Small Cap Value Report (Mon 22 Aug 2022) - CINE, SMV, NGHT

Good morning! Paul & Graham here today.

Last week's podcast roundup is here. It's quite a good one, even if I say so myself :-)  These will update automatically, if you put the website URL into your podcast provider. I do them every weekend, usually around lunchtime on Saturdays, summarising the week's SCVRs and other random thoughts about the markets & macro. All a bit gloomy this week.

Agenda - 

Paul's Section:

Cineworld (LON:CINE) - Sunday Times ran an article saying it's shortly to file for bankruptcy. The company issues a response today saying that is one option being considered. Shares are almost certainly worth nothing.

Graham's Section:

Smoove (LON:SMV) (£39m) - this owns a website that matches mortgage brokers with solicitors, and a cloud-based platform designed to make the conveyancing process easier. FY March 2022 results are not too great: revenue growth is modest at 13%, and the company burns through £4m of cash. But the cash balance still finished the year at £20m, giving the directors the scope to propose a share buyback while also providing a few years of runway to develop the business. I like this one in theory but there’s no doubt that it’s on the more speculative end of the investing spectrum.

Nightcap (LON:NGHT) (-2.7%) (£28m) [no section below] - this bar group announces the opening of “what will be one of the world's largest Tequila-focussed bars”. Based in Covent Garden, it will be the new flagship site for Barrio Familia, a Latino-themed chain of cocktail bars. Nightcap has 35 sites and 21 possible premises that it is currently working on, and sees “favourable market conditions for site acquisitions”. The company’s net cash position was last reported to be £0.6 million as of 3rd July 2022, and it recently reported a new £10m facility with HSBC. Almost half of that facility is earmarked to be used in development capex. This stock IPO’d as recently as January 2021, at an IPO price of 10p (latest share price: 14.6p). It has raised significant debt and equity finance since then and with a debt-fuelled expansion underway in a sector littered with investment horror shows, I would approach this one with caution.

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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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Paul’s Section:

Cineworld (LON:CINE)

4p (Friday’s closing price)

Market cap £56m

Response to media speculation

The Sunday Times ran a story saying that Cineworld is considering filing for bankruptcy in the US and possibly elsewhere too, due to its insurmountable debt pile of c.$5bn, and a legal case which it lost (but is appealing against) for about £800m. The legal claim would only rank as an unsecured creditor, so would effectively be wiped out in an insolvency. That, and the need to ditch some uneconomic sites is why insolvency looks almost certain now. Hence the shares are worthless, because equity ranks behind all creditors in law.

The response this morning from CINE repeats its previous statement. It says both “additional liquidity” and restructuring its balance sheet are being considered.

Its cinemas are open for business as usual, and expects “no significant impact on its employees”.

Although the Sunday Times says some sites in the US are likely to be closed.

“Strategic options” being considered include a Chapter 11 filing in the US, and “associated ancillary proceedings in other jurisdictions…”.

As regards shareholders, it says -

As previously announced, any deleveraging transaction would, however, result in very significant dilution of existing equity interests in Cineworld.

That sounds an understatement. Shares usually end up worth nothing in insolvencies, although US law is different to UK.

My opinion - CINE took a long time to implode, but the balance sheet is ridiculously over-geared, so there was a big question mark over these shares even before the pandemic struck.

In the short-term this share price could be volatile, as some shorts may want to close before the share is suspended, to bank their profits. The trouble is, when companies actually go bust, short positions can take an eternity to actually be paid out in full. In the meantime, sometimes CFD/spread bet companies put them on 100% margin, so you end up with a load of capital tied up, sometimes for c.6 months, before they finally get marked to zero and paid out. Hence it does make sense to close a short position before the share is suspended.

As for longs - well there’s really no excuse. What on earth were you thinking?

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Graham’s Section:

Smoove (LON:SMV)

Share price: 59.6p (-0.7%)

Market cap: £39m

This was previously known as ULS Technology - not a very inspiring name, so I can’t blame it for changing to “Smoove”!

The name change was announced back in April, and was described as giving the company a “refreshed, refocused and empowering brand”. The company also got a funky new website.

So what does it do? It owns econveyancer.com and digitalmove, tools designed to help the process of moving house go more smoothly (cough).

Let’s take a look at these results for FY March 2022 (it feels late to be publishing these):

• Revenues +13% to £19m
• Gross profit +13% to £7.8m
• Underlying EBITDA loss of £3.8m (last year: £0.4m profit)
• Pre-tax loss £5.4m

One of the few bright spots among the numbers is that the gap between the underlying EBITDA loss and the pre-tax loss isn’t bigger.

The revenue growth might also be considered encouraging. But I prefer to see higher growth (over 20%) from loss-making companies, to help justify the cash burn. At Smoove, the major KPIs grew at rates of between 10% and 20% in FY 2022.

Smoove says that the financial loss reflects “investment in the core eConveyancer business and in new product areas.”

There is a major factor supporting the market cap: cash balance of £20m (as of March 2022), thanks to disposals previously made. So at least Smoove will not need to raise money for some time.

And here are the post-period end highlights (a very important section, since the period ended five months ago!):

• Operational restructuring to align cost base with product development and growth strategy (cost cuts?).
• Launch of Smoove Start, a client onboarding service for estate agents, in pilot phase.
• Tender offer to return up to £5m to shareholders.
• New Chief Financial Officer.

Outlook - the CEO argues that the economic headwinds facing first-time buyers make Smoove’s offering even more important. There’s nothing too concrete in this outlook statement.

My view - I really want to like this company. I agree with it when it says “the home ownership process remains broken and provides huge opportunity for radical change”. And I want it to succeed in its mission of “revolutionising the home ownership market while simplifying processes and reducing the stress and frustration for everyone involved.”

The first-time buyer process, from my perspective, was a trip to the Dark Ages: it involved vast amounts of paper, written signatures, snail mail, and obscure, time-consuming requests for information involving many different people. Everyone was very professional and reasonable, but the process was archaic and not what you’d expect in modern business. I couldn’t help thinking that there should be a better way.

Maybe Smoove’s DigitalMove can help to promote a better way?

The eConveyancer product, meanwhile, has received some industry recognition this year from the Specialist Finance Introducer Awards. They say that 2% of UK conveyancing goes through them - I wonder how big this could get?

Valuation - if we used the year-end cash balance of £20m, that leaves an enterprise value for the business of £19m.

The trailing revenue figure is also £19m, so the business is available to be bought at around 1x sales.

I generally don’t buy shares in loss-making, speculative companies, because most of them don’t work out. But if I had to buy one, this would be on my shortlist.

My reasons for liking it are:

• It’s easy to understand what they are trying to achieve, and the mission makes sense - the house moving process needs to be modernised.
• I like to invest in “portal” businesses (e.g. I own shares in Rightmove (LON:RMV) ) and eConveyancer might have the potential to be a portal with good market share in its niche.
• The cash balance reduces short-term funding risk and supports the valuation, although it won’t last forever if losses continue. The £5m tender offer, if approved, is unlikely to change much.

My reasons for caution are:

• The cash will run out in a few years, unless the current rate of burn can be stopped (£4m was burned in FY 2022, and the cash balance will be less than £15m after the proposed tender offer).
• Gross profit would need to grow by over 60% to reach breakeven, based on the FY 2022 numbers. As I’ve already mentioned, the revenue growth wasn’t at the rate I’d normally want to see from a business at this stage of its development.

These are my initial thoughts. I’ll be eager to read what other people think of this one!