Small Cap Value Report (Mon 30 Sep 2019) - CALL, WATR, CTG

30th Sep '19 by Paul Scott

40 comments 8760 reads

Good morning, it's Paul here.

Please see the header for the results & trading updates which caught my eye, on my initial sweep of the RNS first thing.

Estimated completion time - I'm writing mainly this afternoon, so should be finished by about 8pm. Update at 17:19 - I'm exhausted, and need a break. So will finish off later this evening. Actually, I'll put any further updates from now on into tomorrow's placeholder, so that people don't have to keep checking back to see if this report is updated or not. Hence this report for today is now finished.

Cloudcall (LON:CALL)

Share price: 98.5p (down c.7% today, at 12:48)
No. shares: 26.6m existing shares + 12.0m new shares = 38.6m
Market cap: £38.0m

(at the time of writing, I hold a long position in this share)

CloudCall is a software-as-a-service ("SaaS") and unified communications business ("UCaaS"), that has developed and provides a suite of cloud-based software and communications products and services, which enables organisations to leverage data in CRM systems to enable more effective communications.

There are 2 announcements today, interim results, and yet another placing

Fundraising

This is a conditional placing & open offer, at 100p per share. This is a pleasingly small discount to the previous market price, which I am pleased about. Placings are only a problem, if existing shareholders are diluted a lot, at a big discount, which is not the case here.

What is striking is how much larger this £12m placing is, compared with previous fundraisings. The company seems to be significantly scaling up its ambitions, stating;

Funding customer led growth capital opportunities, with ambitions to achieve >£50 million in annualised run-rate revenue by 2025

To put that in context, the annualised run rate of revenues at June 2019, was £11m, so increasing that to over £50m in the next 5-6 years is a big deal, that could trigger a re-rating of the shares, possibly.

To have got away such a (relatively) large placing, in very tough markets, demonstrates that management must have told a very convincing story to institutions & high net worth investors, in the meetings that usually precede placings.

A couple of more general points;

Liquidity - for companies this small, the institutional & private investor markets are almost completely separate, which can create strange anomalies where private investors are…

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Paul Scott

30th Sep '19

Hi tiswas,

Thanks, at your prompting I had a quick look at results from Aeorema Communications (LON:AEO)

Pre-exceptional profit of £374k, up 29% on prior year - but why would such a tiny company have a stock market listing (which must cost it £100k+ p.a., and be a lot of hassle)? I can't see the point. There's also the risk of de-listing, for something this tiny - an instant 50% loss, why take that risk?

Balance sheet looks good, with healthy cash, as you say.

Dividends - small, and were considerably cut back a few years ago - hence not a dividend you can hang your hat on.

Small companies in the events sector strike me as being people businesses - the risk being that successful people want big rewards, and/or leave to join a competitor or set up on their own. Hence this is not likely to attract a high valuation. PER of 10 seems about right, but only because the balance sheet has so much cash on it (hence an ex-cash PER of about 4 or 5 would be about right).

Given that, to buy or sell, even in small size, you'd probably have to take a hit on the bid:offer spread, and probably wouldn't be able to sell in any size if you managed to buy in size, then something this small looks very unattractive to me overall.

Sorry to pour cold water on you, but thank you for the share idea.

Regards, Paul.

Edinburgh Investor

I was surprised by the large drop given the RNS on Friday after the close, but this afternoon bounce is something else! Not one for the faint hearted either way.

sheeza

Crimson Tide (LON:TIDE) announced half year results last Friday. Major sales effort highlighted during the half, with a doubling of total head count. But sales and overhead costs are only marginally up. Has the year end report been brought forward six months, or am I misunderstanding?

jonthetourist

Hi both

I think the counter-argument to Paul's fair point re listing is Aeorema Communications (LON:AEO) has ambitions to pick up small, complementary businesses going forward, and being quoted may help to facilitate that.

I hold, but it's not a conviction position.

Jon

fwyburd

Thanks Paul
cheers
Francis

Weasel

Water Intelligence (LON:WATR) is the CEO's pay still C25% of Operating Profit!?

Gostevie

Hi Paul.

"Thanks, at your prompting I had a quick look at results from Aeorema Communications (LON:AEO)

I do wonder how much ego plays a part with some of the very small companies on AIM. Do some CEOs and other directors feel that being a director of a publicly quoted company gives them some sort of kudos that is worth the cost? (Not that it's them personally paying anyway.)

For the avoidance of doubt I am not specifically suggesting that is the case at Aeorema, whose management I have never met.

From the 2018 Annual Report and Accounts:

http://www.waterintelligence.c...

Profit before tax: $1,754,350

Executive Chairman's total remuneration: $501,872

So, yes, about 28.6%

davidjhill

Hi rmillaree

lol indeed. I agree entirely around operating margin. Growth I am happy with. 30% compound annual will make holders very happy indeed in the medium term as long as they don't continue with this rate of operating cost expansion, but I'm with you on concerns around that element. Once again with this share we have to wait and see....hmm. Not entirely convinced by the boards expectation management approach.

sharesurfer

Was tempted by Water Intelligence (LON:WATR) before but too many red flags.

1. Don't like it when the Cashflow from Operations is less than Net Income. With Water Intelligence (LON:WATR) It's consistently lower every year.
2. CAPEX is fairly high at around 50% so there's not much free cashflow
3. They're having to issue shares to buy companies (I assume its their franchisees they are buying out). Would have preferred if they were buying out with internal cashflows
4. Renumeration for chairman is excessive (thanks for that)
5. Operating margins aren't great at 8% which indicates there isn't much of a moat (though if the chairman took a pay cut, it'd be 10%).

A forward PE of 21x times is perhaps too much.

Aislabie

Crimson Tide (LON:TIDE) (which I hold) is way below most investors minimum cap levels but is an interesting comparison to Cloudcall (LON:CALL)
Both companies appear to have large markets to grow into and at this stage may have the timing of some lumpy contracts to disrupt short term forecasts ( but that will not be so obvious as they grow). Cloudcall has chosen go-for-broke expansion on the back of frequent placings to fund “investment” in sales. While Crimson Tide has expanded within its cash flow, still adding sales resources but not (yet) calling on the market and year after year showing a small profit and useful cash generation.
Cloudcall found a couple of years ago that the market wanted a severely discounted pound of flesh to get a critical placing away, but maybe Crimson Tide has underplayed it’s hand and will find itself getting pushed out of the market they have created by latecomers with more cash to invest.
It will be interesting to watch the two approaches play out.

1st Oct '19

Cheers!

It's not a company I follow, but I had a note from before that the CEO was paid a ridiculous amount relative to OP. I see that hasn't changed.Not sure I would be tempted to look at it any further after that.

mojomogoz

2nd Oct '19

jjis and others interested in Brand Architekts (LON:BAR) (previously Swallowfields pre sale of manufacturing business).

I had a look at this stock around the time of the announced sale of manufacturing for wedge of cash similar to market cap (bit less I think). Seemed attractive on face of it with a smaller but higher margin business left. However, I had the following questions and concerns:

1) Trading in the remaining brands business has been poor in year to end of June. I felt why it had been weak was not well explained in annual report

2) I observe that their brands are mediocre and probably lack pull with punters in any serious way and very victim to own brand and new brand and need to discount their stuff to sell it - all a bit Superdrug apart from Alice Hart Davis.

3) If 2 above is correct then they need a lot of ongoing new product development to keep refreshing and feeding the retail beast...that leads me to wonder whether losing the manufacturing arm will bring extra costs and diminution in product development capability...

4) To what extent was manufacturing an input on brand development

5) Departure of Tim Perman as CEO following announcement of manufacturing business sale is surprising as he's only been CEO since May 2018...one would guess the sale would have been driven by him and his 'strategic vision'. To depart straight after its been agreed suggests otherwise. What's going on?...

6) They've got a shareholder base that whilst not activist includes a heavy disposition to investors that can be quite active with their companies plus some big individual holders. Perhaps the shareholders are running the show - at present BAR is without CEO or CFO and professional oversight of operations is being provided by two people who went with the manufacturing business

7) My guess from this is that Brand Architekts is not long for this world as a independent entity. Sold, closed or broken up? Dunno. Selling all as one might be hard as its a hotch potch of small middling brands. Closed doesn't make sense as that's money down the drain. Break up by selling brands they can might make sense and be more manageable/digestible path. Obvs they will be seen to be forced sellers so the price wont be great

8) Perhaps the biggest conundrum is that it appears that the small brand business has kept the big (in relative terms) pension deficit. At the end of June pension liability is £9.4m up from £4.5m end of last year. Note that brands business has revenues of £19.7m and underlying OP of £3.6m (which is before shared central costs of old combined Swallowfields). These liabilities originate primarily (I think wholly) from the old Swallowfields manufacturing business (which bought Brand Architekts a few year ago). Why would the pension liability stay with the brand business? Smacks of desperation TBH...the investors are not mugs so they must have felt it was a good quid quo pro to get their hands on the £35m cash from KDC/One for manufacturing.

So what to think re BAR? £7.2m net debt at year end turns into £28m net cash...that's roughly current market cap which looks nice as brand business is free...but then its also carrying £9.4m pension liability. To wind up the businesses and generate cash return for investors they would need to organised a buyout of the pension...don't know how that would price but lets call it a round £10m for simplicity...

So BAR is £18m cash plus a weak brand business with £20m revenue pa (that seems to be going backwards). Obviously, a bit more of the £18m gets used up winding down the business.

Or they could use the net cash to invest n and acquire more brands....that doesn't look attractive and probably not what the shareholder want either as that could mean a decline in SP at worst or a a long duration J-curve effect.

On balance I'd say that despite the high cash position Brand Architekts (LON:BAR) seems more short candidate than long.

At the time of the transaction announcement I took a tiny spec long position in spread bet account. Initially I made a nice little profit...then the share price turned on me. I closed out with the release of prelim for a small loss. The spread bet position was just to have me interested and doing some work and watching.

Note, I sought to ask management some of the above questions and got no response from IR or now departed CEO.

Effortless Cool

I want to give a different perspective on some of the bearish comment that has been made here on Water Intelligence (LON:WATR).

Paul mentions the increase in receivables. Well, $500k of this relates to the investment in Entertainment AI that was being held in escrow at the year-end. Adjusting for this reduces receivables from 42.0% of revenue to 38.9%. This is consistent with the rising trend that has been apparent since it started serving major insurance companies, that business having a less favourable cash flow profile than business with individual customers.
Paul also notes the lack of a dividend. Well, of course it does not pay a dividend! Investing in its business is producing a 30% CAGR in revenue and a 23% CAGR in net profits (Stockopedia figures). With those returns on investment, paying a dividend would be foolish.
Weasel seems to think it is in some way remarkable that the Chairman/CEO has total remuneration that is over 25% of operating profit. Gostevie identifies that this amounted to $502k for 2018. Well, firstly, measuring remuneration relative to profit is a pretty silly measure for a small, high growth company. And is $502k really excessive remuneration given the performance being delivered, especially in a US context? I don't think so. There is certainly good reason to complain about all the related party issues but not, in my view, about remuneration.
ShareSurfer notes that cash flow from operations is lower than net income. This is simply a result of the changing nature of the business. As previously noted, it is partly to do with the insurance company relationships that have now been established. It is also a reflection of the shift in revenues from independent franchisees to corporate franchisees.
ShareSurfer also notes that capex is high, reducing free cashflow. This is a strategic choice. That capex is generating great returns, so shareholders should be happy that it stays high.
ShareSurfer comments that operating margins are unremarkable and challenges whether there is much of a moat. If you take the trouble to understand the business properly, I think there is a very clear moat. There are no other national businesses in its field and the relationships that it is tying up with the major national home insurers will make it very difficult for any others to become established.
Finally, the margin situation is complex because of the rapidly changing business mix in the group. There are, however, underlying trends that are potentially very positive for the future. I'll post more on this on the Water Intelligence (LON:WATR) thread at the weekend.

Gromley

Excellent rebuttal EC ( Water Intelligence (LON:WATR) ),

I have been looking (as something of a side project) to develop an extensive investment 'checklist' to take in as many possible factors as I can - together with acceptable reasons / mitigations for exceptions. You've certainly given some more ingredients with those points!

Some of your arguments I think stand up by themselves without too much further thought, a few though make me really want to check the facts further - which is always good.

I'll certainly be interested in your further thoughts on why "the margin situation" is complex (such a description is rarely in my experience positive - but I very much respect the work you have done here so I'm not going to leap to conclusions)

For me the governance issues are a far bigger no-no, but I remain intrigued and potentially could be interested again. (Despite my overall concerns I did speculate on a momentum play a while back which resulted in a small loss - would have been a small gain if I had properly followed the momentum rules I was following.)

3rd Oct '19

Thanks, Gromley. Governance is certainly a very legitimate concern at Water Intelligence (LON:WATR) and is the only thing stopping me from adding to my holding, as I still believe that the value opportunity is compelling.

GrahamF

Just in reply to point 6 about the moat for Water Intelligence (LON:WATR) being national coverage, I would be very wary of counting too much on that.

In my experience purchasing managers very rarely are content to have only a single source of supply (particularly as the size of the spend increases and the length of tenure of the supplier increases). Yes, it makes life easier for them to do a deal with a national supplier but in the absence of other national suppliers they will encourage smaller regional competitors to either collaborate geographically with each of to form a consortium with national coverage or allow competitive bids for just some parts of the business.

So, I would take this aspect as a temporary advantage rather than a sustainable competitive advantage (or moat).

Graham, welcome to the discussion. Unsurprisingly, perhaps, I disagree with the point you make.

The national coverage Water Intelligence (LON:WATR) provides is extremely valuable in selling their services to major insurance companies. Insurers don't want to do deals with individual plumbers or with loose local coalitions of businesses - it is simply not cost-effective. WI offers them the opportunity of negotiating an attractive fee scale (this is lower margin work than normal work for WI) whilst ensuring the work is carried out to a contractual standard. They can then implement this solution nationally.

Water Intelligence (LON:WATR) offers US home insurers with a one-stop fix for water leak claims across almost their entire domestic portfolio.

"Weasel seems to think it is in some way remarkable that the Chairman/CEO has total remuneration that is over 25% of operating profit. Gostevie identifies that this amounted to $502k for 2018. Well, firstly, measuring remuneration relative to profit is a pretty silly measure for a small, high growth company. And is $502k really excessive remuneration given the performance being delivered, especially in a US context? I don't think so. There is certainly good reason to complain about all the related party issues but not, in my view, about remuneration."

I suspect we will have to agree to disagree on that. For me that level of remuneration relative to OP is excessive. If you feel it is acceptable given the performance being delivered then fair enough. Each to their own. As I said, I don't hold and haven't looked at the company in detail so I have no idea on the relative performance. Not doubting you, just saying I have no horse in this race and everyone has different things they look for or look to avoid in a share.

A difference of opinion is what makes a market after all.
I wish you and all holders well.

Ps, As we disagree and this is the internet, do I call you a bleep bleeping bleep first or do you start by calling me one!? I'm never too sure, dammed etiquette! * Lol

* For the avoidance of doubt that is a JOKE!!!!

Berksbee

16th Jan '20

CTG: Useful and like the bit on the pens deficit.

Small Cap Value Report (Mon 30 Sep 2019) - CALL, WATR, CTG

Cloudcall (LON:CALL)

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Paul Scott

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