Small Cap Value Report (Fri 5 June 2020) - RBG, SOM

Good morning, it's Paul here with the SCVR for Friday.

Estimated timings - I have to stop for a zoom meeting at 1pm.
Today's report is now finished.

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Revolution Bars (LON:RBG)

(at the time of writing, I hold a long position in this share)

Fundraising & move to AIM

Key points (written before 8am market opening);

• Raising c.£15m (before fees)
• Price of 20p per share, a deep discount of 42%
• Firm placing: 45.0m new shares
• Open offer & placing: 30.0m shares - this is the most important part for existing investors to understand. Existing shareholders are entitled to apply for 3 open offer shares, for every existing 5 shares held. The open offer makes up 40% of the total fundraising - one of the largest I've seen. This is really good news (in a bad situation), as it means that we existing holders can stand our corner and apply for cheap shares ourselves, thus not being diluted as much as if it was just a placing.
• The key thing is that the share price should, theoretically, settle somewhere between yesterday's close of about 33p, and the fundraising price of 20p. This should mean that investors have a loss on our existing shares, but a profit on our new shares. The two have to be seen together. Whether the market will see it that way, remains to be seen, when the market opens. Remember if you sell before 7am on 9 June, then you lose your entitlement to the 20p open offer shares - that's the ex-entitlement date. [Edit: NB check everything with your broker, I'm not 100% sure about this specific point, my apologies]
• Moving from main market to AIM, mainly because that enables cheaper fundraisings. Otherwise, it would have had to go to the considerable time & expense of preparing a prospectus for this fundraising. I like this move, as it will enable IHT portfolio buyers to get involved. AIM is a more appropriate market for a micro cap.
• Main use of funds - to reduce gearing, which I'm sure everyone agrees was going to be too high.
• Bank facilities will reduce by half the fundraising amount, at £7.5m, but not until March 2021 - so it should now have tons of liquidity headroom for the foreseeable future.
• Board investing £132k - a worthwhile amount - I get the impression they are ordinary people, not wealthy people, so this is a useful sign of commitment. Bear in mind the Board also voluntarily reduced their salaries by 50% recently. I can tell you that they are working their socks off on behalf of shareholders.
• Finncap & Peel Hunt managed this fundraising. Thanks to them for giving such a large entitlement to existing shareholders, with the big open offer. I'm told that both brokers, and RBG itself of course, thought this was the right thing to do, given that the shares are widely held by private investors now.
• Re-opening of bars - scheduled for Aug 2020, with selective openings. I'll write more about this later.

Share count - here are the new figures to use when valuing the shares;

Existing shares: 50.0m
Placing shares: 45.0m new shares
Open offer: 30.0m new shares (any not taken up by existing holders, will be placed with institutions) Correction - sorry, I misunderstood this point. There actually will be an excess application facility, so all the 30.0m shares could go to existing investors. My apologies.

New total 125.0m (an increase of 150%)

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My opinion - I was a bit shocked when I got wind of this fundraising earlier this week. Obviously once you're inside on the deal, then you have to keep total radio silence & cannot transact in the market. I'm not usually made an insider on many deals, but there are so many going on at the moment, that the odd one filters down to my level.

I had assumed (wrongly as it turns out) that the twice increased bank facilities had done the job, in terms of providing the necessary liquidity. But it now turns out that the company wanted to raise more equity too - probably under pressure from the bank, I imagine. What a pity that it had to raise money at this stage, just before re-opening, when uncertainty is at its height - hence the low price of this deal.

My apologies for me being over-bullish on the liquidity situation. Obviously at some point more equity would be needed to strengthen the balance sheet, but I had assumed that the company could get through the re-opening, then raise fresh funding at say 50p+ later this year, or next year. Unfortunately not.

On reflection, I suppose it's not unreasonable for the bank to ask that shareholders take up some of the strain, and de-risk their position further. After all, banks are not in the business of risky lending, due to their thin margins.

I zoomed management recently, and did a Q&A with them, see below. Nothing price-sensitive was disclosed.

The insolvency risk has now basically gone. Therefore, the business will be very much stronger following this big fundraising. However, that is now being spread over 150% more shares. Therefore the upside per share is not going to be as high, but if we take up our open offer entitlements, then we'll each have 60% more shares.

Example market caps based on new share count of 125m;

20p per share: £25.0m
25p per share: £31.3m
30p per share: £37.5m
35p per share: £43.8m
40p per share: £50.0m

Given the newly strengthened balance sheet, I think a successful re-opening (and assuming no second wave of covid) could see the share price recover to about 40p later this year, maybe?

What will it do today? Who knows. It depends whether "flippers" got involved in the placing or not - i.e. people looking for a quick profit who sell immediately using a short CFD, which can then be closed out when they receive their placing stock. I reckon we're probably looking at a fall to 23-25p today, so a painful day is about to begin. Still, it could be worse. Without the enlarged bank facilities, which enabled this placing to happen, then the share price could have been in single digits by now. Indeed, it bottomed out recently at about 16p. Therefore I can understand people being miffed with what's happened, but at least the business has been shored up to an extent that solvency is now secure.

Remember that many competitors won't be re-opening at all, so RBG is likely to have a considerable market share gain when re-opening is allowed. Therefore this is a time to hold our nerves, in my opinion.

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Q&A with Rev Bars management

I've summarised this to just include the main points, and omit anything that might be commercially sensitive.

Q1. What is purpose of the fundraising?

A1. Debt reduction mostly. We don't want to spend the next 2 years paying down bank debt. Front foot move - want to take advantage of numerous opportunities in the sector - less well-funded competitors likely to go bust, we can take their customers. Single site acquisitions - our financial strength will enable great deals, long rent-free periods, on best sites that come up. Refurbs of existing sites can resume, key to gaining market share. We can grow the estate when others are out of the market, & create shareholder value, and no danger of going bust with extra funding. Right capital structure, we'll be under 1x EBITDA by June 2022 - first financial year unaffected by covid. Major shareholders have consistently told us they want to see debt down to 1x EBITDA, which is the right risk rating.

Q2. My main concern is dilution of existing shareholders. If the price discount is more than 10%, then I strongly urge you to do an open offer with the placing, so that the small shareholders are not diluted away.

A2. We can't guide you on price, that is a negotiation between the brokers & the institutions. There will be an open offer of £6m, with a clawback (i.e. instis get any new shares that existing shareholders don't apply for). Edit: but there will be an excess application facility, which means that existing holders could end up with all the £6.0m open offer shares.

Paul: Great. A lot of my friends & readers have followed me into this, so I didn't want to see them get sh*fted!

Company: We're cognisant that, particularly after a large institutional block of shares was recently sold & dispersed, private investors hold a lot of our shares, so we want to look after them. The company, and both brokers, think the open offer is the right thing to do. Any surplus shares that are not taken up in the open offer, would then go to institutions.

Q3. It's starting to look as if ending of the lockdown could be better than anticipated. How do you see it unfolding for you?

A3. Our base case is opening in August. But some hospitality may open from 4 July. We're planning on opening 6 bars from 4 July, to test out processes, social distancing, etc. We're planning on opening without late night trading to begin with, and with customers seated, because can't do social distancing. Why incur cost of DJs, door staff, etc.? That bit is mothballed until social distancing lifted. We'll focus on daytime & evening trade up to 11pm, with service at table, including launch of ordering app. Hoping that end of furlough scheme (end Oct) might coincide with end of social distancing, then we can bolt on the late night trade again.

Q4. Presumably the first bars you'll open will be the most profitable ones?

A4. Not necessarily, because the most profitable sites pre-covid may not be the most profitable now, given social distancing. So we're looking at sites with the biggest outside areas, tourist destinations, e.g. Albert Dock, Liverpool site. Want to get a spread across the country & type of bars, so we can learn & nuance the openings of the other sites in future.

Q5. Social distancing - how is it done, and will sites still be viable? How can you socially distance a load of p*ssed 18-25 year olds at all?!

A5. We have disproportionately large bars, so we have an advantage, can spread out furniture a bit more. 2.0m distancing rule is a problem. Feels like Govt wants to reduce from 2m to 1.5m - much better, 1.0m best. Budget of £2,500 per venue, for screens, hand sanitisers, etc.

Q6. Spreading business out over the day & week has always been a challenge for you. How do you drive that?

A6. Larger sites like ours should be able to open sooner, as we can spread out the customers. Focusing our managers on becoming excellent at managing the daytime & early evening trade. There's a medium term win here, where we can then bolt on the late night trade, onto a much better managed daytime business. We do 60% of our sales pre-11pm already (pre covid). We need to flatten the curve. A lot of 18-25 year olds didn't got out until 11pm, maybe drink at home before. That won't be possible, as nightclubs won't be opening, so we need to pull forward those customers - e.g. come out at 7pm, then in the kebab shop by 11pm, like it used to be when we were all at Uni!

Q7. BigDish is a good app for getting customers to pre-book. Will you do discount, or even surge pricing?

A7. We've just had customer research done which says our pricing is now competitive, rather than expensive. Roadmap for order & pay at table app has been accelerated, due to launch. So no, no plans to lead on price, we'll follow the market.

Q8. Rents - presumably you're paying the rents on top sites, to avoid losing the leases?

A8. We withheld March rents, and wrote to landlords. Most engaged positively. We've got 8% off the rent roll for March. There's a Govt summit on 10 June, with UK Hospitality, and trade bodies for retailers & landlords, looking at possible rent furlough scheme (where tenant, landlord, and Govt each shoulder 1/3 of the rent cost) - trying to broker a deal. We need shared pain. Not fair for landlords to expect 100% of their income, while tenant has 0% of its income. We think the majority of landlords are conciliatory & want to work together, as they don't want loads of sets of keys back. We want a deal with some kind of rent-free for the time bars were closed, and a move to turnover rents in future. We expect the moratorium on legal action against tenants (ending June) to be extended. Needs Govt intervention.

Paul: I agree, and recently wrote to my MP supporting the idea of a rent furlough scheme, which was mooted in the Telegraph recently.

Q9. Latest tweaks to the furlough scheme - will this force you into making mass redundancies?

A9. The cost is about £1m. Hopefully can mitigate that by having some people working part-time, and use furlough to top them up.

Paul: I think there will be a good payoff in goodwill terms, if you treat staff well during this crisis.

Company: Yes. We're doing engagement things with the staff now, rated at 93%, which is 6% ahead of average, best in class. We do a weekly call with HQ management. Just done a charity relay run, raised £10k for charity. Doing lots with the team to keep them engaged.

Q10. Suppliers - once you resume trading, I'm assuming that's cashflow positive - money in till now, pay suppliers later on 30 days. Will suppliers continue offering 30-day payment terms?

A10. Our major drinks supplier has been very supportive. It will be business as usual. Had one dispute with a supplier, since resolved. We can demonstrate from recent RNSs that we have adequate liquidity. So no problems expected.

Q11. Disposal of loss-making & empty sites. Has this deal gone ahead?

A11. We renegotiated it, as you can see from previous RNSs. Got £1.3m off the price, and more time to pay, deferred until September. Made it a cracking deal, as it saves £1m p.a. in future.

Q12. Any permanent rent reductions possible in future?

A12. Not at the moment, as we're in a holding pattern. But in future, we expect there will be deals to be done. We want to move to turnover rents, to give us some protection against any future virus outbreaks. There are a handful of sites where we're asking landlords to cut us a deal, otherwise there's no point in us re-opening those sites. As they are already shut, this is a much more powerful negotiating position, as a closed site wrecks the landlord's book value on that site, hence they're willing to negotiate.

Paul: Thanks for everything you're doing to keep the company going during this lockdown period, it's much appreciated.

My opinion - I rate this management team very highly. Every meeting I have with them, they have all the facts & figures at their fingertips, and seem shrewd & hard-working, experienced operators, with deep sector knowledge & experience.

With a strengthened balance sheet, there are no longer any solvency issues at all. Clearly a 20p raise, with lots of dilution, is a setback for the current share price. However, if we take up our 20p open offer entitlements, then we can offset the profit on those new shares against today's c.8p drop in value in our existing holding. Therefore, it's not actually that bad overall.

It's now all about how the re-openings go. Let's see what happens.

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Somero Enterprises Inc (LON:SOM)

Share price: 215p (up 2% today, at 11:48)
No. shares: 56.4m
Market cap: £121.3m

(at the time of writing, I hold a long position in this share)

COVID-19 Update

This company, based in the USA, makes & supports laser-guided concrete laying machinery.

Somero gave an update on 30 March, saying what you would expect - material impact on the business expected from covid, cost cutting, conserving cash, liquidity position is fine, etc.

Today it reports that further cost cutting & cash preservation measures have been taken. 20% of staff furloughed. Bonuses cancelled. Cuts to discretionary spending & capex. Achieving annualised savings of $5.0m.

Net cash position unchanged at c.$24.0m. Also has an unused $10m credit line. Looking into possible Govt support (why, they don't need it).

Current trading - 25% below original market expectations - I think this means revenues, not profit. Company remains profitable & cash generative at that level. Would still be cash generative if a further 20% fall in revenues were to occur - so cash breakeven point is c.$54m revenues. Uncertain outlook. New product development is continuing.

My opinion - this sounds fine to me, in the circumstances. It's a very cyclical business, as we saw in 2008, when it came close to going under. However, this time the balance sheet is way stronger, so I don't see any solvency risk. Particularly as this has been an artificial recession, caused by virus/lockdown. Hence businesses are (mostly) coming alive again. If the USA comes anywhere close to a V-shaped recovery, funded by unprecedented & massive stimulus, the SOM's share price should recover.

Therefore I remain happy to hold, and accept that 2020 results are going to be a write-off. It should not need to do a fundraising (famous last words!) although I think we have to accept that divis might not be forthcoming until 2021 or 2022 at a guess.

My conclusion? Nice company with good recovery potential.

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That's it from me! Have a lovely weekend.

Best wishes, Paul.