Small Cap Value Report (Thu 11 July 2019) - SOS, VCP, SOM, MMH

11th Jul by Graham Neary

50 comments 10955 reads

Good morning!

I added a section on Ten Entertainment (LON:TEG) late last night to yesterday's report. That report now includes Superdry (LON:SDRY), Equals (LON:EQLS), Alpha FX (LON:AFX), and Ten Entertainment (LON:TEG).

For today, we have:

Sosandar (LON:SOS)
Victoria (LON:VCP)
Somero Enterprises Inc (LON:SOM)
Marshall Motor Holdings (LON:MMH)

Sosandar (LON:SOS)

Share price: 14.5p (pre-market)
No. of shares: 163 million (after Placing)
Market cap: £24 million (pro forma)

Placing to raise £7 million

Paul is going to chime in on this, but here are the facts:

Conditional placing at 15p (less than half of the share price at which it raised money last year).
Placing shares will represent 28.7% of enlarged share count. Meaningful dilution for existing holders, therefore.
General Meeting on 29 July to confirm the deal.

Analysis - It's not a huge surprise that Sosandar needs more funds, since cash had reduced to £3.6 million as of March 2019, and it is going to make loss this year while at the same time trying to almost double revenues.

Paul himself put it to management last week that "cash looks set to run out in early 2020", and received a reply he described as "generic".

It must be difficult for management teams in situations where we can see that they need more money, but they need to put on a brave face on things and give nothing away about conversations which might be happening in the background.

While I'm an outsider in this situation, I suspect that it was best to get this Placing away sooner rather than later. It's better to do it before the need for cash becomes desperate. Also, after a disappointing Q1, the direction of least resistance for the share price was downwards. Diluation at 15p might sting, but dilution at 8p after a weak Q2 would be far worse.

The size of the Placing is also quite interesting. £7 million should keep the wolf from…

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About the Author

Graham Neary

Premium Member

Full-time investor and independent analyst. Editor at Cube.Investments, small-cap writer at Stockopedia. Previously a fixed income analyst in the City and institutional fund manager. I'm a CFA charterholder and have the Investment Management Certificate and STA Diploma in Technical Analysis for good measure. When I'm not talking about finance, I enjoy recreational poker, chess and Mandarin Chinese. more »

50 comments

mojomogoz

11th Jul

Ha ha. I was just waiting to be put under review!

The power of the elecro-snub. Feel the buzz!!!

-14

mojomogoz

11th Jul

Wimbledonsprinter

Hard to know for sure but history says fines are usually not at level that cripples business (so business capacity aware) and the fact that they would settle with the very massive Reckitt Benckiser (LON:RB.) for $1.4bn hints that the very big cash pile that Indivior (LON:INDV) has may be more than enough.

There's good upside optionality now particularly if they show traction with new patent protected monthly dose.

The covenants on debt are restrictive and they do need a nice cash buffer on that

(Off to purgatory now)

WallerMa

11th Jul

Hi
Do you intend to cover 600 Group which was on yesterday’s list?

Graham Neary

11th Jul

Hi WallerMa, hopefully we have a quiet day for results tomorrow, in which case I will be able to scroll back and catch up on stories I missed, including 600 (LON:SIXH) !

Graham

Gromley

11th Jul

Scapa (LON:SCPA) announces that Scapa Tapes (North America LLC) files a complaint against ConvaTec for breach of contract with regard to a Master Supply Agreement (MSA), claiming damages in excess of $83.81m.Scapa Group/Tapes have also filed a motion to dismiss the complaint filed by ConvaTec with regard to the MSA. Why are ConvaTec making a complaint??

Alleged breach of a non-compete agreement.

I summarised the events and timeline here, based on some excellent research on another site from Alistair Blair (linked to).

Personally I don't feel I have enough information to judge the likely outcome of the cases at all. Chances are the share price will go up markedly if they win and down markedly if the lose, so a bit of crap-shoot as far as I'm concerned,

Paul Scott

11th Jul

Hi Everyone,

Here are my comments on the fundraising announced today by £SOS (in which I have a long position)

An excellent summary from Graham above in the main report, thanks for that.

I last commented on Sosandar when it issued results for FY 03/2019, here on 3 July 2019;

https://app.stockopedia.com/content/small-cap-value-report-wed-3-july-2019-nar-soli-imo-mlvn-sos-loop-redd-tpt-wrks-purp-488901

The Q1 update seemed weak, at only 23% Y-on-Y revenue growth, so I rang the company. The explanation they gave (poor weather, so slow sales of summer clothing, hence they deferred marketing spend) makes sense to me. With better weather, and normal marketing spend, they might have been perhaps 50-60% up Y-on-Y, but I don't see that they would have hit the 100%+necessary to meet this year's forecast.

I've spoken to them again, in more depth since, and they are adamant, and very confident, that they will hit this year's forecast, because they're planning for a monster autumn/winter (A/W) season.

At this point, I need to apologise to a subscriber here called "thirty fifty twenty" (can't remember if that's the right order!) for a rather snappy reply I posted here on results day. He speculated (wrongly at the time) that I may have been made an insider & hence couldn't comment.

So imagine my surprise, when my broker rang me on 5 July, to ask in the usual way, if I wanted to be made an insider on a fundraising. That's the way it's done, on a recorded line, I have to give specific consent to be made an insider (which only happens rarely). My broker screens out all the junk that I wouldn't be interested in (e.g. junior resource stocks), and only offers me placings in companies that fit my investment criteria (retail, eCommerce, decent profitable companies, and things I'm currently or previously invested in). I've used this broker for over 15 years, so he knows exactly what type of stocks I like.

When my broker said the company raising funds was Sosandar, I was very surprised. Although the vague answer that the company gave me (which I wrote about on 3 July here) about cash requirements now made sense! At the time we spoke, the company was putting together a fundraising, but couldn't tell me at the time.

Anyway, with placings you usually meet the company, and have a confidential meeting. I couldn't get into London, so dialled in to the meeting on a conference all, and just listened.

The tone of the meeting was very upbeat, which surprised me, as this looked initially like a distressed fundraising - after relatively poor growth in Q1. So I was expecting it to be done at c.10p, and put in a fairly big order anticipating that sort of price.

I was very surprised when my broker messaged me to say that there was very strong demand, and the placing would be done at 15p. My order was scaled back to about half, as were others, the placing was significantly over-subscribed. That's encouraging, as it means that the depressed share price (it recently bottomed out at c.12.5p I think) reflects negative sentiment by small shareholders trading in the market, but definitely does not reflect the more positive views of institutions & other large shareholders (who typically don't transact in the market through market makers, so they have little to no influence on the share price).

Back to the meeting, I remember starting the call feeling rather negative about things. Why was the company raising more money, when the share price had dropped by about two thirds from its peak? What a pity shareholders are being diluted (although not disastrously so).

After an hour on the phone, things felt much more positive. Management explained that Q1 was only a small part of the overall forecast for this year, so it really didn't matter particularly that growth had slowed to +23% in the quarter. The key season was the upcoming autumn/winter season, and the company has big plans for this. Specifically;

Large expansion of the product range. We've seen with BooHoo how range expansion feeds through pretty directly to increased sales (i.e. if you double the product range, then sales roughly double too). SOS is planning to roughly double its range this A/W

Increased design/buying team - new (talented) designers have been employed recently, to focus on specific product areas where the company sees strong growth potential - namely denim (there's been a recent influx of new denim styles on the website): https://www.sosandar.com/catalogsearch/result/?q=denim

Also, a large expansion of accessories ranges is in the pipeline, with a new buyer. Leather & knitwear are other ranges that are being greatly expanded too.

These areas have been picked for key reasons, e.g.: lower returns rates on those products, high cash margins, less seasonality (e.g. denim sells all year round) hence should make sales less weather dependent in future. I think that's a very clever strategy.

At the moment, about 50% of sales are dresses, as you can see from the website that is the main product area, with lots of choice. The returns rate is high on dresses, because it's a complex fit. Therefore the focus is to grow the other areas mentioned above, which should gradually reduce the returns rate from the current rather high rate of c.50%. Although 40-50% is the industry average, for womenswear. Which stands to reason - when we try on clothes in a fitting room of a physical shop, we typically buy half, and put half back. So why would online shopping be any different?

With denim in particular, there's an aspiration to become a go-to shop for denim, with customers coming back again & again to buy their favourite style of jean, or denim dress. TopShop are said to be very strong on demin for a younger customer. Sosandar want to "own" this area for their demographic, which could be lucrative if they pull it off.

Footwear and active wear are other areas where new buyers have been brought in. So clearly the company has very ambitious plans for A/W.

CFO James Bowling explained that the new buyers have brought with them existing supplier relationships, therefore a large broadening of the supply base is taking place. That's great, and will mean higher gross margins, but it also puts a strain on cashflow. New factories require up-front payments, whereas his existing forecasts planned for credit terms from suppliers to increase.

The other pressure on cashflow is that suppliers all over the world are very nervous (understandly) about supplying UK retailers, because of the spate of CVAs & other financial problems - e.g. Arcadia, House of Fraser, Debenhams, and plenty of others all having to financially restructure. The withdrawal of trade credit insurance on UK retailers is another issue.

Therefore, to fund the greatly increased A/W ranges, Sosandar needs more cash. Plus of course it has ongoing trading losses to be funded by shareholders.

Another growth area is online platforms. Previously, the company sold only through its own website. A decision has been made to start selling a few key styles through third party fashion websites. This will clearly put Sosandar's products & brand name in front of a very much larger audience.

Margins are much lower on third party sales, as it's wholesaling basically. The online platform takes most of the profit. However, there's no marketing expense this way, so new customers (potentially large numbers) are recruited at zero cost. If the Sosandar styles sell well, then the online platforms promote Sosandar through their customer emails, etc. I'm delighted that Sosandar is going down this route, and it could really turbocharge growth.

Marketing - they want to step up a gear here too, which obviously costs money. New areas being launched include sponsoring celebrity & influencer podcasts (e.g. white wine question time by Kate Thornton), and screens on escalators on the tube.

New customer acquisition is driven by marketing spend. they didn't try to acquire new customers in Q1, due to poor weather - the ROI would have been poor, so they dialled it down. This is a very nice feature of online businesses. I think private investors saw this as an excuse for lacklustre growth in Q1, which is a bit unfair in my opinion.

Although I have a hunch that there were some product issues in Q1 which might have impacted sales growth. I'm sanguine about that, because most small companies experience growing pains along the way.

International expansion is also being considered. The company already does international delivery, although I don't know what % of current sales are overseas. Probably very small, as no overseas marketing has been done. However Sosandar says it has "got our eyes on America" - which would only be a specific region initially. If you look back at Asos & BooHoo in the early days as listed companies, their share prices really went through the roof when international expansion began to gain traction. Maybe the same could happen here in due course? It's nice upside potential anyway.

Repeat custom - management really stress this area as being very exciting. Once customers buy from Sosandar, many return to buy more. Hence sales will snowball over time. Another great benefit of repeat custom, is that the product returns rate is much lower, about 35% instead of 50%.

My opinion - I've always been very bullish on this stock, because the concept is excellent (product designed & targeted to suit an under-served demographic of 35-55), and management really know what they're doing.

I think Sosandar made the same mistake that almost all small, growth companies make in the UK - not raising anywhere near enough money. Forecasts always seem to under-estimate the amount of money, and the time needed, to achieve scale. In fairness to Sosandar, it actually beat the very aggressive growth targets last year.

The only disappointment has been Q1 of this year, but management are absolutely adamant that it's not a problem, and the full year target of £9.3m is definitely achievable. Third party sales is extra business on top of the existing forecasts, as Graham points out above. Although personally I would expect that to start small.

The £7m placing greatly de-risks things. In the past, management didn't want to dilute themselves & others, but on reflection that was a mistake. We can't go back and change that, so dilution at 15p is disappointing, but in return we're getting a much better business, with strong funding, which can execute growth more aggressively. That's clearly very positive.

So the road's been a bit bumpy here, but I'm very positive on the outlook for the company, over the long term. How it's valued in the short term, who knows? That's up to market sentiment. I'm thinking longer term with this, and expect it to be a very much larger business (and strongly profitable) in 5 years' time.

It's not without risk of course. If the company doesn't generate the planned growth, then it could run out of money again in maybe 2 years' time, and get into a death spiral of increased dilution at lower & lower prices. So it's not one for widows & orphans, obviously. You don't usually get multi-bagger potential without increased risk.

Gromley

11th Jul

Ben. Also note that Reckitt Benckiser (LON:RB.) has also announced a $1.4b settlement with the USFeds today with respect to sales of Suboxone Film. Clearly relevant for Indivior (LON:INDV) - but unclear to me if positive or negative.

Yes this is interesting imho and if Graham or anyone else has any insight I'd love to see it.

Just a bit of background for the un-initiated.

Indivior (LON:INDV) was spun out of Reckitt Benckiser (LON:RB.) at the end of 2014.
Earlier this year it was announced that £INDV were being indicted on various charges of essentially "drug pushing" / mis-selling.
AFAIK Reckitt Benckiser (LON:RB.) were not formally charged with anything.
Today Reckitt Benckiser (LON:RB.) have "settled" out of court for $1.4Bn
The vast majority of the charges relate to the period of RB's ownership.
This might (??) suggest that Indivior would be able to settle for a much smaller sum. Thus far they have protested their innocence "the allegations are unsupported by the facts and the law" and "the board believes they are flat wrong."
$1.4Bn would probably kill off Indivior, but they do have a significant cash-pile that could fend off anything less than (say) 50% of this.

It is fair to point out that even discounting this issue, Indivior (LON:INDV) have suffered serial train-wrecks over the last couple of years, however today's earlier announcement indicates that underlying business performance has been much better than expected.

I retain a very small position here (used to be somewhat larger!) for no other reason than it's nearly too small to be worth selling.

Any observations most welcome.

Cisk

11th Jul

Graham, nice write up on Victoria (LON:VCP), however I still have lingering doubts about this company, and especially the CEO Wilding, I just get the impression that he likes the sound of his own voice too much! That may be an unfair assessment, but remember how much he has made personally from the company, and the fact that he’s an ex-investment banker, so there’s no excuses that he / they messed up the bond issuance so royally.

Throw in an acquisition-led growth policy, with its associated numerous moving parts, makes me very wary.

Is he now trying to compare himself to Buffett - a bit of wishing thinking perhaps?!

aflash

11th Jul

No insight!

I do not speculate with theories, thoughts & predictions, only cash!

On that basis there are profits to be made. Anyone who bought (INDV) Individor on 10 April at 21p doubled their money in a few months. I missed it but see I sold twice for a 15% then 21% profit last year on the fluctuations.

-3

Camtab

11th Jul

Paul,
I think you are still long on IGP. Just wanted to point to an article on their website intercede.com/british airways following recent record fine of latter. Hope it is helpful.
Best

Trident

11th Jul

I always been a bit nervous of the CEO of the Victoria (LON:VCP)

Hats off to an investment banker who is actually getting in involved in a business. It usually a bit dirtier and harder to manage that just looking at ratios, and checking the balance sheet and free cash flow.

Unfortunately, that's the bit that seems to have gone slightly wrong. But it has to be said he has done immensely well by selling significant tranches of shares along the way, based on maintaining momentum via acquisitions.

Admittedly, he barely pays himself a salary, but that sacrifice has been massively outweighed by his sale of shares. So, his incentives were arguably aligned with shareholders, but unlike institutions, and let's face it, quite a few shareholders, he sold quite a few shares along the way. And there is something slightly unnerving about that. But nothing arguably unethical or underhand.

Due to his clever deal making he did acquire a significant share in the company, by raising the share price on the basis of an option deal. So he has plenty left.

Do you really want a CEO who is effectively trading shares alongside you? Because that tends to signal Company related statements could be self-serving.

Not my cup of tea.

davidjhill

11th Jul

Paul - thanks for the Sosandar (LON:SOS) Call update. That helps my thinking considerably and answers a number of key questions I had when looking at the announcement. Appreciate you taking the time to do that.

Graham Ford

11th Jul

It feels like Sosandar (LON:SOS) is still very much a leap of faith.

The original rationale seemed to be that two fashion gurus would expertly address an underserved area of the market.

Well they seem to be bringing in a number of additional expert buyers/designers which suggests that the skills they have may not be as remarkable as originally proposed. They are also venturing into new areas of the market to reduce returns, reduce weather effects and seasonality etc. which again would suggest that their judgment was not as spot on as one would have expected at the outset considering how their expertise was lauded. They’ve now decided that denim is also where they want to be and they want to be the go to place for that. And how are they going to become the go to place for denim? Perhaps there is a cunning plan but it sounds like another bet on their design expertise versus other fashion retailers, so a further gamble.

Hopefully, this will work out well for all investors. But, although the placing may have derisked the need to raise more cash, from the perspective of whether they have a winning product (for anything but the short term) it seems to be even higher risk than before as the founders’ skills do not seem to be quite the silver bullet they were made out to be initially.

So, for me this remains a huge bet on whether one believes the founders have the undefinable design magic to pull this off and the probability of that bet paying off just went down as their credentials are now somewhat tarnished compared to where they were before.

cholertonandrew

11th Jul

Thanks Graham and Paul for the write-ups. You’re both brilliant.

Regards
Andrew

Paul Scott

11th Jul

Hi Camtab,

Paul,
I think you are still long on IGP. Just wanted to point to an article on their website intercede.com/british airways following recent record fine of latter. Hope it is helpful.
Best

Thanks very much for pointing out the post on Intercede's website. I like this company a great deal. Its client list is stunning. New management are very much more focused on driving sales upwards, whereas previous mgt seem to have been more excited by developing the tech, than actually selling it!

I hadn't drawn the link between the massive fines being levied by the ICO, and the upside potential that gives for Intercede, so thanks for pointing it out.

My broker arranged for me to meet mgt of Intercede recently, and I was mightily impressed. The new CEO said he was attracted to the company by the quality of its clients, and the size of the opportunity. He inherited a ropey situation, and has been focused on fixing the problems, but he sees a lot of opportunities going forwards. Therefore I'm holding onto my shares tightly, and buying more when any scraps of stock appear in the market. It's very illiquid, so you have to just be patient & wait for sellers to appear, which they do from time to time. I think it took me a couple of months to build up my position here originally.

The risk is that if things don't go well, then it would be almost impossible to sell my shares.

Upside is if it works well, then we could have a 5-10 bagger on our hands.

As you say, cyber-security software is a great spot to be in right now.

Regards, Paul.

JohnEustace

11th Jul

Re IGP, I hold their US competitor OKTA. They are operating on a much larger scale turning over $400m (and losing $125m) per annum. Their share price is up 170% over 12 months.
www.okta.com

Paul Scott

11th Jul

Hi Graham,

Well they seem to be bringing in a number of additional expert buyers/designers which suggests that the skills they have may not be as remarkable as originally proposed.

I think that's a bit unfair on Sosandar (LON:SOS) management. No matter how good anyone's design skills are, it would not be possible for 1 or 2 people to create ranges which are now over 100 new styles every month, and cover all categories. It's just too much work.

Therefore, I think it's the right thing to bring in specialists for each category. The specialist then creates a large range of possible styles, and Julie/Ali choose the best ones, and tweak products according to what they think will sell best. That's how most fashion businesses work. Management set the overall strategy, and curate the collections, with everything else delegated to specialist designers & buyers in each product category.

Just as importantly, the specialist buyers have the right contacts with factories which are best at making the specific ranges they design. So it's as much about the supplier relationships, as the designs. Bear in mind that SOS management came from a publishing background, so the one area of their experience which is lacking, is those supplier relationships.

Don't forget also that SOS is a "test & repeat" operator, similar in that respect to BOO. Some Sosandar styles (e.g. fit & flare dress) are now becoming a permanent fixture in their ranges - i.e. customers like that style, so they keep re-interpreting it each season, in the latest colours, and prints. That's working well.

Incidentally, I think a lot of private investors are being overly sceptical about SOS. There's no substituted for talking things through with management, and they're genuinely excited about the opportunities ahead.

To bridge the gap, I've offered the company another audio interview with me, so that they can flesh out the growth plans in more detail, and answer your questions. They're keen to do this, so watch this space!

Regards, Paul.

purpleski

12th Jul

Just want to thank Paul for all the information he has shared on Sosandar (LON:SOS). I hold very small position.

Meldrew

15th Jul

I second purpleski. Thanks Paul

I've been asked when the placed shares are eligible to trade, although I think the question is probably irrelevant because I doubt if many, if any, will be traded any time soon.

clarea

15th Jul

Anyone any idea what's going on with Somero this afternoon I can only think that its trades going through outside the normal ems size on the sell side that is dragging the price down as volume last time I looked was below the average unless there's a seller looking to reduce a sizeable holding or in line statement last week has spooked someone.

Small Cap Value Report (Thu 11 July 2019) - SOS, VCP, SOM, MMH

Sosandar (LON:SOS)

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