Small Cap Value Report (Mon 29 July 2019) - JE., PHD, RCH, YOU, SFOR

29th Jul '19 by Paul Scott

16 comments 8062 reads

Good morning, it's Paul here.

See Friday's report for a couple of updated sections that I wrote up on Saturday morning, including a review of the Sports Direct (LON:SPD) debacle - in particular a potentially huge tax liability that has cropped up in Belgium. I'm expecting a big drop in share price there today.

The catalogue of things that have gone disastrously wrong is quite astonishing. There is the huge, total loss on DEB shares - which Ashley tries to blame on anyone but himself. He now admits that buying House of Fraser was a mistake. Some see him as a brilliant entrepreneur, but I feel he's far too arrogant & erratic, to be able to sleep at night as a shareholder. Hence why I'm steering well clear.

Takeover bids

Continuing a theme from last week, I note that there seem to be a surge in takeover bids for UK listed companies. Tech companies in particular. This could be an area for rich pickings, if we can identify any patterns in takeover bids, and then buy shares in similar companies which might become bid targets. Tech companies which dominate a particular niche seem to be popular targets at the moment.

Last week, bruised shareholders in accesso Technology (LON:ACSO) got a nice surprise, when it announced it had received potential bid interest. This morning we have a similar announcement from Proactis Holdings (LON:PHD) . A takeover deal would be a good move for PHD, as management have over-geared their balance sheet, and not performed well (profit warning in Feb 2019), so getting bought out would possibly be the best option for shareholders.

There is also news that a Dutch company called Takeaway.com NV is bidding for Just Eat (LON:JE.) at a modest 15% premium, in an all share deal. The two companies are a similar valuation - JustEat shareholders would own 52%, and Takeaway.com shareholders 48% - those percentages strike me as rather appropriate, given that the bid is from Europe! I can't see why JustEat shareholders would want to own Dutch shares though. Selling this deal to JE shareholders might be a struggle. Takeaway.com looks to be well behind JustEat, with smaller revenues, and is still loss-making. Therefore I would…

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MrContrarian

29th Jul '19

My morning smallcap tweet: Leaf spouts cash.

i-nexus Global (LON:INX), YouGov (LON:YOU), Liontrust Asset Management (LON:LIO), Eden Research (LON:EDEN), Leaf Clean Energy Co (LON:LEAF)

i-nexus Global (INX) warns FY rev and cash below Board's expectations but EBITDA in line. Still has sufficient funding to execute on its growth strategy.
YouGov (YOU) guides FY comfortably ahead of expectations (whose?). Cash conversion poor here.
Liontrust Asset Mgmt (LIO) approach by Neptune Investment Management Limited.
Eden Research (EDEN) has received a 120 day "emergency use" authorisation for fungicide, Mevalone, in France for apples. "We are working actively with Sumi Agro to support the full authorisation of Mevalone for use in the treatment of pome fruit storage disease." No idea on numbers. I'm short.
Leaf Clean Energy (LEAF) to return 101p/sh. Will retain an equivalent cash amount to the interest award of $30m together with its best estimate of further costs and potential liabilities until final resolution of Invenergy's appeal on interest. LEAF very likely to win in appeal IMO. I hold.

rmillaree

£ SPD Sports direct.

I see it has been reported (telegraph) that the sports direct auditor didn't know about the Belgian tax demand until friday !. Quite unbelievable that results would still be released the same day if that is the case bearing in mind the materiality of the demand figure quoted.

Martin C

Suprised £SPD only down 10%. Opening a small short position...

ACounsell

Any thoughts on Keller (LON:KLR) interims announced this morning. 1H poor but claim signs of improvement in 2Q. Promising further improvements in 2H and will achieve expectations for full year. High level of debt perhaps not being reduced fast enough. Market not impressed with shares down +5% this morning so far. Following Stocko profit warning guide this looks like another share that should have sold on first profit warning back in early October 2018. Surprisingly Stock Ranks show it as Super Stock with rank of 89 - not sure the markets agree.

ken mitchell

Martin Sorrell's new age/new era digital advertising and marketing services Company S4 Capital issued a positive trading update today. Revenues and gross profits are growing faster than the targeted rate needed to double revenues and gross profit organically in the 3 years since the start to 2021.

Acquisitions so far seem to be going well though how well will be clearer with results on 11th September.

Martin Sorrell who built WPP from scratch before being unceremoniously dumped seems to feel he has a point to prove and targets similar success at SFOR. So far it's looking good , though after a good run share has flat lined for a few months now., but up 4p so far today at 155p.

Would welcome reader comments if anyone else holds or follows and also Paul's opinion too, though maybe Paul or Graham will want to wait for next results.

MiserableJacktPotato

I hold S4 Capital (LON:SFOR) and am encouraged.

Biggest risk I see is Sir Martin’s age and what happens if he becomes incapable of continuing. Because of this Insee it as a short term holding rather than a buy and keep forever.

Thanks to Laurie who points out that Liontrust Asset Management (LON:LIO) is in talks to BUY Neptune, not vice versa as I said.

Old ManFit

Agreed on

Sports Direct (LON:SPD) ridden that shorting horsey all the way the last couple of months, the guy reminds me of an old boss I had, treated the company like his private money box and ego boost. Since he owns 62% and the price is now "cheap" - he might even consider taking the company private, less stress and having to explain his decisions to the world at large. Long might be the next opportunity - though I would defo spread bet with guaranteed SL, if I did.

Just Eat was a nice little earner, got in just before close Friday.

Sold Reach this morning , on reading your report, made a small gain, but on reflection too risky.

Thornabian

As an owner of JE. Shares I'm unsure what to do but inclined to sell after earnings on 31st as I think it will be somewhat of a rebound to their previous earnings.

I guess this takeover debacle could move quickly but they seem to be giving it a few weeks to confirm..

Considering further cashflow of both JE and Takeaway, I can't see how this is a good deal for JE shareholders as it currently stands even with some deferred tax benefit on the deal.

If anything, I think it shows how undervalued JE were to takeaway.com and potentially how undervalued UK shares are in general compared to their international counterparts.

Future cashflow*

davidjhill

Reach (LON:RCH) - a minor but important point Paul is that net debt is down to £12.9m rather than the £40m you refer to. It will be about £8m by now too.

In the half year they reduced net debt by £27m whilst still paying increased dividends and pension contributions. That is prodigious cashflow of £70m, so I doubt very much dividends are at risk in the foreseeable future. In fact management are guiding to progressively increasing at 5% p/a.

Once the net debt is eliminated I expect them to buy the JPI assets they referred to at a good price. This will allow another round of rationalisation and cost benefits for the following 2 or 3 years, further increasing annual cashflows, revenues and profitability. It will of course push net debt back up again and that will get paid back over the 2 following years. This is a pattern at play.

The market is dramatically under appreciating the amount of cashflow this business will generate before it "dies off" as everyone says it will. It produces £140m of cash each year against a pension deficit effectively just a couple of times that.

As you also point out the digital revenue line is now £48m and growing at circa 10% p/a. Whilst you don't expect it to take over as the lions share of the business anytime soon on a 5-10 year horizon it should be pretty material to the resulting valuation of the business. Management generally seem to have done a good job.

I personally think this is mis-priced and way too undervalued. It feels like a long wait for that perception to change but at least I get a 9% yield in the interim growing by 5% p/a.

Gromley

Very good summaries from Paul and this response from davidjhill on the subject of Reach (LON:RCH) .

I may have mentioned once or twice that I hold these shares. I have also definitely mentioned the amazing consistency in their reporting, today they confirmed "The Board anticipates trading for the year to be in line with market expectations", this is probably the 20th or 30th update in a row that has given us the same update (except for the ocassional small beat, usually in Q4.

The reduction in debt is certainly very impressive and it is true to say that by the end of the year they could be debt free again should they so choose. (They probably won't as it does seem likely they will take some of the JPI assets.)

However, one should not forget the deferred consideration re the recent acquisition this amounts to £59m over the next 4 years. I see no reason to view this as a risk, but you could argue that it pushes the effective "debt free date" a little into the future. (There is no interest on the deferred consideration I should point out.)

I have for some time held the view that the amount of cash the legacy business throws off during "run down" far more than supports the current valuation even without the digital future.

And on the subject of the digital future it is worth noting that the Q2 like for like growth was 13.6% - this I view as being the best guide as the Q1 figure was somewhat impacted by algo changes adopted by Google and Facebook in early 2018. That is still short of their KPI which is for 15% growth and this in turn is lower than they were targeting in previous years (20%).

It is clear that driving digital growth has been more of a challenge than originally expected however the 13.6% is encouraging and whilst I do agree that as things stand one has to look a long way out to see digital growth outstripping legacy declines. Nevertheless, the existing cashflows and efficiencies in the legacy business continue to support both the valuation and the ongoing progress in the project.

I do sense that the market sentiment may be turning now, but it is quite fickle. I would say that the business in better shape now than it was five years ago when the share price was more than double the current level. I do not suppose this will set the world on fire from these levels, but like david I do think the shares are currently undervalued.

Paul Scott

Hi davidjhill,

Thanks very much for pointing out that I'd picked up the wrong figure for net debt at Reach (LON:RCH) , accidentally putting in last year's figure, instead of this year's. It's really important when people spot an error (thankfully rare!) and point it out to me, so I can quickly correct any mistakes. Much appreciated.

You're probably right re dividends - they don't look under any immediate threat, and could conceivably continue for several more years without any worries. But it all depends on what happens to profitability. The acquisitions are masking a declining core business, which does worry me.

I'm quite tempted to pick up a small position in Reach (LON:RCH) despite the various concerns, as you could well be right in thinking that the market has over compensated for the known problems.

There could be a bid from European or American publishers at some point.

Regards, Paul.

P.S. Thanks also to Gromley, for pointing out the deferred consideration liabilities, which need to be taken into account, and should probably be added to net debt for valuation purposes.

30th Jul '19

I didn't have time earlier to listen in to the Reach (LON:RCH) analysts presentation, but having done that now I would throw in a few more observations.

(If anyone interested in taking a position I would strongly recommend watching it here )

Anyway a few "take-outs" :

Paul mentioned in the write up above the impressive operating margin of 20%. Simon Fuller (CFO) made the point that this is the highest Operating Margin since 2007 - bearing in mind that they still have some significant synergies and efficiencies in the pipeline this is quite important. It is true that they cannot go on reducing costs for ever (although there was a statement later about costs becoming increasingly marginal), but they have given themselves substantial headroom here whilst they wait for digital growth to offset traditional declines.
They presented a really interesting chart of "capital allocation" illustrating how the impressive cashflows support : investment in the business, paying shareholders and stabilising the pension - I was tempted to post it here, but actually without the associated chat it may not be be the clearest.
Simon Fuller also made a comment on them being on track to meet their aspiration to become debt free in the coming months - sort of mirroring what I said above. In common with what I mentioned though, he (and Simon Fox [CEO]) later went on to talk about their low level of leverage giving them "firepower" for additional growth opportunities (IE acquisitions from JPI) so I doubt they will actually choose to be debt free.
Some of the spiel on Digital was actually quite impressive - (Including for eg the fact that they are the 6th largest UK digital 'property' after Google, FB, Amazon, MSoft & BBC). For me it is not the main investment case, but it does strike me that if the digital business were attached to a cash-pile rather than an unloved cash-machine they would probably be more highly valued. I will be looking out for signs of euphoria; certainly the analysts questions seemed more directed to possible upsides rather than how grim the press business is.

Happy to remain holding based on what I heard.

Reach (LON:RCH) nice Gromley. Thanks for the summary, that was really useful. I am away so haven't seen the analysts presentation.

Small Cap Value Report (Mon 29 July 2019) - JE., PHD, RCH, YOU, SFOR

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