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

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.

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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 effects, despite its attempt to create a "platform" business. This makes the private-to-public valuation gap hard to justify.
• Future's management have been generously paid by inconsistent remuneration policies, and have cashed out.
• Future's top management are allegedly connected to each other through family ties and their prior careers, and have created a poor work culture (based on Glassdoor reviews)
• Detailed analysis of Future's acquisitions throws up many questions about the quality of the assets being acquired.

My view

I've written a little on Future (LON:FUTR) in the past. It has generally been in my "too difficult" tray, thanks to its acquisition-fuelled strategy. There were too many pieces of the puzzle, so I felt that the risk/reward of studying it in detail was poor.

Why do a lot of work on a company, if it's probably not the sort of thing that I would ever invest in, anyway?

Since I respect the views of Matt Earl, his bear report helps to confirm that my instincts were correct: it would have been a waste of time trying to make sense of the company, because the rabbit-hole would have led me to many more questions than answers. 

That said, I would not want to join Mr Earl & Co. in shorting this stock. The reason is that I don't see any mention of a near-term catalyst which would all but guarantee the collapse of the stock.

Shorting is difficult at the best of times, and I wouldn't bother doing it without a near-term catalyst. This could be:

• looming insolvency
• the prosecution of fraud
• proof that the business does not have anything like the scale which investors believe that it does.

Without these catalysts, you are left with what I'd call a valuation short - a short based on the belief that the company is overvalued by the stock market.

And while that belief might be well-founded, it can take a very long time for the market to agree with you.

In the meanwhile, your funds are locked up in a trade which is costing you various fees and preventing you from doing something more useful with your money.

This can make sense for some funds and some portfolios, e.g. as a hedge against a leveraged long portfolio, but I would say that for most people, it is best avoided.

Future is not alone in being (probably) an overvalued, acquisition-fuelled media stock with excessively paid management.

The NASDAQ 100 is on a trailing multiple of 30x, and a forecast multiple of 22x. Shadowfall thinks that Future is overvalued at a PBT multiple of 29x - it's right, but many other overvalued companies are currently out there.

Side note - Google

One little piece of Shadowfall's report which I found interesting was this excerpt from Future's 2019 annual report:

“Future is very exposed to Google to the extent that its websites are reliant on ‘search’ (i.e. a user navigating to one of Future’s websites via a search engine such as Google).

Any unforeseen change to the Google algorithm, its nature or business model could significantly impact the Group’s revenues.”

As a shareholder in Alphabet ($GOOGL), it amazes me how often I am reminded of its power. You'll remember that XLMedia (LON:XLM) recently suffered when its websites were demoted by Google, and many other businesses rise and fall based on their ability to win good search results from Google.

This is not a tip, but shares in Alphabet might be a good hedge against the failure of many other companies. Think about it!

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Burford Capital (LON:BUR)

• Share price: 617p (-2%)
• No. of shares: 219 million
• Market cap: £1.35 billion ($1.76 billion)

Update on 2019 trading performance

This is another large, complicated company that has been the target of a bear attack (in Burford's case, by Muddy Waters).

The formula for a bear attack is:

• find a company with a large retail following, i.e. lots of liquidity and possibly having a fragile, short-term orientation.
• find a company with very complicated accounts and inadequate disclosures, where it's possible to sling a lot of mud. Complexity makes it easier to sow fear, uncertainty and doubt.
• find a company with lots of overseas revenues (relative to where the shareholders are). This makes it harder for anyone to verify what is going on.

Burford, a large litigation finance company, ticked all of these boxes. Its share price has still not recovered from the short attack last summer.

Today's update is a profit warning for 2019, but the company tries very hard to assure investors that it is purely a timing issue and that the company's long-term prospects are as bright as ever.

The company first focuses on its cash returns for the year, before revealing that the income statement won't be very pretty:

...Burford expects net realised gains to be approximately $20-30 million lower than in 2018.  It is more difficult to forecast the outcome of the valuation process on fair value gains, but Burford expects to book approximately $50-70 million less in net unrealised gains than in 2018.  Thus, we expect our income and our profit to be lower than in 2018. 

It's a bit cheeky to focus on cash returns first in the statement, before revealing that profits will be down - it wouldn't do this if profits were up and cash generation was down!

Some large wins are said to have occurred in January 2020, and the company says it is unconcerned about the lack of success on the 2019 income statement:

We are entirely unconcerned about that, and as January 2020 has proved, circumstances can change quickly in our business.  We focus on cash, and the best value outcome for shareholders from our investments, rather than managing realisations to an accounting year-end. 

Elsewhere, it says:

Burford is not a business for those focused on short-term profits or for those who eschew volatility and seek predictability.  We finance large, complex commercial claims.  Our cash flows come from their resolution.  There is no "normal" for such claims; they are inherently idiosyncratic.  We have had cases resolve in less than a week, and we have matters from 2010 still going strong.....  If litigation were predictable as to outcome and duration, banks could finance it; there would be no need for Burford. 

That's very clear! If you want predictability, you should go elsewhere.

My view

I'm tempted to open a small, speculative long position in this share, given how far it has fallen. But I will wait for the next annual report, so that I can have the updated figures.

Net assets at the time of the interim results were $1.57 billion. The present market capitalisation is only a 12% premium to this.

Before the short attack, Burford was trading at 4x or 5x book value. Those valuations looked excessive to me, despite the company's excellent ROE of c. 30%.

But if we can buy it around book value, then it doesn't even need to generate an above-average ROE, to justify the price paid.

In summary: so long as the whole thing isn't a house of cards, then I think it could offer good value around here.

There are some legitimate governance concerns. Note that the company is incorporated in Guernsey and operates primarily out of North America.

So I wouldn't bet the house on it, and I'd certainly like to wait until the full-year results before dipping my toe into it, but I'm definitely interested at these levels.

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Fireangel Safety Technology (LON:FA.)

• Share price: 14p (-8%)
• No. of shares: 76 million
• Market cap: £11 million

Trading update

This accident-prone developer of "home safety products" (fire alarms etc.) reports that its underlying loss for FY 2019 will be in line with expectations.

On top of that loss, there will be exceptional charges of £5.3 million, up from £3.7 million last year.

Exceptional charges related to warranties, restructuring, and fundraising were in line with expectations, but more charges need to be recognised, relating to:

...stock provisions and the impairment of intangible development costs as a result of a thorough review of product lines and future development plans in line with the Group's evolved strategy to become a more technology-led connected home solutions provider.

This could be interpreted in different ways. In simple language, the company has wasted £3.2 million in various ways, and has decided to acknowledge this on its balance sheet.

It's giving up on previous plans, and going for a narrow strategy by "developing and promoting those products and services which give the highest and quickest returns". 

Net debt at year end was £4.9 million.

My view: I see no reasons for optimism and would have to give this bargepole treatment.

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BigDish (LON:DISH)

• Share price: 3.15p (+9%)
• No. of shares: 349 million
• Market cap: £11 million

Operational update

This is a "yield management platform" for restaurants - an app where restaurants can offer discounted meals, depending on how busy they are at that particular time.

It had 177 restaurants on the platform in mid-November. This has now jumped to 351, plus another 91 that have agreed to join - excellent growth.

Today's update includes a strangely-worded paragraph suggesting that the company will be able to make money from "marketing partnerships", and that these could turn out to be more lucrative than the company's existing core activity:

Building a national product with increasing restaurant numbers will enable BigDish to leverage national brands for large-scale marketing partnerships in order to drive consumer acquisition which is integral to the strategic marketing plan. It is anticipated that some of these deals will be monetised and that going forward the sums involved may be more significant than future transactional revenue.  BigDish is aware that currently such a positive scenario may not have been considered by its shareholders or observers of the company.

Anything is possible, but there is a lot of blue-sky speculative guff on AIM and I can't distinguish this paragraph from all the rest of it. DISH would need a huge active user base to make money this way, which will be expensive and/or difficult to achieve.

At the half-year report, DISH reported £1.3 million in cash, with sufficient funding to Q3 2020. Today it says:

The Company will continue to monitor its budget forecasts which may result in extending the funding runway beyond Q3 2020.

This unhelpful management-speak means that DISH might run out of money in Q3, but it might not.

My view 

The app is an interesting concept which sounds like it could work, but it will be expensive for the company to achieve its goals. It looks under-funded relative to its ambitions. I have no reason to argue with Stockopedia's categorisation of DISH as a Sucker Stock.

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Quarto Inc (LON:QRT)

• Share price: 72p (unch.)
• No. of shares: 20.4 million (pre-Open Offer, which creates 20 million new shares)
• Market cap: £15 million (pre-Open Offer)

Result of Open Offer

Paul covered book publisher Quarto's open offer earlier this month.

It has had a rocky balance sheet for some time, and this is its first attempt to plug the hole with fresh equity (perhaps not the last). The £13.9 million in fresh funds should help to calm down the bank for the time being.

My view - the balance sheet is bad enough, but the business itself has been loss-making in recent years as the market for books remains "soft". The company previously guided that H2 2019 would be "particularly challenging".

To me, these shares are still options over the bank debt. I'd rather be the bank, collecting guaranteed interest and fees, than the shareholders.

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Porvair (LON:PRV)

• Share price: 766.84p (-2%)
• No. of shares: 46 million
• Market cap: £351 million

Preliminary Results & Board Changes

This large filtration company has produced a decent set of results. The share price had already been bid up over the last two months, in anticipation.

The CEO makes a very strong comment:

The Group's fundamentals are robust.  Over the last ten years, Porvair has delivered revenue growth of 162% (10% CAGR). The Group is positioned to benefit from global trends: tighter environmental regulations; growth in analytical science; the expansion of air travel; the replacement of plastic by aluminium; and the drive for manufacturing process efficiency. These trends offer opportunities for which the Group develops differentiated products. Trading in 2020 has started well, order books are healthy and investment plans are on track. 

The company clearly lays out its business model, and it all sounds incredibly sensible.

Even better, the company has the financial track record to justify what it does.

It calculates its return on capital employed as 14% - I'd prefer if this was higher, but too few companies bother to make the calculation in the first place.

The secret is out that this is a decent company. At a forward P/E multiple of 30x, it is surely up with events for the time being.

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Watchstone (LON:WTG)

• Share price: 142.15p (+5.5%)
• No. of shares: 46 million
• Market cap: £65 million

Update re: the sale of healthcare services business

The Quindell story is finally coming to an end, with the confirmed sale of its Canadian healthcare businesses.

The only remaining business is Ingenie, a small telematics brand.

The prospective cash balance here must be very large. From the half-year report:

As at 31 August 2019, the Group had cash and term deposits of £37.9m (with a further £50.3m remaining in escrow pending resolution or determination of the Slater & Gordon claim).

Of that £50 million in escrow, £39 million was released back to Watchstone.

And the Healthcare businesses are being sold for £22 million.

A large cash distribution to WTG shareholders should be on the cards. I don't know for sure if there are any outstanding legal problems which might prevent this - as of the most recent half-year report, an SFO investigation into the legacy matters was ongoing.

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Arden Partners (LON:ARDN)

• Share price: 15.5p (-3%)
• No. of shares: 29 million
• Market cap: £4.5 million

Preliminary Results

This boutique investment bank has seen better days.

Revenues have fallen by £0.8 million to £6.6 million, and the pre-tax loss is only a little better than the previous year, at £2.6 million.

Since these results only go as far as October 2019, let's skip ahead to the outlook:

The current financial year has started well with the completion of a number of transactions including a number of equity fundraisings.  The decisive result of the UK General Election in December 2019 has removed some of the uncertainty...

Revenues generated in the current financial year are well in excess of those achieved in the same period last year and we are trading profitably in the year to date. 

Balance sheet at year-end is not terrible: net assets of £6.1 million, "liquidity" of £6.9 million, and cash of £2.5 million.

I don't think it can afford another £2.5/£3 million loss without putting itself under serious pressure, but on the basis of the outlook statement, it should live to fight another day.

Does it make sense to be listed at this size? I doubt it!

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Spaceandpeople (LON:SAL) - this is another company that is probably too small to be listed.

Lots of people have talked about the shrinking small-cap market. With companies such as this still floating around (market cap £2m), I think it's fair to say that there are still too many and that the shrinking could have further to go.

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Northamber (LON:NAR)

• Share price: 53p
• No. of shares: 27 million
• Market cap: £14.5 million

Completion of AVM Acquisition

Northamber completes the acquisition which it elected to announce after its recent AGM.

Comment by the Acting Chairman:

We believe there is a strong opportunity for AVM to develop within the Northamber Group.  The Acquisition reflects our determination to grow our revenues, broaden our product offering and improve our margins.  We remain committed to returning Northamber to profitability and will look to evaluate further opportunities for acquisitive growth.

"Further opportunities for acquisitive growth" - a clear warning that the company's assets might not be returned to shareholders.

This "cigar butt" share, which I've owned twice, is a perfect example of a value trap. There is lots of value inside, but whether it will ever be released to shareholders is highly uncertain. 

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Out of time for today - cheers!

Graham