Small Cap Value Report (Mon 8 Oct 2018) - ramblings, FCCN, AMO, QUIZ, SPE, ANG

Good morning, it's Paul here!

The first couple of sections were posted last night. Today's news follows below.

Brexit

I've tried to avoid commenting on this, as it's polarised, and political.

I've come round to the view that most people (including me) believe what they want to believe. Therefore it's completely pointless discussing these issues, now that most people have formed fixed positions, largely based on defending how they voted in the Referendum (not in my case though). We'll just have to see what happens, and most people are talking rubbish, in my view.

Looking through the politics, and engaging our common sense, what is most likely to happen? The bottom line for me, is that the UK is a large net importer of physical goods from the EU. Therefore it is ridiculous to suggest that the EU will try to impede trade. One way or another, trade will continue very much as before, possibly with some short term disruption.

As regards services - companies in the EU don't use London for their financial services out of the goodness of their hearts. They use London because it's competitive for their needs. The feared exodus of jobs from London, in preparation for Brexit, simply hasn't happened, or only in tiny numbers.

Last week, I had drinks with some European bankers, who told me that German & Dutch clients are terrified about losing easy access to the UK. Some are setting up UK subsidiaries as a cautionary measure. That's the mirror image of scare stories going the other way - of UK companies setting up a nameplate subsidiary in Dublin, or Frankfurt, just to be on the safe side.

Bottom line - it's all going to be fine. All these issues will get ironed out, probably quite soon, as it's in everybody's interests to reach agreement. Therefore, I am coming round to the view that Brexit is probably far less of an issue that I previously thought. It could even be an opportunity to pick up some bargains maybe?

As usual, this is just my personal opinion, and please feel free to agree or disagree. I think we'd all prefer that the comments section does not fill up with a load of strident, partisan, political comments - that's best done on Twitter!

Corbyn Government risk to share prices

The far bigger worry for share prices (which is what I'm concerned about here), is the risk of a Corbyn Government. Again, forget the politics, I'm talking about the economics. A big initial rise in Corp Tax would hit earnings by about 10% initially. Of course, history tells us that socialist Governments initially hiking taxes, is just the thin end of the wedge. Therefore, it wouldn't be long before  Corp Tax would be much higher - probably 40%-ish, is my view. The stock market would factor this into prices in advance, so we could be looking at maybe a 20% drop in share prices, across the board, for UK-based companies.

Add to that various bonkers ideas like stealing 10% of the equity, and giving it to employees. Hiking top rate tax to maybe 60% or more (per a McDonnell interview not long ago), and top brass whose stated desire is to destroy capitalism, and it's not a pretty picture for people like us, who own shares.

Remember that McDonnell and Corbyn are admirers of the Cultural Revolution in China, where millions were killed - including landlords being murdered, so that property could be given to the people.

If these nutcases ever end up running the UK, we would have a return to the conditions of the 1970s - older readers will remember the "brain drain" - when high earners simply left the UK, to live in tax havens. This was one of the key reasons that pop videos developed - because the live Top of the Pops show could not find enough musicians in the UK to perform live. So groups like Queen recorded videos instead, from tax exile status in Germany, or Switzerland, at the time.

We know from experience, and economic theories such as the Laffer Curve, that high tax rates actually collect in less tax, beyond a certain point - because they drive high earners out of the country. Therefore, a crowd-pleasing increase in top rate tax, to force the rich to fund a better NHS, might please gullible voters, but won't actually raise any more tax revenue. It's more likely to put the whole economy into a tailspin, as the rich simply leave.

It won't just be the rich leaving next time, either. There are many professions which can now be operated online. As an example, I recently used a British solicitor who is based in South America. Why? Because he was an expert in what I needed, and was a lot cheaper than a UK-based legal expert. The same will probably become increasingly true for other specialists. Higher direct tax rates will simply drive out high earners.

In conclusion therefore, on the macro risks, I don't see Brexit as anything to worry excessively about. A Corbyn Government on the other hand, would be catastrophic for share prices. As the Naked Trader commented on his website recently, if it looks like a Corbyn Government is imminent, then he would sell everything.

French Connection (LON:FCCN)

Share price: 54.5p (up 27% today, at 10:52)
No. shares: 96.4m
Market cap: £52.5m

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

Sky News report - thank you to various friends who messaged me with this press article over the weekend.

This is an interesting report from Sky, saying that Numis is actively looking for potential buyers for the founder CEO/Chairman, Stephen Marks, 42% stake in fashion & lifestyle brand, French Connection. The company is up for sale - which is the catalyst I have been waiting for.

Although, as Sky points out in the article, there have been previous mooted takeover deals in both 2016 and 2017.

To summarise, these are the main reasons why I think FCCN could have value in excess of the current £41m market cap (at 43p per share). There are no guarantees of course, so this is educated guesswork at best, and may turn out to be right or wrong.

• Outlook for current financial year - company has said it expects to reach profits, as opposed to H1 losses. Note that H2 is much stronger cyclically
• Loss-making shops - I've been doing more digging on this, and believe that the company has 3 shops in London, which are disastrously loss-making. The leases on all 3 expire within 3 years. When those leases expire, there should be a £3-5m p.a. boost to profits. Potential buyers of the business would factor this into the figures
• Potential for licensing revenues to increase. More deals like the successful DFS sofas tie-up? Lots of potential here, with FCCN as more of a design house, than a retailer
• Wholesale is already doing very well - scope to push online faster?
• Scope to gear-up balance sheet - a private equity buyer could add bank debt, and hence part-fund a takeover with FCCN's own balance sheet strength

Let's see what happens, but with 80% of the shares in 3 hands (or 6, arguably, if we allow 2 hands per person) - Marks, Sports Direct, and the other one.

Update on Monday morning - the company has confirmed what it calls "press speculation", by saying today;

... The Board confirms it is currently reviewing all strategic options in order to deliver maximum value for its shareholders, which includes the potential sale of the Company.

There can be no certainty that an offer will be made for the Company, nor as to the terms on which any offer will be made...

The second paragraph is standard wording that we always see in situations like this.

The for sale sign is very firmly aloft. We'll have to see what happens.

Personally, I'd be disappointed with any bid below 100p, and can't see why Marks would want to sell at that level. It would make more sense for him to wait another couple of years for the worst 3 leases to expire, as that should be very positive for profitability.

For patient investors, I think risk:reward looks really good here, even after a 27% rise in price today. This is the most serious attempt to sell the company to date. Even if no acceptable bids are forthcoming, then we're left with a company which has already said that it should be moving into a full year profit this year. Another 2 years on, and profits should have risen to c.£3-5m (or more), on the expiry of the worst 3 onerous leases. 

Therefore I'm sitting tight, to await developments.

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Amino Technologies (LON:AMO)

Share price: 148p (down 30% today, at 11:01)
No. shares: 72.8m
Market cap: £107.7m

Trading update (profit warning)

I haven't even read it yet, but to drive the share price down 30%, it must be a profit warning. We seem to be getting an awful lot of profit warnings at the moment. Bad luck to shareholders here.

Amino Technologies plc (LSE: AMO), the global provider of media and entertainment technology solutions to network operators, provides the following trading update for the year ending 30 November 2018 ("FY2018").

Adjusted profit before tax is now expected to be $11.5m, note that the company reports in US dollars. This is down from previous broker forecasts of between $15.5 - 15.7m, which is about a 26% drop. 

Broker forecasts for next year have also been reduced by about 35%, as the factors affecting this year are expected to continue. I'm quite surprised the share price hasn't fallen more today.

What's gone wrong?

• Intensification of external macroeconomic headwinds (a nice catch-all!)
• Lower than anticipated orders
• Higher component prices (hence lower gross margin) - expected to see further cost increases
• Delayed orders in emerging markets
• US tariffs creating confusion amongst Amino's customers

On the positive side

• Cashflow remains strong, and
• Dividends - will increase this year's divi by at least 10%, and will continue to pay the same amount for at least 2 more years - this must be what's providing some support for the share price today.

Valaution - broker forecasts for this year and next year have come down by about 30% today.

These are now both around 10.5p (I'm assuming that the broker EPS figure is in dollars, so I've divided it by 1.3 to get to sterling). This gives a PER today of about 14.

The dividend yield (based on 7.3p being paid out) is good, at just under 5%.

I've had a quick look at the most recent balance sheet, as at 31 May 2018, and it looks OK, with NTAV of $10.3m, including cash (and no bank debt) of $15.0m.

My opinion - this company has a history of running a solid balance sheet, and paying out generous divis. TV set top boxes is not really an area I understand, and who knows where the industry trends are going? 

So it's not of interest to me. Lumpy sales, delayed orders, and component price rises sound like unpleasant headwinds, and the PER doesn't look particularly cheap. With those headwinds present, there could be a risk of another profit warning at some stage, so it's not for me.

When a share goes into a nosedive like this, I find it's often best to sit on the sidelines and see what level it finds a base, rather than diving in straight away (which is often a mistake). But each situation is unique.

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QUIZ (LON:QUIZ) - following on from Friday's unfortunate profit warning, I see that this share is down over 30% again today. It's amazing to think this share touched 200p in July 2018. It's now down to only 65p. It's tempting to trade a few for a bounce at this level. Although it's not really a share I want to own at all, as the product and branding just don't look very good.

Credibility has largely gone now, as it looks as if the company was polished up for IPO, and priced too high, with unrealistic growth assumptions. Although I am drawn to the still-rapid own website growth.

I wonder whether the financial controls are good enough, given that the company told the market everything was fine in early Sept, then put out a profit warning just a month later? It's starting to look reasonable value now though, providing nothing else goes wrong. It all depends whether this is just a bump in the road, or a more serious downturn? I don't know the answer to that.

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Angling Direct (LON:ANG)

Share price: 108p (unchanged today, at 14:45)
No. shares: 43.0m
Market cap: £46.4m

(I no longer hold shares in this company)

Interim results

Angling Direct plc (AIM: ANG), the UK's largest specialist fishing tackle and equipment retailer, is pleased to announce its unaudited financial results for the six months ended 31 July 2018.

This share reminds me of Gear4Music (in which I have a long position), in that it's a rapidly-growing niche eCommerce retailer. Although ANG also operates from physical stores. Both companies also face a lot of competition, and currently have low margins. So why own the shares then? The theory is that, once they achieve greater scale, then marketing spend should greatly reduce as a % of revenues, thus giving a much higher operating profit margin at a later date. This is why smaller eCommerce companies look expensive on a PER basis.

A few comments on these interim results;

• Very strong top line growth of 55.8% to £21.9m - partly fuelled by acquisitions & new store openings
• Pre-tax profit only £0.57m (blamed on "investment" in European online expansion)
• Impressive growth of 60% in online sales, of £11.69m, being 53% of total sales
• Positive LFL sales growth in stores, of 4.2%
• Very impressive recent trading, with LFL store sales up 15.4% in Aug, and up 12% in Sept 2018
• Gross margin of 32.9% is low - this is a price competitive sector, with discounting by competitors
• Balance sheet looks OK-ish, with net debt of £0.8m - note that the company has used up the £4.0m net cash pile it has a year earlier, on acquisitions and capex
• I wouldn't be surprised if the company does another fundraising, although with the share price quite buoyant, this is not necessarily a bad thing - highly rated paper being issued to make lowly-rated acquisitions, is a sensible approach

My opinion - as regulars here will know, I take a particular interest in the eCommerce sector. Fishing equipment seems an interesting niche, so a while back I bought shares in both Angling Direct (LON:ANG) and Fishing Republic (LON:FISH) . FISH is a potential turnaround, with performance having been poor. It didn't do (to date) what I expected, so as part of a portfolio clear-out over the summer, of low conviction holdings, I ditched my shares in FISH.

My spreadsheet says that I have a holding in ANG, but on checking my actual portfolio, it turns out that I sold them a few weeks ago, and forgot to update the spreadsheet. So I'll now have to cross-check my spreadsheet with my portfolio, to make sure there aren't any more errors.

ANG seems to be performing well, and I find the figures today quite encouraging. Although we seem to be entering a more sceptical time in the markets at the moment, so I'm not sure there's any particular catalyst to push the share price up immediately. At some stage I'll probably buy back into this one, as I quite like the company & the strong growth. Although the low margins are a turn-off.

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Sopheon (LON:SPE)

Share price: 1020p (up 12.3% today, at 14:19)
No. shares: 10.1m
Market cap: £103.0m

Trading update

Sopheon plc, the international provider of software and services for complete Enterprise Innovation Management solutions, issues the following trading update.

This company is really on a roll! There's another positive update today - here are the key points;

... a number of further transactions have been signed resulting in a record third quarter performance, traditionally our quietest quarter due to the holiday period

... We are therefore delighted to report that revenue visibility has now broken through $30m

...  Sales pipeline activity for the balance of the year remains robust. The Board now expects the results for the year to exceed current market expectations2.

By revenue visibility, I think they are referring to revenues for the full year to 31 Dec 2018. Plus, presumably whatever additional contracts can be won in Q4.

Forecasts - have been increased, to 48.3p adjusted EPS this year, and 55.2p next year. That gives a 2018 PER of 21.1, falling to 18.5 for 2019. That seems a reasonable valuation, given that the company has established a track record of beating forecasts. Therefore, I wouldn't be surprised to see this share break out to new highs in the months ahead.

My opinion - I failed to spot the opportunity here, which is a pity.

Well done to holders! We have a good update out today, and comments from the house broker that a further beat against (upwardly revised) forecasts could be on the cards. That seems to me a strong reason to hang on to this share, if I held (which I don't unfortunately).

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That's it for today. See you tomorrow!

Regards, Paul.