Small Cap Value Report (Fri 8 Feb 2019) - DWF, MYSL, EUSP, HDD, EPO

Tuesday, Feb 19 2019 by

Good morning!

I'm back for one day only, to give Paul a break. A few stories popping up on my radar today:

  • Confirmation of intention to float by DWF
  • MySale (LON:MYSL) trading update
  • EU Supply (LON:EUSP) trading update
  • Hardide (LON:HDD) fundraising
  • Earthport (LON:EPO) improved offer


DWF - Intention to float

Confirmation of intention to float

It continues to amaze me that firms which traditionally would have stayed private, are now selling their shares to the general public.

Another example of this today with DWF, the international law firm headquartered in Manchester.

Law firms are perfectly good LLPs, and they've always been LLPs. Why is now the right time to take on the PLC model? And can they really function as publicly-listed PLCs? I suppose we will find out.

The simplest explanation for me is that there's still quite a lot of complacency out there, and that this has manifested itself in the flotation of companies which would never ordinarily float (not only because investors wouldn't bite, but also because the companies themselves would want to stay private, for the sake of their long-term futures).

Another example of this complacency in my opinion is the property portal On the Market (LON:OTMP), which Paul discussed on Wednesday. This was a mutual organisation which demutualised, and yet its strategy now is to continue acting as if it were a mutual (i.e. to act for the benefit of its customers, rather than its shareholders). In other words, it wants to have its cake and eat it, too.

I used to work for a mutual organisation, so I have seen how they work from the inside. There is nothing wrong with being a mutual, but I would never want to own shares in one. The whole point of the thing is to serve its customers, not shareholders! So shares in a mutual which don't come with the privileges of being a customer are unlikely to generate a good long-term return, in my view - they are a structurally bad investment (disclosure: I own shares in Rightmove (LON:RMV) ).

Similarly, law firms are a structurally bad investment. Why work for a law firm which has…

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All my own views. I am not regulated by the FSA. No advice.

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MySale Group plc is engaged in operating online shopping outlets for consumer goods, such as women, men and children's fashion clothing, accessories, beauty and homeware items. The Company's segments include Australia and New Zealand, South-East Asia and Rest of the world. It operates with flash sales Websites in Australia and New Zealand (ANZ), South-East Asia (SEA) and the United Kingdom. Its Websites host time limited flash sales in each of its territories. These flash sales are focused on fashion, apparel, health, beauty and homeware categories and are undertaken on a consignment inventory basis. Its retail Websites also focuses on these product categories using drop-shipped inventory. Its flash sales brands include OzSale and BuyInvite in Australia, NzSale in New Zealand, SingSale in Singapore, and MySale in Australia, New Zealand, Malaysia, Thailand, the Philippines, the United Kingdom and Hong Kong. more »

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EU Supply Plc is a United Kingdom-based e-procurement software provider. The Company, along with its subsidiaries, owns and operates e-procurement platform for e-sourcing, e-tendering and contract management, tailored for the regulated European public sector market and certain industries in the private sector. It offers the Complete Tender Management (CTM) solution for procurement and contract management is used in various configurations by over 6,500 authorities within the European Union. CTM allows tenders to be created, distributed and evaluated without the need to create and manage paper documents. CTM has various modules, such as Entity Management, Tender Management, Auction Management, Contract Management, Dynamic Reporting, Contract Life Cycle Planning and Spend Aggregation. It offers various services, such as change management, training, auction event management, general procurement services and workshops to configure CTM to meet requirements of the organization or sector. more »

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Hardide plc is a United Kingdom-based company, which is a provider of tungsten carbide coatings for critical metal components in abrasive, erosive, corrosive and chemically aggressive environments. The Company's segments include UK operation, US operation and Corporate. It offers a family of nanostructured and low temperature chemical vapor deposition (CVD) coatings, which provide wear and corrosion resistance. The Company's coatings can be applied to a range of metallic substrates, including stainless steels, superalloys, tool and carbon steels, as well as nickel, copper and cobalt-based alloys. It serves customers in various industries, including oil and gas drilling and production, flow control, aerospace, power generation and precision engineering. Its coatings include properties, such as wear and abrasion resistant, erosion resistant, chemical resistant and anti-galling. It has manufacturing facilities in Oxfordshire, the United Kingdom, and Virginia, the United States. more »

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  Is LON:MYSL fundamentally strong or weak? Find out More »

30 Comments on this Article show/hide all

Paul Scott 8th Feb 11 of 30

Hi Graham,

I agree with you about legal firms listing on the stock market - I'm not keen on this development, and tend to avoid them. As others have correctly pointed out, once the partners (i.e. the big fee generators) cash in their chips, there's less incentive for them to make an effort to bring in more business. That's because the spoils will have to be shared with passive, outside investors.

Any shares to do with legal claims, compensation, etc, tends to have a high risk of going wrong. Lots of this type of shares have gone disastrously wrong - Quindell being the biggest such case, but there have been lots of smaller disasters.

We all learn from our mistakes. My fingers were badly burned about 10 years ago by a company called Accident Exchange. Its business model was to muscle its way into situations where people had car accidents, and offer an (expensive) hire car free of charge to no fault drivers. Then the invoice would be sent to the other party's insurance company for payment. The trouble was, that the insurers (perhaps deliberately?) strung out payment, causing a working capital crunch at Accident Exchange, which was eventually taken private. Stock market investors like me lost almost everything we had invested.

In a similar vein, Redde (LON:REDD) almost went bust c.2011, but refinanced, and seemed to re-work this model of providing hire cars after accidents, but seems to have done it by co-operating with insurance companies. That's worked amazingly well, and the share has been a lucrative payer of divis since. How long this business model will continue to be successful, who knows?

Another mistake of mine in the legal services space, was a company called Fairpoint. It's gone bust now. The company originally did consumer debt management, charging a fee, which was immoral really, as there are free services which do this. Management was a bunch of very credible-sounding accountants (I remember a conference call with them). There was a very large debtor book, supported by bank debt. Anyway, it didn't work, I think the debtors proved to be a lot worse quality than planned, and didn't pay up. Plus Fairpoint tried to diversify into other areas, such as buying firms of solicitors, hence its relevance to Graham's comments in the main article here.

In summary, my view on legal services type of companies, is to watch out for these warning signs in particular;

  • Excessive debtors, combined with a lot of bank debt.
  • Debtors who are willing, and solvent enough, to pay up reasonably promptly.
  • Activities which are regulated by Govt bodies, and particularly where they are taking a keen interest, with consultations, etc. Clamping down on iffy sectors can be a vote winner, and destroy business models overnight.
  • Balance sheet weakened by multiple acquisitions (with heavy goodwill) using bank debt.
  • Personnel - if key fee earners have cashed in most of their chips, then their incentive to continue earning big fees might be little to none. How long are lock-ins for key management? People can walk out of the door, taking their knowledge & contacts elsewhere.
  • Does it feel spivvy, in terms of what the activities are? If so, it will probably be a lousy investment.

Regards, Paul.

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Trigger14 8th Feb 12 of 30

A different take on regulation of legal services and competition.

Until recently, law firms have not been allowed to list publicly. Traditional law firms used to regulate themselves (i.e. their own industry body rather than an independent regulator) and only allowed use of the partnership model. The market was/is extremely fragmented (ouside of corporate law) and almost laughably inefficient and uncompetitive, with little to no investment in technology and lawyers relying on a lack of transparency to pretty much charge what they want.

They have only been allowed to use ‘Alternative Business Structures’, to raise public finance finance and employ non-legal directors as a result of the Legal Services Act 2007. This allows legal businesses to consolidate, invest in technology, hire business people and compete more effectively, particularly in more commoditised elements of law (e.g. probate and conveyancing) people would tend to go to high street lawyers for in the past. This won’t affect the magic circle and corporate law much, though I would expect the more commoditised areas of law to be disrupted over time. In the long run traditional law firms will be at a structural disadvantage in a more competitive environment from lesser access to finance needed to invest in technology (which will become a much more key component in delivering services efficiently). However, this will take a long time. Decent investment opportunities seem rather limited so far...

Blog: Quality Share Surfer
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sharmvr 8th Feb 13 of 30

In reply to post #445458

Hold Duke Royalty (LON:DUKE)
I too am struggling with this one. On the face of it, diversification and much higher yields with some further equity upside.
However, it seems that the target was more aggressive in taking risk and used leverage, which might explain the smaller principal investment.
I understand that these have follow on opportunities which will align them with transaction size more typical of Duke Royalty (LON:DUKE)

Look forward to Graham's interview as well. In addition to the risk, I would be interested in cultural fit since Duke seems to be quite a conservative business, and that was the impression I got from the earlier podcast Graham did on Cube.

Happy Friday all

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Paul Scott 8th Feb 14 of 30

Coming back to you re OnTheMarket (OTMP). To emphasise a point that some readers don't seem to have understood. The company is not issuing shares like confetti to estate agents. What it is actually doing is this (which was the planned strategy at IPO);

First year free - this strategy is designed to quickly increase the number of estate agents using the OnTheMarket platform. This has been very successful, with the company rapidly gaining on Rightmove & Zoopla in terms of number of properties listed. See this RNS earlier this week, with some impressive stats.

Conversion to long-term paying contracts - this is the absolute crux of the matter. If OTMP can convert free trial agents into paying contracts (it charges about a quarter of what Rightmove charges), in enough numbers, then there is a chance that its business model could really take off. Then we would have a 5-10 bagger (more, if it supplants Rightmove) on our hands. That's why this share is interesting - but it's very much binary in terms of outcome!

The key to converting free trial estate agents onto long-term, paying contracts, is the inducement of free shares (with a lock in). The idea being that estate agents then benefit from OTMP doing well, and it incentivises them to promote OTM portal to their clients & everyone who they talk to.

Zeus Capital note - there is a very interesting, indeed innovative, note from Zeus Capital out this week. It's available on Research Tree. It has testimonials from 39 clients of OTMP, and makes fascinating reading. Obviously these will be the best testimonials, and many are from single office, or small chains of estate agents.

A recurring theme in these testimonials is just how fed up estate agents are with Rightmove's excessive charges, repeated price rises, and huge profit margin. Rightmove shareholders need to sit up & listen to this - any business with is obviously profiteering, and upsetting its captive customers, is probably going to run into trouble eventually.

Several small agents complain that Rightmove charges are higher than their office rental! A few have found that OTMP provides enough high quality leads for them to drop Rightmove altogether.

Lock-Ins - given that the original estate agent backers bought shares in the company, then lock-ins were included. Details on this are on p.44/45 of the Admission Document. The good news is that 80% of the original shares are locked in for 5 years, which is 9 Feb 2023.

The bad news is that 10% of the original (36.2m) shares are permissable for sale, with a lock-in expiring tomorrow. Then a further 10% expire on 9/2/2020.

So next week will determine whether the house brokers have done a good job in lining up buyers for any shares which agents decide to sell in the market. I would be surprised, and disappointed, if Zeus are not able to arrange buyers for a maximum of 3.6m shares which could potentially come on the market (see what I did there?!) next week. Zeus should have lined up Institutional buyers in advance.

In practice, I imagine that the number being sold next week is likely to be a fraction of this - because it's fragmented over many estate agents, and some will probably want to keep their shares for the long-term. Also, how many estate agents will have dealing accounts set up with a stockbroker?

Given the first lock-in expiry next week, I think it's probably safest to watch from the sidelines. I want to buy more shares in this, but feel it's best to wait until the first lock-in period has safely passed, hopefully with no disruption to the share price.

Regards, Paul.

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paraic84 8th Feb 15 of 30

Some further thoughts on MySale (LON:MYSL) as it's something I've followed and briefly invested in in the past:

  • One of the main issues has been the introduction of an online sales tax in Australia (its main market), although I would query if that is to blame for the drop in customers. Shareholders reacted slowly to that so there may be a possible buying opportunity if someone spots any positive change to the tax. There's some more background here:
  • It's worth bearing in mind that MySale (LON:MYSL) has historically not been good at delivering on its stated targets or market expectations. That would make me cautious of its claim that it should deliver minor profit in H2. 
  • There is quite a bit of competition, with BrandAlley the leader in this space I would say. Therefore I think this will always be a permanently low margin business. Surely clothing/homeware retailers will just shop around the different competitors for the best deal. 
  • Don't forget that late last year the Chairman and CFO unexpectedly resigned which also raises questions about management of the business or whether there is some bigger underlying problem here. 
  • Some of the sums it has spent on IT seem questionable.

In a nutshell: I would avoid.

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Crusty 8th Feb 16 of 30

Hardide (LON:HDD) will hopefully benefit from sunset dates being set by EU regulatory authorities for several “Substances of Special Environmental Concern”. Some, such as hard chrome, are used on components subject to heavy loads and wear in environments where servicing/replacement is difficult and/or dangerous, and down-time is inordinately expensive. (Think nuclear, o&g, aviation.) The big problem is proving to manufacturers that the Hardide process is the answer. It seems to me the company is getting there, albeit slowly. I have a small holding.

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alihaouas 8th Feb 17 of 30

has anybody got any clue why keywords studio has fallen 10 pc today

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cmpeckham 8th Feb 18 of 30

Graham, I disagree with your argument about legal services firms. Your argument is "why work for a law firm which has to pay out a percentage of profits to external shareholders, when you could work for one which pays out everything to staff?" If this argument was valid then the same argument would apply to other services firms e.g. IT services.

Look at Accenture. It emerged when Arthur Andersen split in two. The audit side continued as a partnership and the consulting side listed on the NYSE. Accenture has gone from strength to strength and the audit side went bust.

Or look at smaller exampes e.g. Scisys (LON:SSY). Why would anyone want to work for Scisys when they could work in a partnership structure?

Maybe you think that all such companies are doomed. If so, you should say so and not restrict your argument to legal services. If not, you should say why legal services are a special case.

I'm not saying these are great companies, I'm just examining the logic of your argument. Keep up the good work, I always read when I can.

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Graham Neary 8th Feb 20 of 30

In reply to post #445563

cmpeckham, to answer your question directly, I have a track record of caution with regard to investing in all types of professional services firms. Architects, accountants, legal, consultancy, etc. I am aware that Accenture ($ACN) stands out as an exception, a consultancy which has also been a fine investment.

I also have a track record of caution with respect to generic "managed services" IT companies.

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kevfle 8th Feb 21 of 30

In reply to post #445563

I also disagree with the negative comments about law firms.

The fact is that most partners in law firms set up as LLPs or conventional partnerships will only ever be able to build up capital equal to their share in the net assets of the business. When they leave they will be paid their capital but nothing for goodwill. With an IPO they will be able to receive their capital plus a goodwill payment because the flotation price will normally be above net asset value.

In most cases they will take some of their capital as shares in the new PLC. Although their base salary will probably reduce compared with their previous profit share, they will also receive dividends from their shareholding and will be able to participate in the future goodwill of the business as it expands and the share price increases. The value of their equity in the business should increase at a greater rate than if they had remained as a partner in the LLP.

Yes, they could leave and start up again but why do that when they could probably earn more remaining with the PLC and receiving a salary plus dividends and help to increase the profitability of the business and thus the value of their shareholding.

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Chrisfarrell21 8th Feb 22 of 30

In reply to post #445578

I think understanding the remuneration is key to understanding why a flotation in good quality law firms won't necessarily be a bad investment, and goes some way to answering one of Paul's points.

Usually, in most commercial law firms, partners will get a (sort of salary) each month, and then get a share of the profit pool at certain points in the year when the business is relatively sure of what it is going to get in. These are the partners' drawings, but, in effect, it's the same as receiving a dividend. So not much has changed here, except that some dividends will now be paid out to third party shareholders. However, for a long time, like everyone else, law firms have relied on banks for funding, so if an equity raise could remove any debt, you would remove interest payments.

To me, what DWF is proposing doesn't change the current remuneration structure so much that it does anything to reduce the partners' incentive to bring in good quality fee paying work, as Paul queries. They still want to bring in good clients, with profitable work, to fund the dividend pool.

What sets apart the best firms, of whatever size (like most businesses), is the ability and enthusiasm to collect in the cash from clients. Some solicitors (like other professionals) are totally useless at this, as it was traditionally deemed unseemly to talk directly about cash with clients. So as Paul says, you want to watch the cash collection and debtor days/amounts metrics particularly closely.

Finally, I would say it's essential to understand the type of work the specific law firm does, and they absolutely cannot all be lumped together. Some types of work lend themselves to prolonged payment periods, such as contingent medical negligence litigation. It can result in decent payments, but a long way down the track. The "best" type of work to look out for would be a continuous and well mixed stream of commercial work (not too reliant on property) such as M&A, property, commercial contract, intellectual property, construction work etc., mixed with a strong commercial litigation practice (as opposed to personal injury/medical negligence/consumer claims), which can smooth out the business cycle somewhat.

Like any industry, some will be good investments and some will be Slater & Gordon.

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kevfle 8th Feb 23 of 30

In reply to post #445598

The other point on this is that younger lawyers who have ambitions to become partners are being attracted to the PLC law firms because of the ability to build up equity through share ownership. This means that not only can they participate in the growth of the firm, but they can also cash in part of their investment at any time if they need extra cash. This compares with the LLP structure where it is very difficult to release capital without affecting the firm's cash flow.

If PLCs can attract the best young talent in this way, then that bodes well for the success of the business going forward.

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ttjs4 8th Feb 24 of 30

"Sports Direct International plc ("the Company" or "the Group") confirms that it has made an offer to acquire the business comprising the trade and assets of Patisserie Holdings plc and its group companies out of administration."

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millen 8th Feb 25 of 30

In reply to post #445548

Post 2366 on advfn suggests a few - sector in downtrend, Keywords Studios (LON:KWS) cross-selling strategy not working out, clients beginning to diversify their suppliers. No idea how true this all is but the poster sounds to have industry knowledge

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Edward John Canham 8th Feb 26 of 30

In reply to post #445623

One more reason to shop on-line.

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Paul Scott 8th Feb 27 of 30

Just a quick comment on MySale (LON:MYSL) trading update.

I bought some shares in this online flash sale retailer in July 2018, after an upbeat trading update.

It seemed very strange to me that, within a few days, the shares continued their downward spiral, despite this very upbeat update.

I gave the company the benefit of the doubt, and bought more. It continued going down. Then a bombshell profit warning in Dec 2018, which explained why the share price had been so weak - all sorts of problems had emerged, including a hike in VAT for online transactions in Australia.

After licking my wounds for a little while and wanting to give the company the benefit of the doubt I've since decided that I don't trust the company any more, so have ditched my long position for an unwelcome loss.

Lessons learned? This experience reinforces my aversion to overseas companies trading on AIM. The trouble is, as a UK shareholder, how can I possibly know the ins & outs of Australian tax law for online retailers?

A few bears on this stock thought that it was going to run out of cash, which looked wrong. The company had simply spent cash on increasing inventories, and making acquisitions. I don't remember any bear suggesting that VAT changes were about to clobber MySale. So bears got lucky on this one, rather than doing any correct analysis.

The market cap now is peanuts, and the Directors do seem to be making some progress on turning it around. But the bottom line is that, for me, anyway, the trust is broken, and I won't be revisiting this share again, at any price. Some you win.... (and plenty you lose too!)

Regards, Paul.

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Dennis Ayling 8th Feb 28 of 30

In reply to post #445548

has anybody got any clue why keywords studio has fallen 10 pc today

No obvious news today for this drop that I can see, the points mentioned on ADVFN post seem reasonable.

For me, the chart says everything, sp halved in less than six months. The stocko rank of 'fallen star' could well be on the money here. This is still a great  business but like a lot of techs on high ratings has got spanked. I have no position but is going on my watch list but fear we are in falling knife mode at the moment.


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willhampson 9th Feb 29 of 30

In reply to post #445548

On Keywords Studios (LON:KWS), I suspect the fall relates to what some of the others have posted.

It's worth having a look at the corresponding share prices of the large publishers - Activision, TakeTwo, EA etc. All of them have struggled of late, some are down more than 50%; other smaller studios have been closed. One of the main reasons blamed is the "Fortnite" effect; in other words, popular free to play games cannibalizing the market and meaning gamers are opting for these "free" games and not stumping up the $50-60 for a full priced game. I'm not an expert, but the perception I've read is that 2018 was a one-off and this year is expected to be more "normal".

EA posted some pretty bad results last week, which resulted in a sell-off in the sector. I think Activision has results this Tuesday. All of these companies are big clients of Keywords Studios (LON:KWS) so I think any troubles they have, or them pushing back/delaying AAA titles will result in a read across for KWS.

I have a smallish holding in KWS (2%) and intend to keep holding it as it is a key growth sector despite the above headwinds. Gaming has over taken the video and music industries, and I think it is accelerating. BBC reported earlier in the year that the "gaming industry is worth more than video and music combined". Good luck and all the best, Will.

Ps - I'm not a fan generally of proactive investors - it can be a bit rampy - but this video from earlier in the week with Andrew Day is worth watching (it explains some of the issues I mentioned above):

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cig 10th Feb 30 of 30

In reply to post #445678

If gaming is worth more than music plus video, isn't it going to hit capacity constraints? All this is chasing finite demand for entertainment... Or we need Elon to terraform some new planets with fast reproducing gamers double quick.

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About Graham Neary

Graham Neary

Full-time investor and independent analyst. Editor at Cube.Investments, small-cap writer at Stockopedia. Previously a fixed income analyst in the City and institutional fund manager. I'm a CFA charterholder and have the Investment Management Certificate and STA Diploma in Technical Analysis for good measure. When I'm not talking about finance, I enjoy recreational poker, chess and Mandarin Chinese. more »


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