Small Cap Value Report (Thur 30 May 2019) - VLE, DISH, SONG, BUR, BRY, WOSG

Morning all,

The main news on my plate has been the announcement by Volvere (LON:VLE) of a large tender offer.

Other things which have happened today:

• BigDish (LON:DISH) has made another rollout RNS.
• Hipgnosis Songs Fund (LON:SONG) has acquired another impressive music catalogue
• Burford Capital (LON:BUR) announces the successful conclusion of a large case
• Brady (LON:BRY) updates in line with expectations at its AGM
• Watches of Switzerland (LON:WOSG) (new ticker) - Watches of Switzerland achieves a market cap of almost £650 million at IPO.

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Volvere (LON:VLE)

• Share price: 1253.5p (+2%)
• No. of shares: 3.1 million
• Market cap: £39 million

Tender Offer

(Please note that I have a long position in VLE.)

This is by far my largest single holding, and it feels like this has been true for a while. It has been in my portfolio for three years.

Yesterday's announcement was released just after 3pm - perhaps a little unusual, but there you go.

Volvere has been discussed in this report twice very recently: on May 22 by Paul and on May 24 by myself.

On May 22, I said:

I would support another share buyback at the current share price... My reasoning is that the cash balance is just a bit too large for it to be used within any foreseeable timeframe, so it makes sense to return a bit more of it to shareholders.

I don't know if management read this report, but they evidently agree with my thought process. The latest buyback announcement is for up to 41% of shares outstanding, with a return of £16.6 million.

Reason for the Offer

Please check the archives for a complete description of the background story. As the tender offer announcement states:

The Group currently has approximately £36.2 million of cash but believes that the appropriate level of cash available for investment on an ongoing basis should be around £20 million and accordingly, the Group has funds surplus to its current operational requirements.

That is perfectly clear and simple.

And I'm glad that the company has settled on a figure on £20 million. One of the big question marks has been whether management can scale up their strategy to work with larger funds under management.

While £20 million is still larger than they have historically managed in this vehicle, I would say that they deserve the benefit of the doubt that they will be able to put it to good use. 

Shareholders will have to wait and see what ideas and plans they come up with for this amount - we already know that they are interested to expand their activities in the food business, but they have also had a lot of successs with "people" businesses.

The Maths

NAV was £40.4 million at 2018 year-end, but this includes the interests of minority shareholders at Volvere subsidiaries. Excluding this, Volvere shareholders had equity of £39 million.

The company then generated £2.55 million (net) from the sale of Sira Defence. I don't know what Sira was in the books for, but I assume that the profit on the sale was well in excess of £2 million. This would put Volvere's adjusted NAV in excess of £41 million, or c. £13.20p. This is also before taking into account any P&L at the food business in 2019.

The tender offer is fixed at1290p, a circa 12% premium to last week's share price, but I doubt that it is higher than the current NAV per share for Volvere shareholders.

After the transaction, assuming that 41% of shares are bought back at the offer price, the company would look like this:

• 1.83 million shares left outstanding
• Cash balance just less than £20 million
• Cash per share of c. £10.70
• NAV per share slightly increased (assuming that it is currently higher than 1290p per share).

I should probably highlight that the NAV per share is using balance sheet values only for the food business (a bit like the way Berkshire Hathaway has been measured). It doesn't give any value for the potential earnings power of the food business and how those earnings might be capitalised in a successful disposal at some future date.

One other thing I noticed in the offer announcement (hard to miss it, as it's in bold):

If the Tender Offer is not accepted in full, the Board... reserves the right in its absolute discretion to purchase in the market, up to such number of Ordinary Shares as is equal to the difference between the number of Ordinary Shares successfully tendered in the Tender Offer and 1,283,927 Ordinary Shares...

So we might see the buyback taking place in the market, if investors don't want to take part in the tender offer.

Directors' intentions - the Lander brothers intend to tender "some" of their shares. They participated in the last buyback, although it left their percentage ownership of the vehicle unchanged. Maybe they will do the same this time?

My view

To reiterate, I fully approve of this buyback, as the cash balance was indeed looking too large relative to the opportunities available to management.

Even utilising £20 million will be a challenge, as the directors have proven that they prefer to do nothing rather than make a mistake. But it will be a much more manageable amount, rather than £36 million.

I haven't decided yet if I will take part in the offer. Some reasons to take part:

• The price being offered seems quite reasonable. It is close to my estimate of adjusted NAV per share.
• The shares are very illiquid, so this is a useful liquidity event, for anyone who needs some cash.
• Management intend to take part, as they did in the previous buyback. If they are happy to sell some of their holdings, other shareholders might reasonably decide to follow their lead.
• Volvere hasn't made an acquisition since H1 2015. The lack of acquisitions suggests that value creation could be about to slow down.
• Shareholders can tender any number of their shares, so it's not an all-or-nothing decision.

These are all good reasons to take part.

On the other hand, not taking part in the offer means that investors can see their ownership interest increase in this vehicle, with perhaps a small boost to NAV per share.

On balance, I am leaning towards not tendering my shares, but I haven't made the final decision yet.

I am looking forward to the AGM on June 24th.

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(This section is by Paul Scott, who has a long position in DISH.)

BigDish (LON:DISH)

• Share price: 6.27p (+18%)
• No. of shares: 286 million
• Market cap: £18 million

BigDish to Launch Nationwide Rollout

BigDish (LON:DISH) is a very interesting concept - yield management app for restaurants, allowing them to offer discounts at specific days/times.  It cropped up on my radar earlier this year, so I decided to download the app and try it out. It's absolutely fantastic - easy to use, and providing large discounts, at good restaurants, mainly at off-peak times.

Even though the business is generating negligible revenues at this stage, it's started a UK-wide roll-out. Today's RNS says they are expanding the regional roll-out managers from currently about 2 or 3, to adding 10 more - so a significant stepping up of the roll-out pace.

How to value the shares? On the historic numbers, you would probably value it at nothing! So it's all about what potential people see for the future. This is how I see it;

Bull points

• Great app - simple, easy to use, and free for customers
• An easy sell to restaurants, as only charges 50p to £1 per diner seated, and boosts their profits from bringing diners in at otherwise quiet or empty times
• Restaurants are fully in control, so can customise offers to suit them
• New CEO is experienced in sector, and formerly at TripAdvisor
• Cheap tech team in Manila
• Attractive sector, with premium-priced takeovers of other similar companies, even early stage ones

Bear points

• Easy to replicate the app, so...
• Better funded competitor could copy the idea, and eat its lunch
• Negligible revenues, and loss-making (although cash burn is quite modest- due to small team)
• Not clear what the marketing strategy is - how to tell consumers this app exists? How much will a proper marketing campaign cost? Will it be effective?
• Claims to be fully funded for now, but will clearly need to raise more cash at some stage, to fund marketing, and faster roll-out. But given share price roaring up, should be easy to raise say £2-3m if necessary with not-too-bad dilution
• Rampy RNSs, and management seem a bit too excitable: big ideas, not enough execution in the past (although new CEO seems more hands on, I'm hoping to meet him soon)
• Highly speculative, and almost impossible to value at this stage!

The share price has been rising on heavy volume for several days now.

What's it worth? No idea!  I bought some shares (average 2.7p) because the app is so good, and the UK roll-out was just about to start. That seemed to me a good time to take a highly speculative, punt on this.

This share won't suit most people here of course.

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(Back to Graham.)

Hipgnosis Songs Fund (LON:SONG)

• Share price: 104.24p (+0.2%)
• No. of shares: 341 million
• Market cap: £355 million

Acquisition of Music Catalogue

This quirky fund announces yet another acquisition.

Hipgnosis has a March year-end, on the basis that it published interim results to September 2018. It will be good to get my teeth into this company's accounts and learn more about the yield it's achieving on these investments.

If the yields are attractive, I think this fund could re-rate to a significant premium to book value. For now, I'm in wait-and-see mode.

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Burford Capital (LON:BUR)

• Share price: 1673p (+2%)
• No. of shares: 219 million
• Market cap: £3,658 million

Burford sees successful end to Teinver annulment

Much bigger than what we usually look at here, but this is a widely followed share.

See if you can follow this:

Burford previously sold a case for $107 million, and recognised $100 million of revenue for it. It didn't recognise the last $7 million, because it estimated that was the value of the buyer's put option (its right to sell the case back to Burford - don't worry, there won't be a test).

It is now recognising the last $7 million of revenue, because the buyer's put option has expired following a decision by the World Bank arbitration panel against the Republic of Argentine.

Burford goes into some detail regarding how it has historically valued the case, to illustrate its "longstanding and conservative valuation process".

Burford is impressing me more and more. I'm warming to the idea that it has generated, through its size and wide range of capabilities, a real competitive moat. And I appreciate the efforts it takes to explains its work to investors.

It feels like I'm very late to the party, and the valuation still feels rather punchy, but this is a stock I could potentially add to my portfolio. 

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Brady (LON:BRY)

• Share price: 57.25p (-1%)
• No. of shares: 83.4 million
• Market cap: £48 million

AGM Statement

Brady plc (BRY.L), a leading global provider of trading, risk management and settlement solutions to the energy and commodities sectors is holding its Annual General Meeting ("AGM") at 12.00pm today.

The Chairman reports "substantial progress" to the end of April, which is in line with expectations.

I await further evidence that this company is worth almost £50 million, or c. 2x forecast sales. It has been loss-making for a while, but is hoping to break into a small profit this year. Let's see.

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Watches of Switzerland (LON:WOSG)

• Share price: 270p (IPO pricing)
• No. of shares: 239.5 million
• Market cap: £647 million

Announcement of Offer Price

Watches of Switzerland Group, the leading multi-channel luxury watch retailer in the UK and a leading retailer of luxury watches in selected regions of the US, announces the successful pricing of the initial public offering 

Details for this IPO:

• £155 million in gross proceeds for the company. Net proceeds only £139.5 million after fees and expenses.
• At least £220 million (maybe more) for existing shareholders to sell down their stakes.

So it's a good mix of new and old money changing hands in the IPO.

I've downloaded some trading information and the prospectus from the company's website, which informs me of the following:

• FY April 2019 revenue was £773 million. The revenue growth figures in the trading update are unclear to me, because the official reported basis seems to differ from the company's own view. Like-for-like revenue growth is 9.2%.
• Net debt will be £120 million after the IPO. This figure is estimated to be 1.56x adjusted trailing EBITDA, so I guess that trailing EBITDA must be c. £77 million, on a heavily adjusted basis.
• Operating profit from continuing operations was £22.6 million in FY 2017, rising to £37.4 million in FY 2018. In the first nine months of FY 2019, it was £34.2 million. Financing costs ate up most of this - the IPO will deleverage it substantially.

My view

Ultimately, this is a distributor and this is reflected in its gross margins of c. 9%. I don't think I would pay a very heavy multiple, but there is probably a level where I would have some interest in it. Worth keeping an eye on.

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Following on from my "Red Ink" comments, I see that the FTSE has recovered by 50 points today, making my trade around mid-day yesterday look much more clever than it really was. It's still too soon to say whether I got the timing right. But I'm glad I was there to take advantage of some temporary weakness in sentiment!

All done for today folks, thanks again.

Graham