Small Cap Value Report (Fri 22 July 2022) - UBG, SGI

Good morning, it's just Paul here today (as Graham does 4 days, and Friday's are usually quiet enough for me to manage on my own). There's hardly any company news today, so I'll work on some backlog items instead, hence a full report should be up by 1pm.

Podcasts

Tomorrow I'll be publishing the 4th episode of my SCVR summary podcast, on my personal podcast website here. It's a Stockopedia thing really, I just publish it myself so as not to create any admin for the busy team at HQ. The audio can be downloaded on wifi very easily (click the 3 dots, and select download) for listening on the move. I'll look into how to get it onto a proper podcast platform at some stage, but want to keep it as simple & quick to do as possible for now, to get into a manageable routine.

New podcast (today) - I've just interviewed renowned investor Richard Crow, who talks us through his favourite share ideas, his stock selection process, and his surprisingly upbeat current market overview.

Doing podcasts is good fun, and feedback from listeners has been positive. With the SCVRs, the information is already fresh in my mind, so it makes sense to recycle it into a podcast at the weekend. Also, I do enjoy making podcasts, and am much more relaxed about it now, having done quite a few. It's not life or death, so if something goes wrong, it doesn't really matter!

Agenda - 

Unbound (LON:UBG) - a shocking announcement last night, of a large discounted placing, and a huge hole in the forecasts, despite previous (now clearly false) in line trading updates. I feel very let down about this one, and let rip about it below, in detail. Apologies to readers, we've been led up the garden path it seems, although I don't think current events could have been foreseen (wildly wrong forecasts from the company/broker).

Stanley Gibbons (LON:SGI) - announces it is delisting, at the request of the 58% controlling shareholder. An exit price of 1.5p is offered, which looks fair. In a bear market, delisting risk increases considerably for micro caps, as liquidity dries up. So that's something to think about, for holders of the tiniest companies' shares.

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Explanatory notes -

A quick reminder that we don’t recommend any stocks. We aim to review trading updates & results of the day and offer our opinions on them as possible candidates for further research if they interest you. Our opinions will sometimes turn out to be right, and sometimes wrong, because it's anybody's guess what direction market sentiment will take & nobody can predict the future with certainty. We are analysing the company fundamentals, not trying to predict market sentiment.

We stick to companies that have issued news on the day, with market caps up to about £700m. We avoid the smallest, and most speculative companies, and also avoid a few specialist sectors (e.g. natural resources, pharma/biotech).

A key assumption is that readers DYOR (do your own research), and make your own investment decisions. Reader comments are welcomed - please be civil, rational, and include the company name/ticker, otherwise people won't necessarily know what company you are referring to.

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Paul’s Section:

Stanley Gibbons (LON:SGI)

1.45p (before market opens)

Market cap £6.2m

Proposed Delisting

After a long stint (over 20 years) on AIM, and producing a dismal performance for shareholders, SGI is proposing to bow out. It is controlled by 58% shareholder Phoenix Asset Mgt, which has understandably concluded that there’s no point in maintaining the cost & hassle of a stock market listing.

The reasons provided below are worth pondering, for read-across to other tiny, illiquid shares, and clearly make sense. Point 3 is an interesting one, that being listed and the disclosures given, educates the competition, so is actually a drawback commercially -

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There’s a sting in the tail too - a threat to withdraw financial support, if shareholders don’t agree to Phoenix’s demands.

On the upside, Phoenix says it will buy shares in the market, at 1.5p (slightly above the current price) for anyone that wants to sell. That’s rather decent of them I think, as otherwise the share price might have halved, which is usual when delistings are announced.

My opinion - it’s difficult to argue with this. There’s no point in maintaining a listing for a micro cap with a controlling shareholder, and years of dismal financial performance.

The 1.5p exit looks completely fair to me, so nobody can really complain about this.

Investors need to think hard about delisting risk for micro caps generally. In bear markets, liquidity dries up, and plenty of the smallest companies leave the market. This can often be accompanied with a crash in share price. So if you can’t see any reason why one of your shares is listed, and it’s almost completely illiquid, then be careful. Especially if there’s a controlling shareholder who can force through a delisting.

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Unbound (LON:UBG) (I hold)

13.5p (down 39% at 08:06)

Market cap £5m (before placing)

Fundraising

Clearly this has been an unmitigated disaster, so my apologies for leading you down the same garden path that I’ve been led down. It’s now become obvious that we were sold a pup.

Management had previously denied that they needed to raise funding, and that only a small amount c.£1m might be raised, purely for expansion - they told me this directly, on a recent call, and sounded very relaxed about funding/liquidity (3 weeks ago). Which naturally makes me question management's integrity.

Last night a placing/subscription for £3.3m was announced, for 22.0m new shares, being a considerable 58% increase in share count from the existing 37.9m. (the RNS says it’s a 52% increase, so maybe they’ve included share options to reduce that % figure?)

Pricing - is 15p, a discount of 32% to the market price, which had already been in freefall for a while.

Singers have done the fundraise, and I think should be congratulated for getting it away at all, they must have called in some favours.

A city source tells me that the original fundraising proposal was a £5m placing + £1m open offer at 25p. That then reduced to 15-20p range, and ended up as £3.3m (under-subscribed) at 15p, due to lack of investor appetite. So if they say it was over-subscribed, that’s not true.

There is a £1m open offer, also at 15p, but with the share price currently (08:20) at 12-13p bid-offer, then the take up is likely to be little to nothing.

The 25p nominal value of the shares will have to be reduced, to allow a fundraising, but that should be a formality at a general meeting, using the standard mechanism of dividing existing shares into new, lower nominal value (1p in this case), and worthless deferred shares (24p theoretical value, but actually worthless).

Directors have put up £268k of the fundraise, 8.1% of the total, so some skin in the game there at least.

I don’t believe the reasons given by management for the fundraise - claimed to be for expansion. Since they previously said that would only need a small fundraise c.£1m, for expansion, then clearly trying to raise £6m originally, means there’s a deeper problem.

Current trading - only gives revenue & gross margin, not profits. But they are up on last year -

The Directors are pleased with the progress that Hotter Shoes has made in the current financial year to date. Revenues in the four months to 31 May 2022 were £16.9 million, up 12.5 per cent. on the prior year period (£15.0 million), with gross margin also improving to 68.7 per cent. (2021: 66.7 per cent.). This improvement in revenue partly reflects softer comparatives in the prior period…

Overall, Hotter Shoes continues to trade in line with the Board's expectations for the current year ending 5 February 2023.

Net debt - I’ve previously mentioned here that I was a bit worried about net debt, which looked too high. This certainly looks too high now -

Overall Group net debt was £9.7 million at 30 June 2022, comprising £10.1 million of net debt within Hotter and £0.4 million of cash held by the Company.

Forecasts were completely wrong - this bit is absolutely appalling. Market expectations come from the company, via brokers. So it seems, almost unbelievably, that the CFO forgot to budget for £2m of costs! He should be fired by close of play tonight, for total incompetence (and that’s being charitable) -

Furthermore, the Directors note that current consensus market expectations do not reflect any income or expenses associated with the Group's growth plans for the wider Unbound platform or other Group costs such as for the head office. The Directors estimate that these other Group costs will be approximately £2 million in FY23.

Although I'm not sure I believe this explanation, it could just be an excuse for under-performance and cost over-runs? A city source has told me this morning that brokers covering UBG insist their forecasts did include head office costs originally. It would be strange if they didn't.

Existing forecasts - I’ve downloaded the last 3 notes from Edison (commissioned, so the figures would have come from Unbound’s CFO) - and the forecast for FY 1/2023 was consistently £2.0m adj PBT, and 3.8p EPS.

Unbound had issued several trading updates this year, saying trading was in line with that. That's why I continued to hold the shares, because it looked increasingly cheap.

But we’re now told, almost as an aside, that they forgot to include £2m of costs. So actual performance is now likely to be just breakeven.

Once this came to light, the shares should have been immediately suspended. Instead, they kept quiet, and did a covert fundraising. These fundraisings take several weeks, so there has been a totally false market in UBG shares probably at least for July to date, maybe longer.

Highly material, price sensitive information was not disclosed to the market, when it clearly should have been, weeks ago. So rules have almost certainly been broken here.

The trouble is, the £3.3m fundraise, which will probably be under £3m after costs, probably won’t be enough to pacify a bank that is likely having kittens about being owed nearly £10m by a business that it thought was nicely profitable, but now turns out to be operating around breakeven.

My opinion - the new share count is likely to be about 60m (assuming little to no take up of the open offer), so currently at 12.5p, the new market cap would be about £7.5m.

Is that a bargain? Yesterday, I would have said yes, because the company had confirmed repeatedly that it was on track to make a profit of £2m this year.

Today we now know that the forecasts were wildly out, and the latest picture (if even this can be believed) would be about breakeven.

Almost £10m of debt, and a fundraise (net) likely to be c.£3m, would still leave net debt at about £7m. We’re not told what the bank’s position or attitude is, but I strongly believe this fundraising (attempting to raise £6m originally) was probably driven by the bank getting cold feet over the forecasts being completely wrong.

I think it’s important to focus here on what has specifically gone wrong, and learn the lessons from it. No doubt people will say that they never believed the business model, etc, which is fine, but that’s missing the point. What has specifically gone wrong here is this -

• Unbound was floated with too much debt, and this was glossed over in the demerger process.
• An incompetent CFO forgot to include £2m of costs in the budget, supposedly, and so should be replaced immediately with someone who can count!
• The market has been misled about forecast profitability. Surely this can’t have been deliberate, as it would have been discovered sooner or later? It just sounds like a gigantic and obvious mistake by the CFO. How on earth can you overlook £2m of head office costs when budgeting? It’s just unimaginable, speaking as a former CFO myself. You should have every detailed line of expenditure in your budgeting spreadsheet.

On the positive side, Hotter Shoes is a nice enough little business, which seems to have coped well in the pandemic, and more recently with supply chain & inflation. For me it was always a minor consideration, with Hostmore (LON:MORE) being the most interesting, and valuable part of Electra.

The jury’s out re the broader strategy to drop-ship complementary products, which seems low risk, and worth a try.

But for me, none of that matters now. The basis that I invested (or continued to hold after the demerger) was that this was a profitable business, with possible upside from a cheap, and low risk strategy to broaden the product range.

That’s no longer the case. We now have a business operating at breakeven (or worse, who knows what other skeletons there might be in the closet?), with too much debt, that has tried to raise £6m, but will probably end up with about £3m. With £7m remaining bank debt, which looks risky.

Risk:reward has completely changed, for the worse, a lot.

I don’t trust management and think they should be sacked by shareholders.

In particular, in good faith, I did a Q&A with management & posted my notes here on 1 July 2022. That was only 3 weeks ago. I don’t believe that management could have been blissfully unaware of their forecasts being wildly wrong, with a massive hole in them, just 3 weeks ago. So I feel used, and manipulated, to prop up the share price unwittingly, and given clearly false information about funding/profitability, which I then relayed to you here in good faith, since I wrongly believed it to be true.

Although to be fair, the other information, about the drop shipping model, was correct, and the reader comments the previous day were incorrect, about it requiring substantial working capital.

So I think we should be careful not to conflate those issues here.

What has gone wrong, has nothing to do with the business model. It’s a catastrophic failure of forecasting & funding, by totally incompetent management. They’ve got to go, and I don’t think there will be a chance to raise any more equity under this management, if at all. Therefore it's a possibility this share could end up at zero, if anything else goes wrong.

Sadly, the only conclusion I can come to, is Unbound is now uninvestable.

I’ve therefore decided to ditch my shares, and just take the loss, and learn from it.

Lessons to learn - the dust hasn’t settled yet, but I can already think of several things that I can learn from this -

• Opaque accounts - the problem with Unbound, is that it was the vestiges of Electra Private Equity, and it wasn’t clear what the clean figures just for Hotter Shoes would look like.
• Balance sheet - I didn’t focus enough on the financial position of Unbound as a standalone company. It’s now clear that it was left with too much debt, an error made by Electra, not the management of Unbound, who had to take what debt they were given, but maybe should have fought harder to have Hotter’s debt reduced by the cash pile at Electra before floating.
• Management - a lot of us thought that the fancy buzzwords used by the CEO in presentations sounded lightweight, but is that enough of a reason to avoid a share? Probably not. I don’t think anyone could have guessed that the CFO would be useless at budgeting, and make a £2m mistake in the forecasts. That’s just one of those things you can’t predict, unfortunately.
• New listing risk - we nearly always avoid new listings here at the SCVR, because they are so often over-priced and/or rubbish. Unbound was a bit different, because the price has always been set by the market (previously as Electra shares), and it looked like the businesses were undervalued, based on the information we had at the time. Although a consumer downturn & bear market in discretionary spend type companies has inevitably smashed the share prices of Hostmore (LON:MORE) and Unbound (LON:UBG) since they listed, which would have happened anyway. But clearly with UBG there’s been a lot more wrong under the surface too, which has only come to light today.

Profuse apologies from me on this one, I clearly got it horribly wrong, and was misled.

It fooled the StockRank system too, surprisingly -

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