Small Cap Value Report (Tue 12 Feb 2019) - SOS, PLUS, DEB, LOOP

Good morning, it's Paul here.

I finished off yesterday's report in the early evening, adding new sections on Avation (LON:AVAP) and Stride Gaming (LON:STR) . So if that interests you, here's the link.

I will be busy this afternoon, planning & recording my telephone interview with management of  Sosandar (LON:SOS) (in which I hold a long position). That should be published by early evening today. I will tweet out & put a link into Weds SCVR here. There seems to be a lot of interest in the company from you, so many thanks for the interesting questions you submitted to me. Time constraints mean I probably won't be able to cover all of them, but will do my best. We can always do a follow-up interview after the FY 03/2019 results are published in the summer.

On to today's trading updates & results statements.

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Plus500 (LON:PLUS)

Share price: 1105p (down 32% today, at 12:35)
No. shares: 113.7m
Market cap: £1,256m

Preliminary results - for year ended 31 Dec 2018

Only a brief comment, as it's far too big for a small caps report. However, lots of us are fascinated by this company - the key questions being whether its massive profits & cashflow are real - that's an easy one, the answer is yes. But are those profits/cashflows sustainable? That's the big question mark - hence why the shares have only attracted a fairly low PER, and huge dividend yield in the past.

The 2018 financial results look absolutely stunning; 

• Net profit us up 90% to $379m
• Cash generated from operations is up 78% to $495m
• Dividends of just under $2 were paid (c. 155p per share) - a yield of  14% at today's share price

Profit warning - here's the problem, in the "current trading" section;

Following our latest assessment of the impact of the ESMA regulatory measures, FY19 revenue is expected to be lower than current market expectations.

This, combined with our intention to maintain our marketing spend, is likely to result in 2019 profit being materially lower than current market expectation...

Directorspeak - The CEO doesn't sound too worried about this downturn;

"In summary, our highly flexible business model, industry leading scale and market share, technology edge, lean cost structure and robust financial position will help mitigate the impact of regulatory measures and ensure the delivery of sustained market leading financial performance.

We are therefore confident that we can continue to successfully develop our business and expand into new markets, enabling us to continue providing strong shareholder returns."

My opinion - I remain rather sceptical about this company.

What seems odd is that this material profit warning seemed to come out of the blue. PLUS had previously (quite recently) issued a series of positive updates. Business seemed to be storming along. Therefore today's profit warning is all the more perplexing. Regulatory risk has always the problem with this company. This is not the first time that regulatory problems have smashed the share price down.

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Debenhams (LON:DEB)

Share price: 4.25p (up 36% today, at 12:55)
No. shares: 1,227.8m
Market cap: £52.2m

Update on refinancing discussions

Key points;

• Extra £40m facility agreed for 12 months - giving more headroom
• Quite expensive at LIBOR +5% initially, rising in Q2 - so it's a bridging loan, to keep the company afloat while it tries to find a longer term, comprehensive refinancing solution (possibly a CVA, combined with fresh equity raise?)
• Waiver & amendment of certain covenants
• New partnership with Li & Fung, to source better & cheaper product

My opinion - I remain of the view that DEB is not viable in its current form. It was wrecked by asset-stripping private equity a few years ago, so they're very much to blame for it being in the current parlous state.

To my mind, the only question is whether DEB is able to do an orderly refinancing with a CVA to dump the excessive rent liabilities? There would need to be a debt for equity swap as part of that deal too. My broker tells me that DEB bonds are currently trading at almost a 50% discount to par - an indicator that the equity is probably worthless.

Or, whether it falls into administration, and is then picked up via a pre-pack by Mike Ashley (who already has a substantial stake). He wants to slash the rents, as he did with House of Fraser, and then merge the 2 companies. This is a gigantic conflict of interest with other shareholders though. So could be legally tricky.

Normally, I would see the shares in DEB as being worthless. However, the interesting element here, is whether Mike Ashley will want to preserve the market value of his existing equity? Or whether he's happy to write it off, pushing the company into administration, then cherry pick the bits he wants and jettisons all the liabilities.

On balance, I continue to regard this share are uninvestable. There's a very high risk that the equity might end up wiped out. People need to remember that, once a company is in a distressed debt position, then the equity has little to no value. this is because creditors rank higher up than equity, so can pull the plug if equity holders don't agree to whatever lenders demand.

DEB could survive for some more time, because it's still trading at a level where there's no immediate pressing need to shut the company down. When you strip out the depreciation charge, it should still be generating some cash. Mind you, given the run-down state of some of the stores (the ones ear-marked for closure), then I expect LFL sales to be firmly in negative territory this year & in future. Hence the clock is very much ticking.

I'd also like to mention 2 very useful reader comments below (thanks for these);

Comment no. 15 - "Edward John Canham" points out that today's announcement should have helped reduce bad debt risk for QUIZ (LON:QUIZ) (in which I hold a long position), whose concessions are mainly in DEB stores. I covered this issue in detail, here on 14 Jan 2019 - even doing a store visit as part of my research!

Comment no. 16 - "HornBlower" crunched the numbers, and reckons that DEB might have seen a £200m+ cash outflow in recent weeks.

Falling Knives

As regards catching the falling knife at DEB, I am definitely not tempted - its finances are too precarious, with a high risk of insolvency.

In theory, I only try to catch falling knives where a company's balance sheet is bulletproof. Recently I had a very close shave with FlyBe. I (mistakenly as it turns out) thought that its balance sheet was alright, due to the huge value of its owned aircraft more than offsetting its debt. My buying some shares at 12p, and selling them at about 16p, seemed like a good deal, but it turned out to be more luck than judgement. Then the takeover bid came through at just 1p. Scary indeed, hence why I've tightened up my criteria for considering whether or not to catch falling knives.

On this point, I should disclose that I have recently caught 2 falling knives, for companies which seem to have been struck by short sellers, and may be overdue a bounce - namely Learning Technologies (LON:LTG) - where the shorting dossier looks fairly weak to me. And accesso Technology (LON:ACSO) - where management seem to have badly handled the last trading update, yet the market reaction seems overdone, in my view.

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LoopUp (LON:LOOP)

Share price: 352p (up 8.5% today, at 13:51)
No. shares: 55.1m
Market cap: £194.0m

Trading update

LoopUp Group plc (LSE AIM: LOOP), the premium remote meetings company, is pleased to provide a trading update for its financial year ended 31 December 2018.

There's a useful amount of detail in today's update. The key part however is this;

The Group has traded strongly in FY2018, with revenue in line with consensus expectations and profitability comfortably ahead

Outlook is also upbeat;

Looking ahead into 2019, we continue to see strong demand for the LoopUp product and remain confident in our ability to deliver future growth."

Valuation - this is the tricky bit. The historic figures look unimpressive. Indeed, the key focus should be on cashflow, in my opinion, because the company capitalises a lot (about £3.8m p.a.) of its payroll into development spend on the balance sheet. That is a perfectly allowable accounting treatment, but it does mean that EBITDA is meaningless, and certainly not a proxy for genuine cash generation.

Looking at the most recent interims, and prior year, LoopUp has effectively been running at cashflow breakeven (after development spend). So how on earth can we justify a market cap of £194m? The market looks forwards of course, not backwards. With strong organic growth, a recent large acquisition, and high gross margins on a mainly fixed cost base, this is all about operational gearing.

In theory, profits should shoot up in future. It's forecast to make about 7p EPS in 2018 (I've taken that from consensus forecast of 6.41p shown on Stockopedia), and added on about 10% extra to allow for today's positive trading update. That puts the shares on a PER of about 50 times 2018 earnings.

One issue with that, is the acquisition of Meeting Zone only kicked in half way through the year. So 2019 will benefit from a full year of that company's earnings, which was a sizeable acquisition, involving a £50m placing at 400p, and a loan on top.

Consensus EPS forecast for 2019 rises substantially to 13.7p. That would lower the PER to 25.7 - more palatable for a growth company. Although not cheap by any means. As with all growth companies, if LOOP fall short of the 2019 forecast, then the share price would probably take an instant 30% dive. And then probably continue going down, as that's what we're seeing happening left, right & centre in the current difficult market.

I would need to look properly at the 2018 results, due out on 21 March 2019, to be comfortable with the method of calculating EPS. It might be adjusted, and I'd need to get comfortable with the adjustments, before I'd want to buy back here in any size.

Bid/offer spreads - this share is a great example of how the current stock market system for price quotes on small caps is not fit for purpose. Indeed, I see it as very concerning that the published prices on small caps are false. 

Here's an example of LOOP's prices;

Quoted prices on live price stream

Bid:  340p   Offer: 365p    Spread: 6.8%

Actual prices (from my broker)

Bid:  347.5p (10k shares)     Offer: 355p (2.5k shares)   Spread: 2.1%

As you can see, there's a huge difference between the published prices, and the genuine prices (which are concealed from private investors, but are available to brokers through the RSP system).

Several points to note here;

The stock exchange needs to change its reporting, so that best prices are publicly available on small caps, not concealed from investors using the RSP system. RSP quotes should be the published prices, not hidden from view.

Any analysis that investors do, using quoted market spread, are meaningless, because the data is not the actual price, in small caps.

You can find out the RSP prices, by asking a traditional broker over the phone, or by putting in a dummy trade on any online share dealing platform, then cancelling the trade before it is executed (usually a 10 or 15 second window)

My opinion - LOOP has a great product, which I've used myself, it's superb.

I like the company very much, and the growth is strong.

There is a question mark over valuation though, which does seem high, even after recent falls.

I'll review the 2018 numbers when they are published on 21 March.

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That's all I have time for today.