Small Cap Value Report (Thu 31 Oct 2019) - CPR, FOXT, PHD

Good morning, it's Paul here.

This report is earlier & shorter than Mon-Wed reports. That's because I'm flying out to Malta at lunchtime, for a cheap, end of season break. Am taking my laptop with me, so I'll write Friday's report as usual, just from abroad.

Estimated time of completion: 10 am. Update at 09:29 - today's report is now finished. I managed to cover everything of interest, as there's not much small caps trading/results news today.

Agenda - it's a quiet day for news, thank goodness;

Carpetright (LON:CPR) - possible offer

Foxtons (LON:FOXT) - trading statement

Proactis Holdings (LON:PHD) - results

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Carpetright (LON:CPR)

Share price: 9.12p (pre market open)
No. shares: 303.8m
Market cap: £27.7m

Refinancing, possible offer, and trading update

This carpet retailer did a CVA, to dispose of its problem leases, and has been propped up financially for some time by its major shareholders Meditor European Master Fund. Without Meditor's large financial support, Carpetright would have almost certainly gone bust. Note that Meditor bailed out the banks, by buying them out in Aug 2019. It's obvious now that Meditor made a bad mistake supporting Carpetright - a classic investing error of repeatedly throwing good money after bad. I know that feeling well, albeit on a rather smaller scale!

Funding requirement - today's announcement says that Carpetright needs £80m in funding;

The Board believes that approximately £80 million is needed for the Company to (i) repay the Debt Facilities; (ii) meet the Company's ongoing working capital requirements; and (iii) provide the Company with the necessary growth capital to execute its strategy as set out below.

Funding options - the company has explored other funding options, but it sounds as if Meditor is the only game in town.

Possible offer - Meditor has sounded out other institutional shareholders, to see if they would accept a 5p cash offer for the whole company. This makes sense, as Carpetright is totally reliant on Meditor's existing financial backing, that they might as well buy the whole lot. The intention is then to convert debt into equity, and presumably lick their wounds in private, rather than on the public market.

Indications of support for a 5p bid have been received from holders of 24.0% of the shares, plus Meditor's existing c.30% holding, means that they're already more than half way there. It's not a firm offer yet. I suppose that the alternative would be to withdraw lending facilities, making Carpetright insolvent, and then do a pre-pack administration, which would wipe out other shareholders. Cheaper, but more disruptive, than the 5p offer.

Strategic update - largely irrelevant to investors, as they're about to be bought out at 5p. This section of the announcement is more for the press, and to reassure other stakeholders (staff & suppliers in particular).

Trading update - again, this doesn't really matter to shareholders now, but here it is anyway;

The Board believes that Carpetright is performing well despite the challenging economic backdrop and intense sector competition. Group profitability is improving as the Company drives store efficiency and reduces the central cost base.
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Supplier terms is a key point for people to consider at the moment, with all struggling companies. When companies do go bust, it's often because suppliers have lost confidence in getting paid, often at the behest of credit insurers removing cover. Investors tend to overlook this crucial point, and focus too much on bank debt. The trouble is we're rarely given any information about the attitude of trade credit insurers.

Whilst management of supplier terms has been challenging, the Company continues to work well with partners in its supply chain and expects this to yield an improved position moving forward.

Expanding on this point, when I spoke to management at Sosandar, they indicated that one of several reasons for their recent £7m placing, was that new suppliers are very nervous about UK retail. Many of these factories have been hit with bad debts from UK retailers going bust. Hence they are now reluctant to extend credit. This puts many, even large, UK retailers in a potentially precarious position. I reckon it's likely to be absolute carnage after Xmas, with lots of retailers going bust. Hence why it's so important to not go near anything in this sector with a weak balance sheet, that relies on credit from the bank & suppliers.

My opinion - Carpetright shareholders have no negotiating power whatsoever, against the major shareholder which is financially supporting the whole company with loans.

Therefore, the only sensible option is to accept the 5p bid with gratitude. The alternative is 0p in a pre-pack administration, so the 5p possible offer should be seen as generous. There's little chance of a competing bid, since Meditor would want its debt repaid before shareholders get anything.

If you can get more than 5p in the market, then I'd be inclined to bite the buyer's hand off!

This is a good reminder that takeover bids do not necessarily happen at a premium. Especially where a company is financially distressed.

Another stunningly quick retail collapse;

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Foxtons (LON:FOXT)

Share price: 63p (down about 5% at 08:04)
No. shares: 275.1m
Market cap: £173.3m

Trading Statement

Foxtons plc (LSE: FOXT), London's leading estate agency, today issues its trading update for the third quarter ended 30 September 2019.

The share price has exhibited a strong recent bounce (up from 50p to 70p), which is wilting somewhat in early trades today.

This is a rather annoying update, as it fails to give the crucial information as to whether or not trading is above, in line, or below expectations. That must be explicitly stated in every trading update from every company. Dodging that issue just creates uncertainty, and increases the risk that a profit warning might be in the pipeline.

Directorspeak - this bit doesn't exactly fill me with confidence;

Overall, this was a resilient performance set against the London sales market which continues to deteriorate and the impact of the tenant fee ban on our lettings business...

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Revenues are still dropping -

Group revenue for the third quarter was down 7% to £32.5m (Q3 2018: £35.1m). This takes Group revenue for the first nine months of the year to £83.6m, down 5% on the prior year (2018: £88.1m).

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Stamp Duty - nothing is said on this today. Some investors are hoping that the punitive rates of Stamp Duty, stupidly introduced by George Osborne, which killed the top end property market stone dead, might be reduced soon. That would be a clear benefit to Foxtons, as it might kick-start the London market.

Letting fees ban - came into effect on 1 June 2019. Foxtons has decided to absorb this loss of income (not increasing fees to landlords), in order to grow market share by having a more competitive offering. Q3 lettings income is only down 4%, so looks like this is not a major issue.

My opinion - at some point, this share could be worth buying. I just don't know when, unfortunately. It feels to soon to anticipate a recovery in the London property market, so I'm keeping this on my watchlist, rather than diving in.

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Proactis Holdings (LON:PHD)

Share price: 56.5p
No. shares: 95.5m
Market cap: £54.0m

Final Results

Proactis Holdings PLC, the business spend management solution provider, today announces its audited results for the financial year ended 31 July 2019.

Rather poor results here. Adjusted EPS is down from 10.6p last year, to 6.6p this year.

I don't completely trust the accounting here, which seems a bit aggressive.

Management previously went on an acquisition spree, which has not worked out well - there's a whacking great £27m impairment of goodwill charge in today's figures.

Balance sheet is horrendous, although being a software company, it doesn't need much in the way of fixed assets. Even so, a current ratio of 0.73, and a ton of debt in long-term creditors, make this uninvestable for me.

Cashflow - operating cashflow looks good, at £14.2m this year, and £9.7m last year. However, it's capitalising £7.6m of development spend. When you take off other normal cash outflows like tax & interest cost, most of the positive cashflow is used up. Therefore in the real world, I do not see this as a particularly cash generative business.

Sale process - Proactis is up for sale, with apparently "a number" of expressions of interest. 3 months ago it announced;

...it has received a preliminary unsolicited approach from a US-based investor with regard to an offer for the Company and a number of preliminary unsolicited expressions of interest from other parties...

I think something would have happened by now, if the approaches were serious, and at a high potential premium. But you never know. Generally speaking though, the longer things drag on, the less likely a good deal is. Brexit delays might complicate things though, as I can see why bidders might want to hold back, for more certainty on that issue.

Operational problems - as previously reported, there was management change, and an exodus of customers a little while ago. I don't like that.

My opinion - I wouldn't touch this personally. I've focused on the negatives, which for me make it uninvestable. I suppose the positives should also be mentioned - mainly that it has a good client list, and lots of recurring revenues. For me, the excessive debt, and very weak balance sheet make it too risky.

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I can't see anything else of interest in the small caps space today, so will leave it there.

Once I arrive in Malta later today, I'll get my laptop rigged up on the wifi, and will have a look at your comments. If there are any interesting small cap company results or trading updates, then by all means leave a comment here, and if it's quiet tomorrow (which is usually the case on Fridays) then I might be tempted to write a section on it tomorrow.

As always, when putting in a request, tell me why it's interesting. I don't want to write about boring companies just because a reader happens to have a shareholding in it! We're trying to find the little nuggets of gold that are buried out there! And to avoid all the junk that is littered throughout AIM. I do sometimes despair at the low quality rubbish that gets floated on AIM. Surely all these brokers & company promoters can find something decent out there?

There must be thousands of decent UK companies which could benefit from a stock market listing. Instead the brokers tend to float speculative dross that usually ends up disappointing investors. If brokers carry on in this vein, they'll kill the golden goose. Time for a re-think at some of these brokerages, I reckon. They should stop chasing short term personal gain, and instead think about building a more sustainable small caps market, with higher quality companies, delighting & enriching shareholders, instead of trying to fleece us.

Best wishes, Paul.