Small Cap Value Report (Fri 28 Dec 2018) - IDEA, placeholder

Good morning, it's Paul here!

We're in that strange time of year, when Mon-Sun days of the week lose their meaning completely, and instead each day has its own unique name. This is very confusing. Also, it usually takes until about Easter for me to get the new year correct too. Doubly confusing, reporting on 2018 figures in 2019.

I've got this strange, vivid, childhood memory of writing "1976" in the margin of a schoolbook, and thinking it was terribly modern. That was just before the teacher put the fear of God into the class, by telling us emphatically that the world's entire reserves of oil would run out by the year 2000. So we had better prepare for the worst. Growing up in the 1970s was such fun!

As regards dates then, please just assume that in early 2019, I'll get lots of them wrong, and work on the basis of what I probably meant, rather than what's actually written here.

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Nobody likes to prepare for the new year with a backlog of work to finish off. Therefore, I've kicked myself up the proverbial, and completed the SCVR from 21 Dec 2018, which is now here. Sorry for the delay.

Craneware (LON:CRW) and Focusrite (LON:TUNE) were the main features, and I also wrote up my recent lunch with Ideagen (LON:IDEA) . I'll copy it here actually, so that everyone sees it, as follows;

Ideagen (LON:IDEA)

Share price: 126.5p
No. shares: 219.2m
Market cap: £277.3m

(disclosure: the company paid for our meal, over a working lunch)

Meeting with management

By way of background, Ideagen moved from Plus markets to AIM in 2012. It has been a successful buy & build software group - specialising in highly regulated sectors. The company is rightly proud of its successful track record in creating shareholder value - a >10-bagger on AIM, until the recent market sell-off, but still a great performance;

The former CEO, recently moved up to Exec Chairman (to focus on strategy & acquisitions), is David Hornsby ("DH"). David is highly regarded in the private investor community, for having created such excellent shareholder value, but also for being very accessible to investors - coming along to Mello and ShareSoc investor events over the years - giving up his spare time to update shareholders, and building long-term relationships with investors.

Both David Hornsby and myself treat Mello events as a mainly social occasion, so we decided to meet up more recently for a serious business lunch, to discuss the business, and the numbers. That is what I am reporting on today.

Acquisitions - the group has grown mainly through acquisitions, and doesn't seem to have put a foot wrong. It was emphasised that this is not easy - a lot of work goes on behind the scenes, both to get deals done, and to integrate companies that are acquired.

There is a proper system for integrating acquired companies, which is controlled on task management software (that's my description, which I hope is accurate).

It is important to not allow a "ghost culture" at acquired companies to persist - acquisitions have to adapt to Ideagen's culture.

Here are some interesting points which I jotted down during my lunchtime briefing;

• Staff incentivised by HMRC approved incentive plan - all levels of staff get £2k free shares per annum. Over 5 years that can be enough for a deposit on a house, so not to be sniffed at
• Other schemes to incentivise top staff
• Note that Exec Chairman does not have an LTIP personally - is happy to share the rewards with the team - seems happy that other Directors & staff are sharing in the group's success
• Software - if it is well designed from the start, then there should not be any over-reliance on key people
• Historically, the group has always hit its forecasts
• Good pipeline of acquisition opportunities
• Weekly board meetings, with a focus on tight control of cash & sales pipeline
• Customer renewals at 90% or more
• Moving to SaaS, which suppresses organic growth during the transitional period
• Seasonality - there's an H2 weighting
• Free cashflow good & improving - recent acquisitions kicking in, see broker forecasts

Discussion on my previous SCVR comments

I'm perfectly happy to meet management of decent companies, and discuss things that I've written in SCVRs here, to hear their point of view, and to learn more about companies. Graham and I have to cover over 500 companies here, so inevitably we cannot be experts on (m)any of them. I explained this to DH, which he took on board. There's nothing emotional about it, we just report on things as we see them, based on the facts, and give an opinion - which is subject to change at any time, if the facts (or our understanding of them) changes.

I had printed off my SCVR here on 13 Nov 2018 on Ideagen's trading update, and we went through it point by point. Having re-read it on the train into London, my feeling was that it was fair & balanced, and hence I stood by it.

As a general point, the danger of meeting management, is that they can be very persuasive! So having done this for nearly 20 years now, I tend to listen politely, but make sure I have sceptical barriers up in my mind, to avoid having the hind legs of my donkey removed during a discussion!

However, in this case, I think 2 specific points or questions I raised previously, were explained well by DH in our meeting, and I am happy to revise my opinion on these, as follows;

Low tax charge - I had raised an amber flag on this, querying why so little tax is paid? The explanation given makes sense, as follows;

• R&D tax credits reduce the tax charge (makes sense)
• Sometimes there are tax losses at acquired companies, which can be utilised (again, makes sense)
• Share-based payments to staff are tax deductible (again, makes sense)

Overall then, this area of previous query from me, looks OK.

Cash generation - I queried this in my last report. However, looking through the accounts again, it seems to me that the group does genuinely generate decent free cashflow, which it then uses to make further acquisitions.

DH pointed out that, with several recent acquisitions kicking in, in future, then broker forecasts are for cashflow to significantly increase.

Dividends - why pay such a small divi? (forecast yield is only 0.24%). The reason is that Institutions like divis, even if they are small, and some funds are only permitted (internal rules) to invest in dividend paying shares.

One final issue, which was good to discuss & clarify.

Stockopedia figures - DH noted that the Stockopedia figures are based on a conservative accounting basis, of including the amortisation of intangibles in P&L figures. This is detrimental to groups which do acquisitions, as it lowers their quality metrics, such as ROCE, etc. So he feels this is wrong.

Whereas broker notes generally tend to strip out P&L charges relating to amortisation of intangibles. I've discussed this many times here in the SCVRs, and indeed Graham and I have a fundamental difference of opinion on this - I am happy to value companies on adjusted figures (providing the adjustments are not silly), whereas Graham seems to prefer the much more conservative statutory profit figures.

Both are correct, they're just different ways of looking at the same numbers.

DH indicated to me that he finds it frustrating that broker notes for Ideagen show high quality metrics such as ROCE, but the more conservative presentation on Stockopedia, shows low quality metrics. This has apparently caused discussion/confusion at investor meetings.

My view is that it's important to understand the basis of calculation of figures, and investors can then make up your own minds as to which basis you prefer. Bear in mind though, that for highly acquisitive groups, the Stockopedia figures will present a conservative view of the numbers. If you want to adjust that manually, by using the company's adjusted figures, then you can do.

I had a chat with the boss (Ed) about it at Mello, and (from what I can remember), I think Ed indicated that Stockopedia intends to move to an adjusted basis for EPS figures (historic & forecast) in 2019. That won't affect most companies, but will make a difference to companies which have made lots of acquisitions.

Valuation - my key message from the SCVR of 13 Nov 2018 was that, I like Ideagen, but that the valuation seemed a little bit toppy to me, at the time, at 141.5p. I stand by that view, although having chatted to management, I'm also receptive to the idea that the group deserves a premium rating, given its excellent track record.

My opinion - I enjoyed meeting DH of Ideagen, for a serious business meeting, and I learned a lot. He's clearly built a great team around him, and has tremendous flair for acquisitions - the long-term track record & share price is proof of that.

Like a lot of growth companies, the share price got ahead of itself earlier in 2018, but looks to be resetting to a more sensible level in this market shake-out.