certain macro economic and political uncertainties" and "the global automotive slowdown".
Things have only got worse since then. The company cites the following factors:
- the strike by a union at General Motors (but this has been over since October)
- suspension of Boeing 737 MAX
- two specific projects being pushed back
- Coronavirus - revenue from sales into China is being delayed into the next financial year (after March).
It all means that the result for FY March 2020 will be significantly below the revised expectations, i.e. we have a follow-on profit warning.
Debt - the company has been trying to derisk, both operationally and financially. The failure to get a good result this year is clearly going to have an impact on those objectives.
Net debt as of September 2019 was $16.9 million (£13 million).
If the share price gets above 20p, the £8.5 million in outstanding loan notes would convert to equity. But as things stand, these loan notes are set to mature in February 2022 and will need to be paid for with cash
My view.
The P/E multiple has been cheap here for a while. Frustratingly for shareholders, it's starting to look like the market's scepticism was correct.
Despite getting rid of its pension scheme, the company still seems to be in a bit of a mess in terms of its balance sheet. And with trading so volatile and unpredictable, affected by so many factors beyond its control, it's hard to have any confidence in future performance.
600 (LON:SIXH) was supposed to earn PBT of $2.5 million this year, from revenues of $70.8 million.
The house broker has this morning reduced its revenue forecast for the company to $62.6 million, and the PBT estimate to $1.2 million (this is what happens when operational gearing goes into reverse).
The net debt estimate is increased to $18.2 million, which I think is after accounting for the $0.5 million disposal of a site in Colchester.
If the share price doesn't improve significantly over the next two years, to enable conversion of the loan notes, we can only hope that they see their maturity extended again or are refinanced in some other way. Finding the cash to settle them would be a challenge, to say the least!
The interest bill has been running at around $1.2 million annually, which just seems too high relative to profitability.
In other words, the business is walking a financial tightrope. If it was my company, I'd want to inject some fresh equity into it.
Stockopedia correctly categorises it as Contrarian. Damn right - you'd have to be very courageous to buy shares in this today!
Fortune favours the brave, but I'm infinitely happier on the sidelines watching this one.
IQE (LON:IQE)
- Share price: 57.75p (-1%)
- No. of shares: 796 million
- Market cap: £460 million
Semiconductor company IQE's shares weakened on Tuesday, in response to news from Apple that it was going to miss its own targets, due to Coronavirus disruption.
Sell-side analysts speculated that the problem could hurt IQE's revenues by a "mid-single digit percentage".
It was the latest in a long line of setbacks on the "wall of misery" which has seen IQE shares drop from over 170p in late 2017, to their current level.
Controversial pay practices
Today we get some information about the latest LTIP plan for IQE's CEO and CFO. They are getting 2.7 million nil-cost options, subject to EPS and TSR (total shareholder return) criteria.
I approved of the recent letter written by Mark Slater to the Remuneration Committee of each of his company's holdings.
In it, he made a couple of points where I also bang the drum:
- nil-cost options are not the right way to align interests
- similarly, there are problems with using "adjusted EPS" as the measurement of success.
IQE continues to use the framework of nil-cost options and EPS as the primary metric for the vesting of options, as do many other companies.
Its shareholders tried to rebel against IQE's remuneration schemes at the recent AGM, after an advisory body warned that total dilution over a 10-year period was beyond acceptable limits (15%), and that conditions relating to early leavers were too generous. See my December article.
IQE responded by saying that it would, over time, try to reduce dilution from options to below 10%, although it wasn't "feasible" to do it immediately, based on options already granted.
The right way to do things (a personal view)
I've said this before, but I favour bonus schemes which are paid in cash, not in equity options. I want companies to treat their equity as if it's something rare and valuable, like gold-dust, not to be diluted.
Handing out millions of options betrays a mindset that the equity is just paper and that there's an endless supply of it . Why would I want to own something which is in infinite supply? The IQE share count has been rising steadily for years.
If options do have to be used, then options at the current share price (instead of nil-cost options) would at least help to align management with shareholders - since managers will only benefit from their options if shareholders enjoy a capital gain.
Performance Criteria - I also prefer bonus schemes which are triggered by ROCE and operational key performance indicators, instead of EPS or share price movements.
ROCE takes into account the amount of funding (both debt and equity) used by the company, and operational KPIs can be finely tuned to the company's goals. EPS is not the worst metric by any means (EBITDA gets that prize), but I still think it's far from the best.
IQE - a worrying track record
I'll need to see the latest annual report (2019) for an updated picture at IQE. For 2018, remuneration at the company definitely looked to be on the high side (bear in mind that operating profit that year was £8.7 million):
- CEO was paid £3.7 million (of which £3 million was from the 2016 LTIP)
- COO was paid £2.5 million (of which £2 million was from the 2016 LTIP)
In addition to the LTIP, bonuses worth 20% of salary were paid to the CEO and COO, despite the fact that they hadn't hit their financial targets:
Financial objectives (EBITDA and cashflow measures) were not met in 2018, however the Committee exercised modest discretion to ensure fairness for shareholders and participants and to avoid unintended outcomes.
The feared unintended outcome was that the participants would leave to work for another semiconductor company, I wonder?
The 2016 LTIP, which matured in 2018, saw nearly 8 million nil-cost options vesting in favour of the CEO and COO.
I've never been terribly impressed by this company as an investment proposition. And with its allegedly excessive pay now a point of focus, I think its fair to ask questions about the sort of corporate culture that has allowed such a huge amount of potential dilution from options schemes.
Checkit (LON:CKT)
- Share price: 39.5p (+8%)
- No. of shares: 62 million
- Market cap: £24 million
PDMR Dealing and Concert Party Holdings
I'm not very close to this story but it seems significant that the Chairman would pick up another 2.5 million shares, at a price of 36p. He now owns 13 million shares.
The CEO and Chairman are considered to be a "concert party" (working together in concert). Together, they own 13.7 million shares.
Only a week ago, the Chairman picked up 2 million shares at 32p. He clearly has a big appetite around that level!
Checkit had a big tender offer at 65p in December, after it made a large disposal. I see that the Chairman sold nearly 15 million shares at that level. So I guess he is using the proceeds from that deal to buy back at a cheaper level!
According to a Feb 13th trading update, Checkit had cash of £14.3 million, sales were running above market expectations, and the Board was "excited by the medium-term prospects".
Consensus forecasts suggest that it will be loss-making for the next few years. Against that, the level of conviction shown by the Chairman with his purchases is mightily impressive.
AdEPT Technology (LON:ADT)
- Share price: 322p (-10.6%)
- No. of shares: 23.7 million
- Market cap: £76 million
We very rarely look at this IT/telecom managed services company - here's the most recent coverage, in July.
Back then, I was impressed with certain aspects of the company, but I also noticed that it was suffering a lot of acquisition-related expenses, and seemed to be very near the limit of its loan facility.
It now seeks to raise £4 million at 320p - a 9% discount to yesterday's closing price.
The rationale is very broad, but the reduction of debt is the first reason given:
Net proceeds of the Placing and Subscription will be used in support of the Company's stated strategyto reduce indebtedness, finance potential acquisition opportunities, accelerate Project Fusion "One AdEPT" and for ongoing working capital requirements. Alongside the delivery of long term, sustainable organic growth, the Board believes that selective acquisitions will continue to provide an expedited route to growth...
Trading update - trading is in line with expectations.
My view - I doubt that the company wanted to raise this money. However, it may have pushed things a little too far against its RCF. At its half-year report, published in November, it said that its multiple of senior debt to EBITDA had increased to 2.58x - this is getting on the high side.
That said, an additional £4 million is not exactly going to transform the balance sheet. It will give a little more breathing room, especially if more acquisitions are on the cards soon.
Personally, I like to see companies letting their acquisitions bed in for a while, and digesting them properly, before pursuing more deals. I wonder how soon Adept plans to buy something new?
Volvere (LON:VLE)
- Share price: 1225p (-2.4%)
- No. of shares: 1.8 million
- Market cap: £22 million
This is a silly 20% of my portfolio at the moment, by far my largest position.
It has been a long time since Volvere made an acquisition - nearly five years, I think.
Since it's supposed to be in the business of acquiring companies, that's a long time to wait between deals.
Of course, the managers were busy during that time - in addition to looking for acquisitions, they were taking excellent care of the existent portfolio (most of which has been sold off for very attractive returns).
Still, one gets the sense that they take the Warren Buffett maxim, that investors should wait for a "fat pitch", to an extreme level. Five years without a purchase, despite having oodles of cash at hand, must have required an incredible amount of restraint.
That sort of restraint is in fact why I've backed them. They have two rare and invaluable characteristics:
- Opportunism.
- A focus on capital preservation.
Opportunism means waiting as long as it takes to get a really good deal. It means turning down hundreds (probably thousands) of potential deals, until the right one comes along.
With the recent acquisition of Indulgence Patisserie, Volvere has not paid more than the value of net assets acquired (freehold property and plant and equipment).
They have bought it out of administration, which means buying it from its creditors. This is completely in line with the Volvere strategy to buy companies in need of a turnaround plan (often because they are in financial distress).
The pricing for these sorts of deals can be very good, since A) the sellers want to get rid of the assets without delay and B) these deals happen in private markets which are inefficient, compared to public markets.
Sales at Indulgence were £3.3 million during the eight months ending December 2019, during which time it made a small loss. If a better margin can be achieved from future sales, the purchase price of £1.25 million could turn out to be good value. One avenue that Volvere will pursue is to look for synergies with its other subsidiary, Shire Foods. Indulgence makes desserts, while Shire makes pies, pasties and sausage rolls.
The focus on capital preservation should also be clear. Shire had cash of £20 million in June, and it's only risking £1.25 million plus a working capital facility on this deal. If it doesn't work out as planned, Volvere will carry on and it might not take much of a loss (since it looks to have paid a discount to fair value for the net assets of Indulgence).
I'm happy to continue holding this one for the foreseeable future.
Calling it a day there. Thanks everyone, and have a great weekend!
Graham
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