Small Cap Value Report (Mon 3 Feb 2020) - FUTR, BUR, FA., DISH, QRT, PRV, WTG, ARDN, LDSG, SAL, NAR

3rd Feb '20 by Graham Neary

26 comments 9912 reads

Morning! Graham here.

There seems to be a problem with Investegate, so I'm on londonstockexchange.com today.

The RNS feed is actually very busy, with all of the following companies making announcements that could potentially be covered:

Future (LON:FUTR) - trading update
Burford Capital (LON:BUR) - update
Fireangel Safety Technology (LON:FA.) - trading update
BigDish (LON:DISH) - operational update
Quarto Inc (LON:QRT) - open offer
Porvair (LON:PRV) - preliminary results
Watchstone (LON:WTG) - update
Arden Partners (LON:ARDN) - results
Spaceandpeople (LON:SAL) - trading update
Northamber (LON:NAR) - completion of acquisition

Timings: finished at 2.50pm.

Future (LON:FUTR)

Share price: 1360p (-16% on Friday, +6% today)
No. of shares: 98 million
Market cap: £1.33 billion

Trading update

This publishing company was the target of a short attack on Friday by Matt Earl's fund, Shadowfall. Future owns websites and magazines such as T3, Gizmodo, TechRadar, PC Gamer, FourFourTwo, and many others.

Today's update neatly sidesteps the bear report, instead focusing on Future's allegedly good performance over the last four months.

Thanks to strong momentum, the outcome for the full year (FY September 2020) will be "materially ahead of current market expectations, despite some uncertainty in the macro-economic environment".

No numbers are given, so I won't bother pasting the rest of the update here.

Bear report

I've been reading the Shadowfall report, so I now have some idea where the bears are coming from.

Their findings are worth a look, especially if you happen to be a Future (LON:FUTR) shareholder or if you find short-seller reports interesting!

There is no "smoking gun". Instead, there are a variety of unrelated charges levelled at the company, namely that:

real organic revenue growth is probably lower than the company says that it is.
Future's stock market valuation is much higher than the valuation it pays for the assets it acquires
Future's M&A strategy is building a collection of independent assets, without any network…

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JonBirdy

3rd Feb '20

I have does the same IGotPoes. This morning I sold my £g4m position (which was doing quite nicely) on concerns regarding electronic components. I closed a lot of other positions last week. No doubt I’ll regret it, but just feel more relaxed in cash at the moment.

shipoffrogs

I think Burford Capital (LON:BUR) is less able to sell cases in the secondary market, following MW's attack and the political uncertainty in Argentina. Hence the lower realised gains. There was also a strong hint at the need for more cash to either fund growth or shore up the balance sheet.

SundayTrader

Just possibly, Fireangel Safety Technology (LON:FA.) might at last be putting its problems behind it. The further problems listed in the update look historic, and their revenue forecast is in line. So you have a company with an EV of £15 million, and revenue of £45 million or thereabouts. 2021 figures could be looking better. As against, capex looks excessive against revenue, and fire alarms remains a competitive business, despite the best efforts of BSI to boost sales. I don't hold.

iwright7

Graham: An interesting appraisal of the shorting attack by Matt Earl on Future (LON:FUTR) . As ever its difficult to untangle fact from fiction, but the bear attack will create doubt which is likely to hold back significant price gains. This aspect has been enough to make me decide sell my holding this morning and to go fishing elsewhere.

Graham Neary

Hi - thanks for the feedback re: Future (LON:FUTR). Good luck with whatever you choose instead! G

Paul Scott

Hi Graham,

BigDish (LON:DISH) is highly speculative, but it's a fantastic service, that's why I bought shares in it.

A small correction - it's not AIM listed, it has a full listing.

It raised about £2m in a placing last year, at 7.2p per share - more than double the current share price. Cash burn is rather higher than I would like, and it will need refinancing this autumn. I don't see that as a problem, because the new telesales strategy is starting to work very well indeed. They only launched this strategy in Jan 2020, so it's started strongly, more than doubling the number of restaurants on its platform. Shareholders can monitor progress by counting up the number of restaurants on the app. I've seen it grow very rapidly in recent days.

Therefore within 1-2 years, BigDish should have thousands of restaurants using the platform, which would make the market cap higher than the current £10m, in my view. A bid approach would then be quite likely, in my view.

The service is an easy sell to restaurants (to precisely manage the day, time, and number of covers that they offer discounts to), which is a far better offering than old style discounts (which cannot be so readily controlled in real time).

The service is also fantastic for consumers - I use it extensively. It's free, and has enabled me to find a lot of excellent restaurants that I never would have otherwise found. Typically a 50% discount makes you try out a new restaurant, then you'll return and are happy with 25% in future, to eat at off-peak times.

I think this app could become very successful, despite management shortcomings, and mis-steps in the past, to me the upside potential is worth the risk. Raising more money is not likely to be a problem now that growth is really taking off. Last time, management proved very adept at raising money at a high valuation.

Definitely not for widows & orphans! Although I think today's news of very strong growth in restaurant numbers has greatly reduced risk.

Regards, Paul.

Mnomis

I would be interested in thoughts on Nahl (LON:NAH). I luckily sold out on profit warning on 23rd Dec. 2nd one today and stock down >40%. What is interesting is that Stockopedia was still showing a rating on stock as of yesterday close of 95, with quality of 87.

Is there not an adjustment factor (to quality I would argue) that knocks a share following a profit warning? Or at least a flag that trading under a profit warning?

abtan

Marathon effort today Graham, thank you!

cmpeckham

I believe that the stocko algorithms could do a lot better in assessing quality. A recent similar example was XLMedia (LON:XLM) which was discussed on this board. It suffered a substantial fall after it announced the latest in a seemingly long run of problems (Google demoted it as Graham mentioned).

I was surprised at the time to see it rated so highly by stocko and just checking today it still has a stock rank of 96 with a quality ranking of 91. Just to pick one example in contrast, Prudential (LON:PRU) has a quality rank of 30. To stocko, XL Media is in the Champions League and Prudential is in the Vauxhall Conference. I'm sorry, but I would suggest that Prudential is very obviously a higher quality business than XL Media and in my view the data is there to support that statement.

dodge1664

superstock NAH down 43% today! ouch!

timarr

I would suggest that Prudential is very obviously a higher quality business than XL Media and in my view the data is there to support that statement.

Yes, but "Quality" in the Stocko sense doesn't mean what you mean by the same term.

"Quality" in the Stocko world means something fairly precise in terms of data that has been shown by research to be predictive of a statistical likelihood of outperformance. It has nothing to do with whether the PRU is a better company than XLmedia (it is, by a very long distance which is why I own the former and wouldn't touch the latter).

In this case the problem is worsened by the fact that most of the Stocko numbers are only updated when there's an actual set of results. So, there's not a lot of data for the algorithms to use to drag down the Quality ranking - yet.

In the end it's not hard to check why any company has a particular ranking, just need to click through and analyse the underlying data that's used to generate it. But, as ever, if people are going to use Stockranks to pick individual stocks they need to recognise that they need to check both recent news and the underlying data: they're meant to be used for portfolio construction, not stockpicking.

Nick Ray

Regarding the Stocko ranking system, I think part of the problem is that we are encouraged to think bigger is better. But in fact it is just an objective percentile ranking for a particular mix of metrics. For Q and M bigger generally is better, although Q is weighted towards five year performance so it is slow to respond to changes in current performance.

For V though the percentile position is not a simple big=best relationship. Above 95 and below 5 are definitely high volatility riskier stocks. They might shoot up or collapse and both outcomes are likely!

This is where the StockRank which combines everything is rather misleading. It is safer to treat QM and V separately in assessing a stock.

timarr

You raise a number of points, but just to respond to 3:

1. I understand your point about factor research, but Stocko doesn't fully reflect the factor research as it was actually conducted. One key point is that certain financials are inappropriately punished for the industry that they belong to, which is a major reason that Prudential's score is so low.

2. There are other quality metrics that could be included and are not. Take the issue raised here - profit warnings. Stocko have done their own excellent research on this issue which isn't reflected in the ranks. In its pure form that would be difficult to do, but there are proxies that could be created. The momentum factor captures part, but not all, of this information. The risk rating captures another part, but this information isn't refelected in the stock ranks.

3. I don't think there is a meaningful distinction here between stock selection and portfolio construction. At the end of the day, you construct a portfolio by picking stocks and you're not looking to diversify between high quality and low quality stocks. Look at how Ed sees it being used in NAPS for example. He diversifies by industry and uses the stock rank to select stocks.

mojomogoz

Burford Capital (LON:BUR) is a much loved and despised stock.

Following the Muddy Waters short raid I re-engaged a half position in the high 700s following the announcement of corporate governance changes (i had owned prior to MW and then traded very big around the volatility buying 2 for every 1 share I had in the 500s and then selling all in the high 800s in days after...not my normal approach but I felt the MW thing provided a chance to trade the emotions and allowed me to put an effective loss floor in at approx 1350p).

So I believe there is value in BUR both pre and post MW.

On today's update for H2 19 I decided to sell a bit ahead of the 11.30am call at 650p level. Why sell?

1) This has turned into an issue of whether BUR has the right capital structure. I could always see this and pointed it out as the weakness...however, its reflexive and if its believed in the capital structure is good and if its not then its bad....its somewhat like a bank...a money printing machine when confident in it but potentially insolvent if not due to asset-liability mismatch.

Subsequently, on the call with mgt most of the questions from brokers and institutions focused on this underlying capital structure issue. What's the BUR response...

2) CEO says as there's such a big opportunity ahead of them it would be 'imprudent' to not raise the funds to take the market share as otherwise other people would. This was directly in response to whether they would buy back shares as muted in peak throes of MWgate). IMO he did not like being asked this question at all.

3) Given the amount of capital they have deployed into cases in last few years and their claim that the duration of case resolution is sub 2 years the slowdown in realised cash and earnings write up gains in H2 19 is close to a financial heart attack. It is at least partially true that timing of returns is an act of God (well the courts and legal process), but...

4) I can't help speculate that their may be an underlying connection between the heart attack and a relative lack of free cash to finance the large commitments they have made in last few years. I'm not an expert in litigation and other legal processes particularly as this sort of scale but I strongly suspect that speed of resolution is partially a function of depth of pocket and how quickly and readily cash is applied. Pre MW it was my supposition that the company would raise equity to fund ongoing investments. That's obviously less attractive and MW have effectively laid a trap as to raise equity post MW is to sort of give credence and kudos to the MW take down....

5) So in the rns and the call they mention that they will raise cash from bond issuance. Interestingly, the old CFO was keen to stress that they wanted to be very cautious on leverage whereas today CEO was keen to emphasise that debt finance is the ideal as it maximises return to shareholders...hypothetically true but then reality is not a capital structure financing model.

6) In addition, its noticeable that the value write up down more than the cash returns. This could be new CFO being more conservative and/or a response to the transparency needs of US listing. Surprise potential in that obvs

7) Today's rns was real smoke and mirrors stuff and smells bad....leading with new commitments is exactly wrong when there's a big profit warning in the tail of it. Its a total irrelevance! Also, the mixing of fund and balance sheet figures was obfuscating. The $1bn casn return sounds super...but only $500m goes to the balance sheet (ie the funds etc take the rest). This is a significant decline on 2018 where there was £630m proceeds from realisations.

8) What has happened to significant contribution from performance fees on funds? 18-24 mths ago these were nearing ready to cascade over their fee waterfalls and into income statement. But its gone quiet. Given the reported short duration of payback (less than 2 years), the high returns the business enjoys and the amount of capital in the funds this should be flowing! Mgt have gone quiet on this. This would be a great model proving point to make now. This is odd.

Burford is now a coin toss on near term cash-flows from existing cases. If there's a stress whereby they slow funds to ongoing cases as they need to fund newer commitments (including their end of a very big sovereign wealth deal) then it may be that some surprising turn of events unfold to reshape the capital structure of Burford including a take private at low valuation....which I suspect mgt motivated by ego will prefer to a dilutive equity raise at low prices as they get to blame dumb/malicious outsiders and get to strike enriching earn outs in a non public context...there's a risk this occurs ahead of US listing as a more 'optimum' outcome for 'stakeholders'.

It basically turned into a sh1t or bust situation. This will play out before the US listing IMO....which I think they will pull unless they have a very big strategic partner taking a stake as why would there be great demand for their equity in the US given the current horlicks?

donald pond

This is an important point, and you are wrong. They have never been able to sell cases other than Petersen in the secondary market for a simple reason. Most cases can only be evaluated if you see the documentation between lawyer and client. This is normally privileged, but that can be waived, but if you waive it for someone you have to waive it for everyone. So if Burford Capital (LON:BUR) tried to sell cases in the market everyone would be able to see the strengths and weaknesses of the case and that would materially prejudicial.

The reason why they can sell Petersen is because the facts of the case are not disputed. Really, it is just a bet on whether Argentina will pony up and if so how much of the $9bn they are on the hook for. And people can take their own view on that.

They did say they may seek more cash through the bond markets to fund growth: is it really a problem that demand for their services continues to grow?

DP - I think you'll find that their historic reports make something of trying to build a secondary market for cases in progress. If you're saying that's all BS, then you're better informed than me.

Good points:

1. Yes, you're right: Stockopedia apply their own algorithms to the data. Whether that reflects the research more or less is arguable - I suspect it depends both on sector and market status. But therein lies opportunity.

2. Correct. There is selection bias in the metrics taken (and presumably how they're combined) and there's not enough longitudinal data to provide any real evidence either way - especially as the market has been on a tear ever since Stockopedia launched. But I don't think the profit warning evidence (which I have taken on board personally) is sufficiently robust to be used to change the ranking algorithms. You'd need a lot more data over a longer period of time to show that it's not a blip. And the ranks would somehow need to incorporate non-regulatory trading updates rather than regulated reported numbers.

3. Here I disagree. The appropriate approach to using Stockranks is to randomly pick a portfolio of stocks with high ranks and then rebalance at an appropriate interval - annually, I suppose. NAPS and other selection mechanisms that involve human interaction will - if the theory behind factor analysis is correct and implemented correctly by the ranking mechanism - simply degrade performance. I wouldn't want to invest in a portfolio purely driven by Stockranks though - e.g. look at the top 30 current Stockranks and consider sinking all your funds in them (*).

NAPS was a good marketing tool while it worked. But it's not really a serious investment proposition, surely ... :)

(*) Actually I hold 5 of them, so maybe ...

Ive been in meetings where Bogart has discussed it and basically the privilege point means that there can only be a secondary market either after the case has been to court or where the buyer is willing to buy without seeing the legal advice that has been given in the case. So while there would like to be a secondary market, other than in Petersen, which is an open and shut case, privilege is an insurmountable obstacle.

dmjram

4th Feb '20

Bond financing for a company with very lumpy, uncertain cash flows that has just issued a profit warning is not usually a good idea.
You need risk capital and a long time horizon for the skewed case returns to be realised.

Tombholliday

15th Feb '20

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Small Cap Value Report (Mon 3 Feb 2020) - FUTR, BUR, FA., DISH, QRT, PRV, WTG, ARDN, LDSG, SAL, NAR

Future (LON:FUTR)

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Graham Neary

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