Small Cap Value Report (Mon 12 August 2019) - BUR, TCG, ANG, GOAL, STAF

Morning folks,

Burford news keeps rumbling on.

At the same time, there are a lot of interesting macro stories at present. And there's also some small-cap news to look at (which is supposed to be my topic, after all!). 

Stories covered today:

• Burford Capital (LON:BUR)
• Thomas Cook (LON:TCG)
• Angling Direct (LON:ANG)
• Goals Soccer Centres (LON:GOAL)
• Staffline (LON:STAF)

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Burford Capital (LON:BUR)

• Share price: 748.5p (-12%)
• No. of shares: 219 million
• Market cap: £1,635 million

Evidence of market manipulation in Burford shares

There are softer stock market targets than a group of litigators, but that is exactly who Muddy Waters decided to pick a fight with. So far, Muddy Waters is winning.

In today's RNS, Burford claims that there is evidence of illegal market manipulation of its stock.

I don't know if that is true or not, but I do know a little bit about market mechanics. Burford explains to us today what "spoofing" and "layering" are, and says:

Spoofing and layering are both illegal and have resulted in criminal convictions in the past.  As an example, layering led to the 2010 "flash crash" when the Dow Jones Industrial Average fell 600 points in five minutes; the perpetrator was found guilty of fraud.

There are a few things I might say about that.

Firstly, the "Flash Crash" was indeed a disorderly event but I can't agree that it was all bad: it was a terrific buying opportunity for fundamental investors, for example. I remember reading about a fund manager who literally sprinted across his building to place his buy orders in the market as quickly as possible. For every seller, there was a buyer. Those who were focused on value did very well out of it, as they should!

Therefore, at the risk of repeating what I have already said about the short attack at Burford, let me highlight that Muddy Waters did not force anybody to sell their Burford shares.

Indeed, those who believe that Burford shares are worth £20 should be pleased that MW has created an opportunity to buy them for £7.50.

But lots of people don't think this way: they want most of all to be able to sell their holdings today for a high price.

I accept that not everybody can afford to have a very long time horizon in the markets, but equities aren't supposed to be short-term investments. They don't have any maturity date and are designed to be held for very long periods!

Secondly (and this is a related point), the Flash Crash of 2010 only lasted for 36 minutes, as the market quickly restored its original perception of what shares were worth. Many investors didn't even notice it, until after it was over.

Similarly, Burford shares could recover to £20, if the company refutes all of the claims by MW and continues to perform well.

What the Muddy Waters report did successfully, in my view, was to highlight that many investors are unable to value Burford properly (myself included). This realisation that "we don't really know what Burford is worth" triggered a huge sell-off, with the sellers probably including some traders who had been merely following the momentum higher.

In other words, I think the evidence suggests that it's the previous Burford share price which was artificial, not the current share price. The previous share price was clearly supported by people who did not have a lot of conviction in their holding, if a 25-page document by a well-known bear was enough to shake them out of it.

So in summary: if the Burford share price recovers quickly, then no harm will have been caused to those who didn't sell. If the share price does not recover, then it's much more likely that the previous share price was false, in terms of the valuation it created for the company.

Thirdly, professional opinion is extremely dubious on the claim that Navinder Sarao was "the perpetrator" of the Flash Crash. 

Sarao was an individual trading from his Mum and Dad's house and was competing with much more powerful, institutional high frequency traders who were spoofing the market much faster than he could possibly trade.

But, despite his severe limitations, he came up with tactics to "spoof the spoofers".

Far from causing the Flash Crash, Navinder was a small player in the market who beat the US-based algorithms at their own game and did not have the influence to protect himself from blame and from US prosecution.

For all of these reasons, I am extremely sceptical when I see how Burford chooses to frame today's RNS.

As a general principle, good companies don't worry too much about their share price. Remember what Jeff Bezos says: the stock is not the company, and the company is not the stock.

The Evidence

Burford points to a large volume of sell orders which were cancelled, both on the day before the Muddy Waters report and on the day of the report itself.

On the day before the report, it says that the share price fell sharply during periods when little stock was traded.

...during five one-minute periods on 6 August (14:17, 14:30, 14:35, 14:43, 14:45), Burford's shares fell 6%, or over £170 million in value, some of its sharpest declines of the day.  During these periods, executed sell orders totaled a mere £186,000.

They hired an academic to help them with this analysis, but I wonder have they spoken to the market makers? Surely the market makers are the ones who can tell them about the supply and demand imbalances on that day?

Just because volumes were low doesn't mean the price can't fall a lot: all it requires is that there weren't enough buyers to soak up the sales.

Similarly, on the day of the report:

On 7 August, a day on which over 28 million Burford shares traded, Burford's share price suffered its greatest declines over just ten single minute periods with very low volumes of executed sales and very high volumes of cancelled sales orders. 

Again, why can't we hear this from the market makers and brokers? Surely they are the ones who would want to complain the loudest if they have been fooled by market manipulators, since they are the ones who get tricked first of all into trading at the wrong prices?

For example, at 08:53, the minute which saw a 7.6% price decline, there were only 27,885 shares actually sold - less than 10% of the number of shares underlying the orders created, 291,364.  It strains credulity to believe that a decline on the order of hundreds of millions of pounds in market capitalization was driven solely by actual trading amounting to a few hundred thousand pounds absent market manipulation.

Actually, I don't think that strains credulity at all. If EURCHF - a major currency pair - can collapse on almost no volume (as it did in 2015), then I don't see why an AIM stock can't collapse on almost no volume.

Burford points to the large number of cancelled sell orders on this trading day. Might these cancelled orders come from ordinary holders of Burford stock who were trying to execute a selling strategy, but were unable to get filled, rather than from market manipulators? The former seems like a more natural explanation to me.

Burford should proceed with this investigation if it feels strongly that its stock has been manipulated. But investors should be cautious about a company that cares a little bit too much about its stock price. If I was advising Burford, I would suggest that it stops talking about Muddy Waters, gets on with business as usual, and proves the shorters wrong through its results.

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Thomas Cook (LON:TCG)

• Share price: 8.1p (-16%)
• No. of shares: 1536 million
• Market cap: £124 million

Proposed recapitalisation - progress update

Thomas Cook announces an update on its recapitalisation.

It contains little that is new, but gives us a target of early October for implementation.

The upcoming dilution is the main event for shareholders:

...the proposed recapitalisation will require a reorganisation of the ownership of the Tour Operator and Airline businesses which would result in a significant amount of the Group's external bank debt (£650 million) and bond debt (€1.15bn) being converted into equity, resulting in a substantial deleveraging of the Group. Existing shareholders are therefore expected to be significantly diluted as part of the recapitalisation, although they may be given the opportunity to participate in the recapitalisation...

This stock is a bulletin board favourite, attracting hundreds of posts every day.

Recently, there has been excitement over share purchases by some foreign investors: well-known travel entrepreneur Neset Kockar owns at least 8% of the company, while the unknown "Rodionova Lilia" from Russia owns about 3.5%.

It's unfathomable to me why these individuals would get involved in a situation where they are likely to get diluted to smithereens, but they may have tactical reasons: shareholders will be able to vote on the recapitalisation proposal, presumably? Perhaps these new investors think that their ability to delay or influence the terms of the recapitalisation will have some value.

While the involvement of these individuals does suggest some speculative value in TCG shares, the outcome remains highly uncertain. 

We can look back at the recent case of Mike Ashley and Debenhams to remind us that just because a wealthy, knowledgeable businessperson is buying into a company which they should understand well, this does not mean that the shares will ultimately prove to be worth very much.

Apart from those investors with some special insight into how the recapitalisation might proceed, TCG shares are best avoided. For gamblers and traders only.

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Angling Direct (LON:ANG)

• Share price: 75.8p (+2.4%)
• No. of shares: 65 million
• Market cap: £49 million

Half-Year Trading Update and New Store Opening

This is more like the typical updates we cover in this report.

Angling Direct's H1 performance is "extremely robust" and revenue is in line with expectations.

Like-for-like store sales are up 15% - are the comparatives a bit soft, perhaps? Were some of the previous year's stores very new? Or as Paul said in May, the comparison could be weather-related. Even so, 15% is an encouraging number to report.

Online sales are up 10% as the company develops its own platform and moves away from third-party websites.

New Store - Angling Direct has opened a store in Leeds, two miles south of the city centre.

My view

Paul and I have both thought this share has some attractions, although the lack of profitability at this stage of its development is a bit of a worry! According to consensus forecasts, it is scheduled to move into profitability next year (FY January 2021).

The StockRanks see little to recommend it, which I think is down to the simple fact that it hasn't generated much by the way of profits yet. 

Cash is reported at £13 million. It's not clear if the company has borrowed any money to fund this cash balance, but for the record, net cash at prior year-end was £13.5 million. So there has been at least a little bit of cash burn during the six-month period.

This could be worth researching in more detail, to examine whether there is scope for significant profits in future periods. Taking the cash balance into account, it looks fairly valued to me:

• enterprise value £36 million.
• forecast sales £55 million this year, £66 million next year.
• nice mix of retail and online sales, with online running at 45% of total
• growth prospects in Continental Europe (insert standard Brexit disclaimer).
• breakeven/profits starting next year, if things go according to plan.

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Goals Soccer Centres (LON:GOAL)

• Share price: 27p (suspended)
• No. of shares: 75 million
• Market cap: £20 million

Update

This has been suspended since March and the shares will be cancelled at the end of next month, as the company is not expected to get its 2018 results published by then. There have been VAT shenanigans worth at least £12 million.

The company has net debt of c. £29 million (as of June) and combined with the VAT liability, it seems unlikely that the existing equity is worth much, if anything.

The company said earlier this month that:

Discussions with the debt providers remain positive and they have confirmed to the Company that the existing debt facilities will remain in place post the initial 31 July 2019 review date, albeit that one of its covenant thresholds has been exceeded.

Today, the company confirms that the former CEO and CFO are under investigation by the company in relation to the historic mis-statement of financial results.

I expect that the existing equity in GOAL will turn out to be worthless, but there remains a small chance that shareholders could escape with dilution rather than obliteration.

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Staffline (LON:STAF)

• Share price: 160p (-2.4%)
• No. of shares: 69 million
• Market cap: £110 million

AGM and Interim Results Notice & Auditor Resignation

This is another company with historic accounting problems, and VAT-related issues. This one announces that its auditor, PwC, is quitting:

"...there was mutual agreement with the audit committee not to participate in [the tender process for the position of auditor] following the completion of the Company's audit for the year ended 31 December 2018."

We don't get a plain English explanation as to why PwC is quitting. Instead, we get:

PwC consider that the matters connected with their resignation that need to brought to the attention of the Company's members or creditors are included within PwC's audit report on pages 62-70 of the Company's annual report 2018.

I've gone back and skimmed pages 62-70 of the 2018 Staffline Annual Report. These pages do describe in some detail the terrible accounting mess which Staffline found itself in, following whistleblower accusations.

Paul has covered this share in some detail (see his most recent coverage), and he views it as a special situation.

Like him, I don't like this sector at present and this share is not something that would normally interest me. With all the recent dramatic developments at this company, however, it might well be possible to discover that the shares are mispriced.

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That's a wrap for today - thanks everyone.

Cheers

Graham