Small Cap Value Report (Fri 24 Jan 2020) - Trade alert, OTMP, SONG, REC, GTC, SMRT

Morning!

My initial impression is that the RNS feed is light today (quite normal for Fridays). There are updates from Onthemarket (LON:OTMP) and Hipgnosis Songs Fund (LON:SONG).

List for today (will evolve):

• Onthemarket (LON:OTMP)
• Hipgnosis Songs Fund (LON:SONG)
• Record (LON:REC)
• Getech (LON:GTC)
• Smartspace Software (LON:SMRT)

As per usual, I am happy to take requests and circle back to stories missed earlier in the week, on quiet days like this.

Timings: I'll be here until around 4pm.  Finished at 6pm.

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Trade alert

I've sold all of my shares in PCF (LON:PCF), again to fund the house purchase.

My top five portfolio holdings now add up to 63% of total portfolio value.

This is quite high, I guess. But when you look at it from the point of view of my entire financial situation, I don't think I've become any riskier. All the shares I've sold are being converted into a lower-risk asset (home equity).

In fact, when you think about it that way, I am now taking less risk on a total basis, even if my shares portfolio is becoming very concentrated.

This is something I learned when I was taking financial exams: portfolio analysis for an individual needs to take all of their assets into account: home equity/mortgage, business assets, investment portfolio, etc.

And this is one of the reasons why giving financial advice is so difficult, and can't be done  on a cookie-cutter basis. Shares and funds which make sense for one person might not make any sense for another person, depending on their individual circumstances, and their ability and willingness to take risk.

For the record, my current top five holdings and their percentage weights are:

• Volvere (LON:VLE) (18%)
• Burberry (LON:BRBY) (14%)
• H & T (LON:HAT) (12%)
• Berkshire Hathaway ($BRK.B) (11%)
• IG Group (LON:IGG) (9%)

The shares which I sold out of are:

• Creightons (LON:CRL)
• PCF (LON:PCF)
• B.P. Marsh & Partners (LON:BPM)
• Goco (LON:GOCO)

Please note that if it wasn't for the house purchase, I would still own all of these shares!

I was thinking this morning that when someone is lucky enough to have a very secure personal situation (a low mortgage, or no mortgage, and more income than outgoings) then they should be able to take a lot more risk in their equity portfolios. Because for them, what is the worst that can happen?

If their equity investments go bad, they still have a roof over their head, and their lifestyle shouldn't change too much. I guess there are a few assumptions involved here (e.g. that they didn't borrow to invest, and that their retirement plans are in place).

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Onthemarket (LON:OTMP)

• Share price: 76p (+6%)
• No. of shares: 70 million
• Market cap: £53 million

Bellway to list residential properties with OTM

This reminds me of the deal announced with Persimmon, which we discussed in this report back in November.

Now we have a deal with Bellway:

We are delighted that Bellway has decided to join us as we start the new year while we continue to broaden our property advertiser base and widen our appeal to active property-seekers.

And a comment from Bellway themselves:

We like the clear and simple way in which OnTheMarket displays its properties and have watched it make real headway as a leading portal over the last two years.

We are always looking for new ways to market our properties and finding new audiences who are serious about buying their next home. We look forward to entering this partnership with OnTheMarket and being part of its continued growth.

It's clear that these deals aren't exclusive. You can find Persimmon and Bellway homes on Rightmove (LON:RMV) (in which I have a long position).

It does mean that OTMP is increasing its total catalogue and becoming a more complete property portal. Not having the likes of Persimmon and Bellway on board was a glaring weakness, for a company trying to offer all-of-market coverage.

I need to put my hands up and say that I'm biased against OTMP, for a number of reasons:

• I have an aversion to speculative, unprofitable companies (OTMP is rated as a Sucker Stock by Stockopedia's algorithms).
• I've been writing negatively about it for a while, so it might be difficult for me to change my mind on it.
• I've been invested in Rightmove for a while, and done well with it. It would be convenient for me if Rightmove continued to control the industry.

OTMP is forecast to break even this year, and possibly turn in a meaningful profit next year (the financial year ending January 2022).

If the stars align for it, and estate agents back it with everything they've got, I can maybe see it stealing a noticeable amount of market share. But many consumers are entrenched in their habit of browsing Rightmove, and this is a sector where network effects are strong. Rightmove's well-invested user interface and functionality are clearly ahead of their competitors, in my view. Consider the excellent "Where can I live?" feature, for example.

What I think is more likely is that Rightmove and Zoopla could stop hiking their prices so aggressively, if they start to feel a competitive pressure from OTMP.

Rightmove's average revenue per advertiser has recently been growing at a rate of 10% p.a., indicating to me that it still enjoys lots of pricing power, despite the arrival of OTMP.

The way I see it, the worst-case scenario is that Rightmove allows its ARPA to flatline for a while, until the threat of OTMP goes away. In that scenario, Rightmove's shares would almost certainly fall from their current multiple of 30x, but the company's competitive position would be assured.   

Having said that, I don't yet believe that the threat posed by OTMP is very serious. Rightmove will release its 2019 earnings next month, and I expect a small loss of market share and a modest reduction in the rate of growth of ARPA. Nothing to get too concerned about, I hope!

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Hipgnosis Songs Fund (LON:SONG)

• Share price: 109.55p (+0.5%)
• No. of shares: 620.6 million
• Market cap: £680 million

Acquisition of Music Catalogue

As noted in the comments, there is no shortage of announcements from SONG about their acquisitions.

Let's just quickly get you up to date on this one.

SONG has acquired a music catalogue from Brian Higgins, collaborator with Cher and Girls Aloud. SONG will get his writer share in relation to 362 songs.

The most valuable songs are probably "Believe" by Cher and three #1 hits by Girls Aloud.

Higgins co-wrote Believe and "co-wrote or produced" the Girls Aloud songs.

His share might be quite small, depending on how many other writers were responsible for each song and what percentage of the writer share he is therefore entitled to.

For example, this background is from the Wikipedia entry for Believe:

A demo of "Believe", written by Brian Higgins, Matthew Gray, Stuart McLennen and Timothy Powell, circulated at Warner for months. Producer Mark Taylor said "everyone loved the chorus but not the rest of the song". Warner chairman Rob Dickins asked the production house Dreamhouse to work on the song. Taylor said their goal was to make a Cher dance record without alienating her fans.^[4] According to Taylor, "Two of our writers, Steve Torch and Paul Barry, got involved and eventually came up with a complete song that Rob and Cher were happy with."

I count six writers, not including Cher herself who says that she wrote a few of the lyrics.

Therefore, far from buying Believe, it's more reasonable to say that SONG has bought a fractional piece of its writer share - perhaps a small piece.

As usual, the financial details aren't given in terms of the price paid for the catalogue and the expected yield. 

My view - the most attractive feature of SONG is its lack of correlation with other companies and with the UK economy. Royalty income from songs with international appeal shouldn't change too much, whatever the UK economy might do.

NAV was 108.46p as of September 2019. If SONG aren't overpaying for the catalogues, then the returns from buying these shares around NAV should be ok!

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Record (LON:REC)

• Share price: 40.51p (+3%)
• No. of shares: 199 million
• Market cap: £81 million

Q3 Trading update (published last week)

I exited this in December, so I currently have no position in it.

It's a specialist currency manager, and a StockRank favourite - current rating is 99/100.

You can read my analysis of its recent interim results here.

Q3 update

Last week's update included a very pleasant surprise: performance fees of £1.8 million were earned in the quarter.

Record has allowed its basic management fees to decline, hoping to prove the value of its work to clients by putting greater emphasis on these bonuses.

In H1, no performance fees were earned at all - very depressing! As a consequence, pre-tax profit fell by 20% (despite growth in AUM).

Q3 was much better: more net inflows than the entire H1 period, and the positive performance fee.

Against that, the company continues to warn about competitive pressures on basic fee rates:

"Management fee rates held up in spite of continued competition and fee pressure.  Our focus remains on building on current business opportunities and on enhancement and innovation of our products and services."

This is the core reason I am out of the stock - I think that maintaining an edge in forex is very difficult. Neil Record produced extremely clever economic analysis of the currency markets, and created a successful business, but I don't know for how much longer it will remain competitive.

The secular decline in basic fee rates, and the plain-speaking warnings from management, indicate that the competitive edge will be difficult to maintain for the foreseeable future.

Performance fees will help to take up the slack, but are impossible for outsiders to predict. So they deserve a lower valuation than the guaranteed income from management fees.

More positively, there is no doubt that the company has made decent long-term progress in both client numbers and AUM (since 2014, client numbers have increased from 48 to 73, and AUM has increased from $51 billion to $64.7 billion).

The problem is that profit growth hasn't kept up with growth in client numbers and AUME - again, because of pricing pressures.

Record does have a great tendency to reward shareholders with dividends (and the occasional buyback), and Neil Record remains vigilant as Chairman with a 31% shareholding - it's unlikely that he will allow anything very stupid to happen, when he has a stake worth £25 million in a company which he lovingly built and put his name to.

So there are positives and negatives to take away, as always. I think the company will do ok, even if I don't have the conviction to keep holding it personally.

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Getech (LON:GTC)

• Share price: 22p (-14%)
• No. of shares: 37.6 million
• Market cap: £8 million

Financial update: 12 months to 31 December 2019

It's been ages since I looked at this one. It provides geological products and services. There is a correlation with the oil price, for obvious reasons!

This update starts off brilliantly:

Against what remains a volatile macroeconomic and commercial backdrop for oil and gas exploration spending, Getech increased its new forward sales by 41%, expanded its orderbook by 48% and the Group's cash balance closed the year at c£3.6 million (31 December 2018: £1.4 million).

It goes on to say that it is creating more recurring revenue, improving visibility and reducing the lumpiness of the business - lovely.

But it hasn't been achieved yet, and certain lumpy transactions still need to be sorted out. They've been delayed, and so we get a sales miss and profit warning:

The fact that they did not complete in 2019... is expected to result in a c £2 million year-on-year fall in revenue.

Thanks to reduced costs, the company still expects positive EBITDA of £0.6 million - £0.8 million (last year: £1.1 million).

The statutory result will probably be very bad - there is £3.1 million in goodwill which is set to be partially impaired.

CEO comment

Alongside the growth delivered in 2018, this highlights how Getech's earnings remain exposed to lumpy transactions, the exact timings of which can be difficult to influence. We are however strategically driving significant growth in our orderbook to progressively lessen this exposure. We also work to protect Getech and its profitability from year-end risk through careful capital management.

We have begun 2020 with a full and diverse sales pipeline, this benefiting from 2019 sales campaigns in new regions, with new potential customers. Our focus is to realise the value of this pipeline and in January 2020 we have already added a new supermajor Globe customer....

My view

The long-term track record here is ok. The company paid dividends until 2015, when it made a £4.3 million acquisition (of which £3.1 million is the goodwill that is now up for impairment).

Aside from that acquisition, which apparently hasn't worked out, the track record is not bad. Stocko gives it a Quality Rank of 60.

And I like the strategic direction, of trying to figure out a way to earn more recurring revenue.

Someone who can familiarise themselves with Getech's products and services might have the level of comfort needed to invest here.

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Smartspace Software (LON:SMRT)

• Share price: 32.5p (was 44.5p before the trading statement)
• No. of shares: 22 milion
• Market cap: £7 million

Trading statement (Thursday)

This company makes the products which enable "smart" offices.

My reponse to this update: Ouch.

While the Company has made good progress and is in advanced stage contract negotiations, the [Enterprise business] has been informed that one of its key hardware suppliers will not be able to fulfil its contractual obligation in respect of timely delivery of product. Although the supplier is seeking to fulfil the order as soon as possible, the Company has been informed that delivery will not take place in FY20.

As a result of this delay, the Company has been unable to conclude negotiations, and consequentially recognise revenue, on a number of material enterprise prospects due to impact in the current financial year.  As a result, the Group therefore now expects to report revenues at a similar level to FY19, with an equivalent impact of this revenue shortfall on EBITDA.

This is another company which is trying to get more recurring, SaaS-type revenue from smaller customers, instead of large lumpy contracts.

I'm open to the possibility that this share price collapse could represent a chance to buy into a company with a big future in an important niche. Anecdotally, I've been shocked at how many of my friends are now working in "flexible offices" at large companies. Regular employees now have to book their desks in advance - I'm glad I started working for myself before that became a thing!

On Research Tree, I've downloaded the latest note published by N+1 Singer (this note has been mentioned by readers in the comments - cheers!). Please note that Singer is SMRT's Nomad & Broker.

Singer says that the purchase of SwipedOn was "a gem of an acquisition". It was bought for £5.4 million last year.

Applying the "Rule of 40", it thinks that SwipedOn could be worth 10x its revenues "in the current market". If that's true, it would mean that SMRT is very heavily undervalued.

Of course, "the current market" is a bit frothy, especially when it comes to anything that can be tied to the Internet of Things - and SMRT falls into this category.

The company reports £3.2 million of cash at the end of December 2019, and is forecast to make an adjusted pre-tax loss of £1.6 million in the financial year ending January 2021.

If that translates to a reduction in cash, and if profitability doesn't appear soon, I wonder if SMRT might need a cash injection at some point?

This could be worth looking into, though it does appear to be at the more speculative end of the spectrum.

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Ok, that's it from me. Paul will be with you next week. Have a good weekend!

Graham