Small Cap Value Report (Fri 30 Sept 2022) - MCB, MADE, TPX, XSG

Good morning from Paul. What a chaotic week it's been, I'm so glad it's nearly over!

Some cracking reader comments this week, I'm delighted to see the reader comments section coming alive with really interesting posts this week, thanks to everyone who is contributing constructively.

Agenda -

McBride (LON:MCB) - a key refinancing announcement with its banks was announced yesterday, that strikes me as remarkably lenient. That then allowed FY 6/2022 results to be announced, which come with a "material uncertainty" over going concern warning. It's loss-making, and very heavily indebted to both the banks, and trade creditors. Cashflow is poor. So this is really a question as to whether the business can survive. It says current trading is improving, after 18% price rises were pushed through in H2, to recoup "rampant" inflation on costs. Shares could have little to no value, so best seen as a high risk call option on a turnaround. Risk:reward strikes me as poor, but I'll keep an eye on it, for a possible future turnaround.

Made.Com (LON:MADE) - as mentioned here before, the facts & figures lead me to believe that MADE is likely to be insolvent soon. I've gone through the interim numbers, just to be sure, and the numbers & commentary back up this view. The company has put itself up for sale, but why would anyone buy something that is now generating massive losses & burning through the little remaining cash? The going concern note is laughable. The shares remain uninvestable, and I would steer well clear. (more detail below).

Tpximpact Holdings (LON:TPX) - it's a profit warning for H1 from this acquisitive group of IT companies focused on the public sector, due to a botched strategy of centralising key functions in the group. However, there seems good visibility for an improved H2. Founder CEO & CFO are stepping down, but staying within the business, in an unusual move where they admit that more experienced leadership is needed, and bringing in a sector expert new CEO. Overall, I think this share is starting to look interesting as a potential turnaround, from a much more sensible (i.e. lower!) valuation.

Xeros Technology (LON:XSG) - a deeply discounted placing/open offer. I work through the numbers, which means ruinous dilution. Can you believe, the share count will have risen from 1m in 2014, to up to 294m (if all the warrants are exercised). A good case study in why we should avoid jam tomorrow shares. We need to check our portfolios to make sure there's nothing in there that is likely to need to raise more equity from a position of weakness any time soon, as those could be disastrous, like this one. Expect more deeply discounted fundraisings.  This is a really, really bad time to be holding speculative, cash burning shares that run out of money. How do you know if companies need more money? Check the accounts, and check our archive here, because I always flag up weak balance sheets and placing risk.

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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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McBride (LON:MCB)

23.3p

Market cap £41m

Amended financing arrangements

This announcement came out at 11:51 yesterday, and triggered a brief spike up in share price, which quickly dissipated.

I won’t go into all the detail, but the banking syndicate have, in my view, been incredibly lenient to McBride, which is very much a distressed borrower. The business is now loss-making, and cash consuming, yet has net bank debt of £152m.

This new arrangement gives McBride a breathing space for 2 years, with no testing of the main bank covenant (Net debt: EBITDA) until Sept 2024. There are other covenants, but set at a level which it should be able to meet.

Lending is now secured, whereas in the past it was unsecured (amazingly).

This looks an astonishingly good refinancing deal, that greatly reduces insolvency risk for the next 2 years. I’ve no idea why the bank have been so lenient? Possibly because they see a better likelihood of recovering their money by giving the company time to turn itself around, than to withdraw support and end up getting little back from an administrator in a fire sale?

Final Results

This announcement came out about an hour after the refinancing announcement above, so presumably had to be held back for going concern reasons until the deal with the banks had been signed off.

McBride, the leading European manufacturer and supplier of private label and contract manufactured products for the domestic household and professional cleaning/hygiene markets, announces its preliminary results for the year ended 30 June 2022.

Revenues £678m

Prices up (+9% for the year, and +18% in H2), but offset by volume declines.

There’s a time lag for raising selling prices.

Adj loss before tax £(29.6)m

Current trading is said to be improving.

Private label products in demand, as consumers switch from branded, to cheaper options.

Cost savings being implemented.

Adj EBITDA £(3.6)m, note there is a £16.9m depreciation charge, and a £4m pension scheme deficit recovery payment each year.

Cashflow is poor at £(30.2)m, as working capital sucks in cash, and there was £13.2m in capex too. So right now, a cash-hungry business.

New E175m RCF agreed, but with the previous E75m accordion removed.

NTAV is still positive, at £30.0m. There is £38.7m freehold land & buildings, on the balance sheet at cost, it would be good to have more information about this, and what its open market value might be now?

Bear in mind that MCB is financed by the banks, and the trade creditors. So trade credit insurance could be vital. With new, solid bank funding in place, I’d guess that trade credit insurers will probably be breathing a sigh of relief. So it’s definitely more financially secure after today’s announcements, for now anyway.

Going concern note - always essential reading for companies with stretched finances. In the base case, it meets bank covenants. In the downside scenario, it breaches covenants. Therefore the “material uncertainty” over going concern is reiterated. It is trying to increase an invoice discounting facility by £25m. My concern over this, is that we cannot assume supermarkets are necessarily good debtors, e.g. both ASDA and Morrisons were bought out using leverage. The UK is just under a quarter of MCB sales, with the bulk being mainly other European countries.

Outlook - "at this stage" seems to introduce an element of doubt. We're not told what their expectations are! 

The early months of the new financial year have seen trading in line with our internal plans. Volumes are showing some early signs of recovery against a backdrop of an environment that should favour private label products. This together with an improving service performance provides reassurance both on our revenue outlook and factory loading levels.
Recent months have seen overall raw material costs steadying but with widely varying trends between material groups. Energy and currency variations add further uncertainty to the cost environment and hence margin improvement actions from price rises or product engineering remain key activities.

At this stage the Group is maintaining its view that full-year earnings will be in line with our expectations.

My opinion - this share has been very high risk, and I can’t understand why anyone would have been holding - taking a very big risk, for little upside. However, today’s refinancing is game-changing. Insolvency risk looks to have greatly reduced, therefore the equity is now basically a call option on the company executing a decent turnaround. If it gets back to say £30m p.a. profit that it used to achieve, then the equity might have some value.

As things stand now, I’d say the equity is probably worth nothing, because the business is loss-making, and a long way from a turnaround probably, and completely dependent on funding from the bank, and its trade creditors (suppliers).

Given how many decent companies, with strong balance sheets, are also bombed out in price, why would you invest in something with such heavy debt, and that is loss-making?

I think shareholders are very, very lucky that they haven’t been wiped out in an emergency equity fundraise. Although that could still happen, if trading doesn’t improve.

Risk:reward has improved a lot, but still strikes me as poor.

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Made.Com (LON:MADE)

3.6p

Market cap £14m

Interim Results

These numbers reinforce my view that MADE is probably only weeks away from insolvency, and 0p share price.

It made a £(35.3)m loss before tax, on £178.2m revenues in H1 (6m to June 2022). Worse still, the cash pile crashed from £107.2m at end Dec 2021, to just £32.1m by June 2022. Hence it seems obvious that the remaining cash is likely to have been burned before end 2022, especially as Q3 trading is said to have worsened.

As we’ve covered here before, the only hope for MADE is that somebody wants to buy it as a going concern, and the company recently launched a formal sale process.

Management says in the going concern note, that they believe a sale will happen, to a buyer with sufficient cash to inject into the business, hence why accounts are prepared on a going concern basis. However, they then admit that the formal sale process has only just started, and there’s “limited evidence from the process so far” that a sale will happen! So this has to be one of the flimsiest going concern notes I can recall ever seeing, based purely on hope.

My opinion - this share remains uninvestable, and I think insolvency is looking very likely in the short term. Who would be interested in taking on this can of worms, when the assets could be bought for a song from an administrator, minus all the liabilities? Miracles can happen though, so we can't be 100% sure about anything.

Management is slashing expenditure to try to survive for a bit longer, but as the going concern note admits, it may not have enough cash to survive until a deal concludes, even if anyone is interested in doing a deal.

Purely for gamblers now, but there’s a very real, imminent risk of a 100% loss, so why take the risk?

It's staggering that this was floated in mid-2021 at a value of £800m, and is now on the brink of going bust.

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Tpximpact Holdings (LON:TPX)

60p (down 43% at 08:31)

Market cap £55m

Trading Update & Board Changes

This is the top 2 faller today, so let’s see what’s gone wrong. I didn’t recognise the name, but then remembered it used to the called Panoply - an acquisitive software group. I recall listening to a webinar where management seemed quite switched-on. The story was that the group was buying up small IT companies, targeting work for the public sector, and providing fast & flexible projects using cloud-based software, rather than cumbersome & time-consuming bespoke software. I was initially sceptical, and had concerns about its balance sheet (e.g. deferred consideration). However, things seemed to have improved by 2021, with a strong order book and improved balance sheet. My report here in Sept 2021 says that the business was doing well, but shares looked expensive at 270p.

It’s now down to just 60p, so something serious must have gone wrong, although the overall market de-rating for small caps could easily have halved the price, even if performance was good.

Today’s trading update is for H1 (it has a 31 March 2023 year end).

Oh dear -

Trading for the first half of the year has been below our expectations, which will impact the Group's full year results.

What’s gone wrong? They’ve tried to centralise the various separate, acquired businesses, and it’s gone wrong, in a nutshell. Hence lower order intake in Q1, leading to reduced revenues in Q2 (it says this was disclosed previously, in July).

Management are ploughing on with the centralising strategy, and are spending more on finance, HR teams.

As a result of this botched strategy -

These investments have resulted in a significant increase in the Group's operating cost base which has impacted profit in H1, and will continue to do so on an ongoing basis.

In addition, there has been a short-term impact on productivity and efficiency of client-facing staff which has impacted gross margins in the first half.

That’s dreadful really, isn’t it? Investors have to work out if these are just growing pains, or whether the whole thing is a complete mess. Or somewhere in between.

Outlook - some signs of improvement here -

During Q2, the order book has shown marked improvement, generating new business in excess of £26m, reflecting the benefit of repositioning the sales, growth and bid management team in that quarter. This new business provides a solid foundation for H2 revenue expectations.

Given the above, the Board is now expecting full year revenues of around £90m, broadly split 45%/55% between H1/H2…

… approximately 75% of the H2 revenues needed to achieve its revenue expectations are represented by committed client spend as at today's date. The remainder represents a realistic assessment of pipeline opportunities that are currently (or will shortly be) in flight…

… Gross margin is now forecast to be around 30% for the full year (31% last year), although H1 gross margins will be below this average, before being expected to recover in H2.

On that basis, the Group now expects full year Adjusted EBITDA to be in the range of £7.0-7.5m, reflecting the investment in talent and operating costs outlined above. H1 Adjusted EBITDA is expected to be around £1.0-1.5m, reflecting the pressures on H1 performance as outlined above.

That sounds OK - reasonably good visibility. The above EBITDA translates into £5.7m adj PBT, according to research from Dowgate (many thanks).

Although I’m not keen on the heavy H2 weighting, combined with a poor H1. Quite often this type of outlook turns out to be too optimistic, and another profit warning might follow.

To be fair though, they do provide some justification for H2 optimism -

Given the momentum in new business evident from orders won during the course of the summer, the level of committed spend within the reforecast and a healthy pipeline of new projects, the Board is confident that H2 will show the anticipated recovery in performance.

Outlook for next year - sounds like they’re expecting things to get back on track -

The Board continues to believe the digital transformation market in the UK - in both the public and private sectors - remains vibrant and attractive, with plenty of potential for continued growth. The Group expects to return to more normal market trends in growth in the next financial year. Given an expected like-for-like growth rate of around 10% in H2 this year, the Board expects to achieve like-for-like top-line growth of around 10-15% next year and an adjusted EBITDA margin of around 12%.

Board changes - this is a bit of a bombshell - both the CEO & CFO (founders) are stepping down immediately (tomorrow), but remaining with the business in lesser roles. So this sounds amicable-ish, and the RNS says “different skill sets” are now required. A new CEO is joining tomorrow, Bjorn Conway, who sounds a big hitter - previously head of Ernst & Young’s public sector division from 2011-16, which sounds highly relevant.

An existing interim deputy CFO, Steve Winters, takes over the main CFO role.

The Chairman’s comments on this are interesting, and very unusual, if we can take this at face value -

"Neal and Olly have done a remarkable job in founding and then growing the Company to more than 900 people, including associates, in such a short period of time. Following the important strategic decision to unify all businesses, the Group is now well placed to become a multi-hundred million pound revenue business in the coming years. Having begun discussing their futures with the Board some months ago, Neal and Olly have demonstrated exceptional self-awareness in recognising their strengths and weaknesses and understanding that a different type of leadership is required if the Company is to achieve its full potential.

"Bjorn Conway has an excellent track record in the UK Public Sector and has the relevant skills needed to take the business forward. I am excited to welcome him to TPXimpact. Steve Winters has impressed since he joined in April and, through his time at WPP, is used to working with large, complex and multi-faceted reporting structures. As a Board we are confident that the combination of Bjorn and Steve alongside our Senior Leadership Team will be ideally placed to achieve our growth ambitions."

Sometimes people do recognise that a growing business has grown beyond their experience & skill set. Although it’s more usual for them to cling on, and have to be forced out. Maybe it’s a bit of both, I don’t know? The outgoing CEO & CFO are still significant shareholders, with about 14% combined.

I see the outgoing CEO & CFO banked £6m combined with share sales in Oct 2021 at 230p - since when the share price fallen by almost three-quarters. Multi-million share sales by Directors in small caps really are a very good bear signal - I think in future I’ll sell immediately when I see Directors banking large profits. There are numerous cases where this is a precursor to everything going downhill.

Last year’s accounts - for FY 3/2022. I’ve had a quick look at these, and it performed well, making adj EBITDA of £12.2m, which becomes £10.9m in adj PBT, and £4.9m in statutory PBT. Are the adjustments reasonable? The biggest item is £5.3m amortisation relating to acquisitions, which is fine to adjust out. The £2.8m restructuring costs are more dubious though.

Balance sheet is a bit weak, with NTAV negative at £(16.3)m, with the main culprit being an £18m loan which I would prefer not to exist. So further work would be needed on the terms of the bank debt, and its covenants. Although there was cash of £7.9m at year end, so the net debt position was about £10m, which looks manageable.

Cashflow was quite good. Note that TPX doesn’t capitalise internal developments costs onto the balance sheet, so EBITDA is actually a meaningful number, that isn’t a million miles away from genuine cash generation (before tax & interest payments, obviously).

Forecasts - many thanks to Dowgate for crunching the numbers, with revised forecasts out in a note today. This shows 4.9p EPS this year, rising to 8.8p next year. If that is achieved, then I imagine the share price could recover from 60p now, to maybe 100-150p?

This is quite an attractive sector to operate in, I think. We’ve seen how Kainos (LON:KNOS) has done very well long-term from lucrative public sector IT work.

My opinion - clearly a disappointing H1, so expect ropey numbers when they report H1.

However, the problems don’t seem disastrous, and there seems good visibility for H2.

The management changes seem unusual, but in a way quite encouraging - founders stepping aside for a more experienced sector specialist. That could be a catalyst for a re-rating maybe?

Overall then, I think this share looks potentially interesting.

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Xeros Technology (LON:XSG)

6.15p (down 66% at 14:36)

Market cap £1.4m

Placing & Open Offer

I hope nobody in our community here is holding this jam tomorrow share. We warned here in the SCVR in March, and June 2022 that another placing looked necessary. Obviously, current market conditions are now dire for any company that needs to raise fresh equity from a position of weakness.

Hence the deal announced today is brutal - fresh equity is being raised at just 5p, which is a 73% discount to last night’s close. That’s horrendous.

Dilution - this is the scary thing about jam tomorrow companies running out of cash repeatedly. When XSG floated, there were just 1m shares in issue. That has reached 23.8m currently. Look what happens with this latest, discounted fundraising -

Placing: 120m new shares at 5p, raising £6m

Open Offer: 6 new for 7 existing shares, up to 20.4m new shares at 5p, raising up to £1.0m (but I wouldn’t bank on a high take-up of this)

Warrants: 140.4m with an exercise price of 5p

Total share count (excl. warrants) and assuming 50% take up of OO - 23.8m+120m+10.2m = 154m - which is a 6.5x increased number of shares in issue.

If all the warrants are eventually exercised, then the share count could rise to 294m.

The good thing about warrants, for the people investing in this fundraising, is that it gives double the upside, if things subsequently go well, with no risk. So warrants are free, but if the share price rose to say 10p, then you would exercise your warrants, which helps the company as you give them fresh money at 5p per share, then you sell in the market for 10p, probably. The effect of this is that it usually caps the share price, because warrant holders are tempted to bank their free money, if the share price goes significantly above the 5p fundraising price. So there's a big overhang of sellers. Hence it will now probably be very difficult for XSG shares to make much meaningful progress, unless the company starts performing amazingly well.

A capital reorganisation is necessary to lower the nominal value of each share, which is a straightforward matter requiring a GM vote. This is achieved by splitting ordinary shares into new ordinary shares, and deferred shares. The deferred shares are worthless. Lots of companies do this, so it’s nothing to worry about. We just ignore the deferred shares in future, because they are just a legal device to lower the nominal value of ordinary shares.

My opinion - we’ve never thought much of XSG here at the SCVR, although there was a spike up on some interesting contract news which briefly excited me, although I managed to quickly dispel the excitement by looking at the balance sheet and cash burn again.

The story is that XSG reckons it might be able to reach breakeven in 2024. Good luck to them, but it’s not something I would want to punt on, given the track record of 8 years of failure as a listed company. This looks very much the last spin of the wheel.

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