Small Cap Value Report (Mon 4 Nov 2019) - TM17, AUK, ZAIM, DUKE, KGH, ZOO, LWRF, DFX, MTC

Good morning! It’s Graham here with the placeholder for Monday’s SCVR.

I’m writing this from a gently swaying hammock, pitched in an indoor botanical garden, in the suburban outskirts of Yokohama, Japan. I’m surrounded by some very strange-looking plants and flowers. The great thing about shares analysis & investing, is that all you need is a laptop and wifi, and you can work literally anywhere on earth.

Cheers!

Graham

(Just kidding :) )

There are lots of "bitty" RNS statements today - trading statements and other minor updates. I might deal with a higher number of updates but spending less time on each one. Let's see how it goes.

Provisional list:

• Team17 (LON:TM17)
• Aukett Swanke (LON:AUK)
• ZAIM Credit Systems
• Duke Royalty (LON:DUKE)
• Knights Group (LON:KGH)
• Zoo Digital (LON:ZOO)
• Lightwaverf (LON:LWRF)
• Defenx (LON:DFX)
• Mothercare (LON:MTC)

Timings: finished at 15.50.

Team17 (LON:TM17)

• Share price: 307.5p (+3%)
• No. of shares: 131 million
• Market cap: £404 million

Trading Update

This is a very brief update!

The Company has continued to experience strong customer traction from both new and established games throughout the second half of the year and now expects both adjusted EBITDA and revenue to be ahead of market expectations for the current year.

The performance has been driven by continued sales momentum across the portfolio of titles.

Team17, owner of the Worms franchise and many other titles, has only been listed since last year. So far, the signs are positive.

There's nothing for me to analyse in this update but from a StockRank perspective this is a High Flyer and could be worth its 28x earnings multiple.

The main thing I would be worrying in the video games sector is a company's dependence on a small number of games for financial success. 

The most recent annual report stated the following in relation to this:

The Group has historically been reliant on a subset of successful titles to generate a large share of its revenues. Should the Group fail to competently manage the lifecycle of its core games this may adversely affect it financial results.

The Group has expanded its portfolio of successful titles over recent years and a core part of its strategy is focussed on continuing to do this in the future. It has a track record of developing franchises with long lifecycles and multiple follow on titles – its greenlight process is directed at identifying future titles with this same potential.

In addition, I note that the company's back catalogue was responsible for just over half of revenues (£22.3 million out of £43.2 million total). If revenues can be underpinned in this way over the long-term, it reduces the risk profile.

The company also states that it creates new IP with 3rd-party developers in a low risk way, "typically using milsetone payments during the development process, alongside revenue share agreements payable post launch".

I like what I've read about this company and while I won't be paying the present multiple for the shares, I'm happy to keep an eye its progress.

Aukett Swanke (LON:AUK)

• Share price: 1.65p (+12%)
• No. of shares: 165 million
• Market cap: £3 million

Trading Update

This small architectural practice includes Veretec in the UK and Shankland Cox in the UAE.

I took a nasty loss on this share a few years ago, and it was one of the lessons which taught me to change my style away from "value" and more towards "quality". Like someone who was bitten by a snake and developed a snake phobia, I now avoid companies which share traits with the likes of Aukett Swanke.

I sold out of my position at a higher level than the current share price, and will certainly not be re-entering, but I remain curious to see what it might be able to achieve.

Today's update confirms that H2 was profitable, and FY September 2019 was therefore profitable, "subject to there being no material impact for IFRS 9 and 15" (e.g. this could affect revenue recognition).

Cash has improved greatly to £1.145 million, and net funds (after deducting an oustanding loan) are >£800k. This is vastly improved on six months ago, when net funds were just £200k.

Current trading is described as "stable".

Russia: Aukett disposes of its Moscow subsidiary, selling it for "a nominal consideration".

CEO comment:

The recovery from the large loss in 2018 is a tribute to the perseverance of the staff in all of our operations and in the internal rigours of reducing cost during a difficult trading period.

My view

Great news that profits are back, but of course there is no certainty and almost zero visibility when it comes to the size and sustainability of these profits.

With Brexit perhaps getting resolved in the next few months, and things (maybe) going back to normal, could the UK business get its mojo back and start to win some profitable business?

To understand the huge increase in net funds, I will check the shifts in working capital (receivables and payables) when the financial statements are published.

Value hunters will continue to find this one tempting, pointing to metrics such as Price/Sales (AUK generated revenues of >£7 million in H1). I'll remain on the sidelines.

Stockopedia rightly classifies this one as Contrarian.

ZAIM Credit Systems (LON:ZAIM)

• Placing price 2.5p
• No. of shares: 437 million
• Market cap at Placing Price: £11 million

Admission to Trading

This is admitted to trading today.

According to the LSE's website, the share price has risen to 3p in early trading.

The operating subsidiary of the listed PLC is Zaim Express, a Russian microfinance business. The Russian name is Займ-Экспресс.

Now we will know what it is, when the ticker pops up in future RNS feeds.

Its investment merits aren't something I'm going to analyse, because I don't speak Russian and I would certainly be the dumb money if I ever bought shares in this.

Duke Royalty (LON:DUKE)

• Share price: 44.2p (+0.4%)
• No. of shares: 240
• Market cap: £106 million

Paydown of Revolving Credit Facility

Good news from Duke, as it (temporarily) pays down its £12 million credit facility:

"Paying down the outstanding balance of the new revolving credit facility was a key commitment of our recent fundraising, so I am delighted to report this milestone which saves interest and reduces the inefficiencies of idle cash on our balance sheet. We look forward to continuing to diversify our portfolio through investing in new royalty partners as well as follow-on investments into existing partners."

This facility, including its "accordion provision", means that Duke has access to up to £50 million in additional funds. But for now, the outstanding balance is zero.

I wrote recently that I was unnerved by the company's plans to borrow at 9%.

The company's advisors have helpfully pointed out to me that I used the wrong LIBOR to make this calculation, and today's RNS clarifies that the facility is based on one-month UK LIBOR (currently around 0.7%).

So if Duke used the facility today, with the margin of 7.25%, the interest rate would in fact be closer to 8%, not 9%.

Alway happy to make a correction when I get things wrong! Cheers.

Knights Group (LON:KGH)

• Share price: 325.7p (+1%)
• No. of shares: 73 million
• Market cap: £239 million

Acquisition of Emms Gilmore Liberson

Knights Group Holdings plc, one of the UK's fastest growing legal and professional services businesses, today announces that it has acquired the entire issued share capital of Emms Gilmore Liberson ("EGL"), a full-service independent law firm in Birmingham.

Knights informs us that 28 fee earners will be brought in a a result of this deal.

Key points:

• EGL revenues last year were c. £4 million.
• "Following integration, the board expects EGL to deliver a PBT margin of approximately 20%", i.e. £800k is revenues are flat.
• Purchase price £3 million up front (in cash and shares), plus £1.7 million over two years if conditions are met.

CEO comment:

"We are delighted to have entered the Birmingham market today with the acquisition of EGL, which is one of the few well-established, full-service independent firms in the city.

"As our fifth acquisition since listing in June 2018, we are delighted to build on our strong momentum with the new team providing us with an exciting platform from which to grow our share in this new market, through both lateral hires and bolt on acquisitions."

My view - legal and professional services are a bit of a minefield, in my experience. Do we all remember Fairpoint (LON:FRP) ?

The market is optimistic about about Knights, putting it on a P/E multiple in the region of 18x. It hasn't put a foot wrong since IPO last year. This could be worth looking into, if you are ok with the sector.

Zoo Digital (LON:ZOO)

• Share price: 80.06p (-5%)
• No. of shares: 74.5 million
• Market cap: £60 million

Interim Results

ZOO Digital Group plc (LON: ZOO), the provider of cloud-based localisation and digital distribution services for the global entertainment industry, today announces its unaudited financial results for the six months ended 30 September 2019.

It's been a while since I've covered this one.

In July last year, at 94p, I said the share price might need to "wait for the company to grow into this valuation".

In April this year, at 49p, Paul had mixed views on it.

Today's highlights:

• H1 revenues up 7% to $13.8 million, excluding the business line which the company has given up on (DVD/Blu-ray). If you include that business line, revenues were down 4%.

(The problem with this is that business lines can become defunct on a semi regular basis - and it's not hard for companies to report growth if they exclude the activities which have stopped working!)

• Gross profit improves to $5.8 million from $4.9 milion ("favourable sales mix")
• operating profit $0.4 million (versus a loss last year)

Outlook

The order book is up, year-on-year, positioning ZOOto meet market expectations for the full year.

Expectations, according to Progressive Equity Research, are for EPS of 0.9 cents in the current financial year, rising to 3.3 cents in FY March 2021.

The current share price (80.06p) translates to 103.3 cents.

So the earnings multiple is 31x, if we are happy to look ahead to the financial year beginning in five months.

CEO comment

"The OTT consumer video market is about to undergo a step change due to the forthcoming launches of several Direct-to-Consumer services from major media companies. These provide an exciting growth opportunity in media localisation and digital packaging given the increased demand for these services to enable international distribution.

We believe that ZOO is well placed to capitalise on this opportunity given the benefits and competitive advantages of our cloud-powered services."

ZOO is very proud to have secured the role of "primary vendor for a major media company".

It thinks that this customer will bring it "improved visibility and a reliable source of orders for the periods ahead, including meeting full year market expectations".

My view

While forecasts are unchanged, the market is evidently disappointed by these results.

I can't claim to be an expert in this industry. But the competitive landscape in media support services such as localisation (ZOO's primary activity) strikes me as rather challenging.

The note by Progressive Equity Research is worth reading, for those of you who are researching this company. It talks about the waves of change both in content distribution and in the localisation of this content.

Netflix ($NFLX) has been king of the hill for a few years, and now the likes of Disney and Warner Bros (owned by AT&T) are likely to heat up the competition.

This disruption could be good for Zoo Digital (LON:ZOO), as predicted by the CEO, but it's hard to say.

Personally, I'd feel much more relaxed owning shares in the likes of Disney ($DIS) or even AT&T ($T), i.e. the organisations which own the relevant intellectual property and outsource localisation to the likes of ZOO in order to save costs. And on current earnings, these companies are available at much cheaper valuations than ZOO.

While these giants might not grow their earnings as quickly as ZOO, I could have some confidence in their long-term earnings power (especially Disney). Whereas I would be nervous that increased competition or technological disruption might end up have damaging effects on ZOO's profitability, sooner or later. We've already seen a lot of variability in ZOO's gross margins.

So if I wanted to participate in the rise of over-the-top (OTT) media, that's how I'd do it - with the content owners. ZOO might turn out well for investors, but I can't judge how likely this is.

Stocko gives ZOO a ValueRank of 9.

Lightwaverf (LON:LWRF)

• Share price: 4.2p (-31%)
• No. of shares: 121 million
• Market cap: £5 million

Trading Update

This is in the smart homes business - see its website.

While revenues doubled in the first three quarters of the financial year ending in September, LWRF says that it didn't have enough cash in Q4 to spend on digital marketing. As a result, Q4 revenues were a big miss.

It now expects to report losses for FY September 2019 that are "materially below market expectations and no less than those of last year". The loss in the previous year was £2.54 million.

Like most AIM stocks, this one is not for widows and orphans. Not investment grade.

Defenx (LON:DFX)

• Share price: 0.5p (-82%)
• No. of shares: 38.7 million
• Market cap: £200k

Proposed cancellation of admission to AIM

Yesterday, this cyber security share had a market cap of £1 million. Today, it's worth £200k.

That's the problem with tiddlers - if nothing good happens, they eventually die a death like this.

Owning shares in a private business isn't the end of the world, but it's not really what most of us are looking for.

Commiserations to anyone holding this.

Mothercare (LON:MTC)

• Share price: 7.9p (-30%)
• No. of shares: 342 million
• Market cap: £27 million

Restructuring update

It's over for the UK operations:

...it has become clear that the UK Retail operations of the Group, which today includes 79 stores, are not capable of returning to a level of structural profitability and returns that are sustainable for the Group as it currently stands and/or attractive enough for a third party partner to operate on an arm's length basis. Furthermore, the Company is unable to continue to satisfy the ongoing cash needs of Mothercare UK.

Checking the archives, I was impressed by Mothercares progress in March. It was aiming to be "bank debt free" by the end of 2019.

By the middle of May, however, net debt remained stubbornly high at £15 million. The final results were a grim read.

Mothercare's brand generated profits of £28 million internationally last year, from a thousand stores in 40 territories. If the proposed administration of the UK subsidiary can avoid toppling the listed PLC, then maybe this could be an opportunity?

Out of time for today, thanks for reading!

Graham