Small Cap Value Report (Tue 2 June 2020) - IGP, TED, DLAR, QTX, VNET, CARD, XAR, ZTF, GMR

Good morning, it's Paul here.

As usual, this post is initially just a placeholder, to allow readers to post any early comments re the 7:00 RNS, as I write up the main article throughout the morning.

This is what has caught my eye this morning;

Intercede (LON:IGP) - final results
Ted Baker (LON:TED) - more thoughts on its placing announced yesterday
De La Rue (LON:DLAR) - more thoughts on yesterday's stellar rise in share price
Quartix Holdings (LON:QTX) - trading update
Vianet (LON:VNET) - final results
Card Factory (LON:CARD) - preliminary results
Xaar (LON:XAR) - trading update

Estimated timings - that's probably enough to keep me busy until the official finish time of 1pm, which I'll aim to achieve.
Update at 13:02 - so close, but not quite! I've done most of today's report, but want to finish off the last 3 on the list, with shorter comments after lunch. Falling asleep on the hammock again is not an option. Therefore, I'll say 4pm for final completion.
Edit at 16:12 - today's report is now finished.

---

Intercede (LON:IGP)

Share price: 71p (up 3% today, at 08:30)
No. shares: 50.5m
Market cap: £35.9m

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

Final Results (pdf version here with graphics))

Intercede, the leading specialist in digital identity, credential management and secure mobility, today announces its preliminary results for the year ended 31 March 2020.

Today's results statement is very detailed, giving us useful background & information about the company.

Here are the main points;

Results for FY 03/2020 are in line with last trading update

Most revenues are contracted, recurring, or repeating - many contracts with large organisations are extremely long-term in nature, with large annual support & maintenance contracts. Hence excellent visibility.

Modest increase in revenues, up 3% to £10.4m

Big increase in profitability, due to continued tight cost control - operating profit up from £59k LY, to £1,152k this time

Note large finance cost on P&L of £600k p.a. - this is mainly interest on the convertible loans, which should be repaid, or convert into equity in the future, hence this hefty cost should disappear, nicely boosting future profits

Taxation - the company receives R&D tax credits, hence tax charge is negative.

Profit after tax £1.0m, versus £449k last year - this is a satisfactory result, given that there were few big new contract wins - most new business was follow-on orders from existing clients

Sales pipeline up 40% on LY, and several times the company emphasises that it is expecting strong revenue growth this new financial year. This could be highly significant, because the operational gearing here is as big as it can get - with gross profit being almost 100% - hence strong revenue growth in FY 03/2021 means profits could go through the roof. Obviously that's not a given, it depends on converting that pipeline into actual contracts, but the smoke signals are looking very positive to me

"Extremely relevant" product in these times;

In comparison to many companies, Intercede is well placed to weather the Covid-19 pandemic.

Our products and services are extremely relevant in the current climate, particularly our derived credential and mobile technology, as they allow our customers' staff to securely work remotely with full access to systems that they would use in their normal place of work.

While we've seen some postponement of decisions on new sales opportunities, this has been offset thus far by the realisation of orders delayed from March and from existing customers preparing for their staff to work from home.

That's very encouraging, I reckon.

Staff attrition rate down substantially - this is very important - down from 33% LY, to 9% (and falling) now. Happy staff mean management must be doing a good job, and augurs well for the future.

Customer advisory board in USA was a great success. Will replicate elsewhere (although it's mainly a US business). It's easy to dismiss things like this, but personally I see an engaged customer base as being very important. It keeps the churn rate very low, and encourages follow-on orders.

R&D is very large, at £2.8m p.a. - none of which is capitalised, a very prudent accounting treatment. Again, I very much like large R&D spend, targeted at the best commercial opportunities. The narrative gives more detail on this, and it sounds encouraging.

No plans to pay divis - fine, as this is a growth company, so I don't want any divis.

Balance sheet - OK overall. NAV is slightly negative, at £(1.38m), but improving.

Very important to take the convertible loans of £4.8m into account. This would use up most of the cash pile to repay, or lead to dilution if exercised. See my previous articles for details on this (I'll put in a link later).

Receivables look high, at about half revenues. I have a call scheduled with management tomorrow, so will ask about this.

Cash - was £4.74m at year end (almost enough to repay the convertible loans), but note that another £3.7m was received on 1 May 2020, just a month after the year end. Therefore, the cash position looks fine. Let's hope the convertible loan note holders opt to receive cash, and don't convert - I don't want to be diluted! It's about 20% potential dilution from memory, so not too bad, and of course that would eliminate debt & leave a strong cash position if the loans are repaid. Directors own a lot of them, so a conflict of interest there.

I would like to see the daily average net debt/cash position disclosed (for all companies, not just this one). This is much more meaningful than a year-end snapshot figure, which is so easy to window-dress.

Broker update - Finncap notes are excellent, and easy to access, bravo to them! There's a nice update note out today, which is worth a read. Again, reading between the lines, it sounds like upgrades could be in the pipeline.

My opinion - I see a lot of potential here. It's all about backing ne-ish management, executing well on a 3 year turnaround plan. They've done everything they said they would do, lots of things have been sorted out. We should, hopefully, now see revenue growth kick in strongly, which would be absolutely transformative. The narrative mentions several times that strong revenue growth is seen coming, but depends on customers being prepared to sign contracts - which can't be assumed, given the current covid situation & recessionary economic conditions.

If this works, I think we could be looking at a multibagger. Risk:reward looks excellent to me. I don't see this as a share to trade. It's a long-term, core holding for me. The share price is very volatile, due to lack of liquidity. It's annoying when small traders get involved, as they whip the price up & down too much. That said, it adds to badly needed liquidity. I try to ignore the share price completely, or buy the dips if I have any spare cash.

Note that the 3-year chart below shows that investors clearly believe in the turnaround story, as they should. Note also how the StockRank system has also become a lot more positive about it since mid-2019.

.

---

Ted Baker (LON:TED)

Share price: 129p (flat today, at 10:05)
No. shares: 171.3m (after placing)
Market cap: 221.0m

(at the time of writing, I have a short position in this share)

Results of Placing

This announcement came last night, and no real surprises, as the placing was underwritten, so could not fail.

However, it's worth taking a look at it, and to dwell on the huge dilution to existing holders. This is what happens when a business gets into serious trouble, and needs to refinance. I can think of other companies that could end up in a similar situation, Superdry (LON:SDRY) springs to mind, so I want to flag the risk.

TED did include an open offer for existing shareholders, but that's only a small proportion of the new shares being issued. Institutions taking part in the large placing get to dilute existing holders heavily, without existing holders having any say in that. I understand why placings are used - they're cheaper & quicker than a conventional rights issue, particularly important in times of crisis, like now. However, it leaves existing small shareholders, who don't even know a fundraising is being undertaken until it's a done deal, at a serious disadvantage.

That the share price has remained as high as 129p, when the bulk of the shares in issue have just been issued at 75p, doesn't make any sense to me. Therefore I see this as a selling opportunity. If I held the shares, I would want to take up my open offer entitlement shares at 75p. However, I would lock in the current 129p selling price by opening up a short position now, equivalent to my open offer entitlement. That way, people can take up the open offer, sure in the knowledge that a 54p profit per share has been locked in.

I decided to short the share yesterday, in a modest position size, just because I feel the share price is likely to be pulled down to near the 75p placing & open offer price.

Shorting can be dangerous. Particularly in this case, there's an aggressive major shareholder, Tosca. I vaguely recall an episode a few years ago, where they smashed short sellers by mounting a bizarrely over-priced takeover bid, for a company they had a big stake in, which was a complete crock. Speculation was that their motivation might have been to preserve their reputation, and disappear an embarrassing mistake by making it look like a success. Hence I'm wary of anything Tosca is involved in - what happens is not necessarily logical or sensible.

The main point here is, that there's obvious read-across from a deeply discounted, highly dilutive placing at TED, to other companies. Just because the bank is being supportive in the short term, doesn't mean shareholders are out of the woods. With generous Govt backed schemes available, it makes sense for companies to extend bank facilities in the short term, to provide breathing space to tap shareholders for more equity.

Last week I was toying with the idea of buying equity in more financially stressed companies, on the basis that the Govt has backstopped the downside with loan guarantees. The distressed equity raising at TED has completely put me off that idea now!

.

---

De La Rue (LON:DLAR)

Share price: 154p (up c.278% in last 2 days!)
No. shares: 104.0m
Market cap: £160.2m

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

Post-script to yesterday's very positive trading update.

I've done a bit more work on it, and belatedly decided to join the party, with a new long position. It was really difficult deciding to buy this, when it was already up 100% on the day yesterday - not normally something I would do, because such a huge euphoric price spike would usually be expected to reverse considerably.

However, this struck me as a very unusual situation, where the outlook for the company seems to have radically improved. Prior to yesterday's trading update, it looked as if DLAR was in potential trouble - very weak balance sheet, profit warnings, etc.

Although on my review here on 6 Mar 2020 (at 124p per share) I concluded that, despite the problems, it was starting to look like a credible turnaround., with speculative upside possibility. That helped me push the button yesterday, buying at around 84p. Amazingly, the price has almost doubled again from my buying point yesterday, when it had already doubled. Is this a speculative bubble then? I don't know, because I cannot get hold of any broker research.

On balance though, I've decided to run with this, and see where it ends up. The share price was so beaten up to start with, that a huge percentage rise from such a bombed out level, doesn't really mean much. The company's prospects seem to have dramatically improved, and it's quite a big business. Maybe I should sell half, and run the rest for free?

.

.

---

Quartix Holdings (LON:QTX)

Share price: 376p (down 2% today, at 12:33)
No. shares: 48.0m
Market cap: £180.5m

Trading Statement

Quartix Holdings plc, one of Europe's leading suppliers of subscription-based vehicle tracking systems, software and services, issues a further update and trading statement, as promised in its statement of 27 April.

This sounds positive;

The Board reports that trading for the first four-month period to 30 April 2020 was strong, and ahead of the equivalent period last year.

The Company's cash balance was £9.5m at 1 June.

All staff working from home.

New installations - very low in April (-60%), but improved significantly in May (-25%).

Process improvements - this is an interesting theme. Management of another company told me recently that having people working from home has helped them examine everything they do, and make improvements to processes. Sounds as if QTX are saying the same thing here;

Significant development has been carried out over the past two months on productivity, process and activity measurement reporting for the Company's sales operations, and this will help the Company in maximising the effectiveness of future investments in sales and marketing.

I wonder also whether the current crisis may have given many companies' management the opportunity to think about the way they do everything. In some cases I'm sure that a crisis actually can sow the seeds for future success, because everything has to be challenged. People that were tolerated in the good times, but who contribute little to the business, tend to be let go in a time of crisis.

Fleet activity - data is given on this, if you're interested see the RNS.

Subscriber base - not yet seen any material decrease in subscriber revenues from the covid crisis. Attrition rate steady, at 12% p.a. Some risk from 6% of the subscriber base, that have asked for payment relief/deferral. Some issues with direct debits, but not yet any significant increase in bad debts. This is a helpful reminder that if we enter a prolonged recession, then some of QTX's revenues are bound to fall away from possible insolvencies. Well done to the company for being up-front about this.

Guidance - this is a cop-out I think, because with recurring revenues, the company should be in a good position to provide base case, downside, and upside cases. Then investors can pick the outlook that fits their preconceptions about the macro outlook.

As stated in the trading statement of 27 April, The Board's view is that the COVID-19 pandemic is unlikely to have a material impact on profit and cash flow in the first half of 2020 but given the uncertainty that remains, the Board is still unable to provide guidance for the financial performance in the second half of 2020 and for 2021.

Unwilling, rather than unable, would be a better word!

This does however reinforce the reality, that if the UK/France (bulk of QTX's revenues) go into a prolonged recession, then revenue & profit could drop considerably. Remember the operational gearing effect of losing say 10-20% of business, would be considerable. That said, Quartix is very secure financially, so there would never be any hint of it getting into financial trouble, even if business did drop. So shareholders could just ride it out.

My opinion - really good company, and terrific management. But for me, the current price looks too high, given the risks & uncertainty.

.

---

Vianet (LON:VNET)

Share price: 93p (up 13% today)
No. shares: 28.95m
Market cap: £26.9m

Final Results

This is the group which owns Brulines, the flow monitoring equipment for pub beer sales, and a vending telematics business.

Very brief points, as the company doesn't really interest me as a potential investment;

Adj operating profit up 4.5% to £4.0m

Final divi withdrawn, due to covid situation, as many companies have done.

Recurring revenues mostly, at 92% of total.

Covid-19 - sensible measures taken to conserve cash. £3.5m loan under Govt's CIBL facility. Confident it has healthy cash runway into 2021.

Brulines - contract renewals achieved. Assisting customers by offering reduced monthly fees during shutdown. I like this a lot - as do their customers, naturally. People remember who helped them out in the tough times & often reward them in future.

Trading well ahead of revised forecasts for April 2020.

Vending division trading well.

My opinion - neutral. It sounds as if management has acted fast & sensibly to protect the business. The main reason to hold this share was the divis, which have probably now gone away for a while, as the focus will need to be on debt reduction. I wonder how many pubs might never re-open? Hence that's likely to dent the Brulines business permanently.

I don't see any logic in this company being listed. Growth is anaemic, and why incur all the costs & hassle of a listing?

---

Card Factory (LON:CARD)

Share price: 39p (down 3% today, at 15:06)
No. shares: 341.5m
Market cap: £133.2m

Preliminary Results FY 01/2020

In normal circumstances, this share would look an astonishing bargain, being on a PER of only 2.5 times underlying basic EPS just reported, of 15.7p. However;

1) Covid. So profit this year FY 01/2021 are likely to be severely lower

2) Even before covid, the company was on a downward profit trajectory

3) The big one - debt. I was relaxed about the debt previously, but this is much more of a problem now that covid has caused a likely collapse in profits, with the shops being forced to shut.

Online trading has been strong since lockdown.

Re-opening strategy - planning to re-open c.10% of stores c.15 June. This is interesting, and it supports my hunch that many retailers would only open their most profitable sites whilst the furlough scheme is still paying staff wages, and acts as a major incentive to retailers to keep their less profitable sites closed, an unintended consequence.

Liquidity - it says borrowing facilities are enough, but I suspect an equity fundraising is looking a near certainty now. Banks seem happy to plug the gap, especially when Govt guarantees are available. But banks don't like taking on risk, hence extended bank facilities tend to come with pressure to raise fresh equity.

My opinion - it doesn't interest me at all now, due to the stretched balance sheet, which is likely to look grim once all the covid shutdown losses have been factored in. Shareholders should be braced for heavy dilution from a future equity raise. If it ends up being a distressed raise (like the one from Ted Baker (LON:TED) yesterday), then that could destroy a lot of the remaining shareholder value. It seems safest to steer clear of CARD, in my opinion. Obviously that's just an opinion, which could turn out to be right or wrong.

---

A few quick comments before I head to the hammock;

Xaar (LON:XAR)

• Short term order book is healthy
• Outlook for H2 "remains uncertain" - so too early to assess impact of covid
• Confident on medium term strategy
• Liquidity - no details given, but says it has "an appropriate level of funding", and is well positioned

My opinion - I don't have enough information to form a view. This was a fabulously successful company in the past, but it seems to be seriously struggling to get back on track. Personally, I'd rather pay more, once/if there is clear evidence that it's getting back on track. Rather than taking a complete punt at this stage.

.

---

Zotefoams (LON:ZTF)

I've run out of time now, but just want to flag up an impressive-sounding update today from this speciality foams company.

It's picked up some PPE contracts, which give it a confident-sounding outlook.

This is a decent quality business in my view, so it's worth a closer look.

---

Gaming Realms (LON:GMR)

There's an impressive-sounding update today from this company today. Sorry I don't have time to research it in detail.

... the Board expects that EBITDA for the year ending 31 December 2020 will be significantly ahead of current market expectations.

We're not seeing many of those updates at the moment! Hence it looks worthy of a closer look.

---

That's me done for today. Thanks for tuning in, and contributing your comments. See you tomorrow!

Best wishes, Paul.