Small Cap Value Report (Tue 21 August 2018) - HSW, VLTY, TRCS, ANG, GMD

In reply to post #392414

re: Tracsis (LON:TRCS). Thanks for the insights! G

In reply to post #392399

Many thanks Graham,

I haven't read security analysis by Ben Graham but will get hold of a copy!

Richard

On the topic of GAME Digital (LON:GMD) BELONG utilisation rates, I have some numbers from my notes:

1. 2016/17 Q4 = 21.30% (min contribution per venue at the time was £100k)
2. 2017/18 end of H2 = 28,50%

I too thought that these seemed low and on the odd occasion that I've randomly checked the belong.gg booking form, they seem to have a lot of availability, which initially worried me. However, Belong continues to throw out positive contribution figures (and improving metrics according to today's release), so presumably people just turn up rather than booking.

Also of note, I follow a few of the Game/Belong twitter feeds and occasionally see a kid's party, which is a market I never thought of.

My BIG worry with Belong is the advent of 5G and internet speeds so fast that one doesn't need to leave home to play.

I hold and will continue to do so. As Paul said, the retail business is thrown in for free (perhaps even with bottom-line profit after mass rent reductions are factored in from this year), with significant potential for growth coming from Belong.

Thanks for the very interesting views yesterday P&G. Wot no placeholder today? Wanted to request Koovs (LON:KOOV) - still a steaming crock or a potential turnaround situation? Depends if the dilution from today's concluded 4-year shares-for-ads media deal is priced in yet.

Hi Graham

I’d be interested to hear your views on Headlam (LON:HEAD) I hold.

You weren’t so keen on growth through acquisition when you covered them in July. Today they note an improvement in margins being helped in part by their acquisitions.

Do you see that as material?

Thanks

Jon

Not sure if there is much interest remaining in Laura Ashley Holdings (LON:ALY) but came out this morning with mixed results announcement and news of the expected disposal of their Singapore trophy property/white elephant depending on your point of view. Trading results are not great in line with much of the retail market although they make a good fist of talking up their on line business.

Focusing on the property disposal, this has been sold for just over £30m representing a loss of about £1m on original acquisition cost (about £4m against carried book value) before costs with proceeds being used to reduce debt by about £20m and the rest being retained. Looking back at the original acquisition in 2015, they indicated the expected running cost of funding the property through debt which suggests the exercise has cost them perhaps a further £5m (plus the opportunity cost of tying up about £9m of their own cash in the interim). Not the best use of shareholder funds in hindsight.

https://www.stockopedia.com/share-prices/laura-ashley-holdings-LON:ALY/news/ashley-laura-hldgs-acquisition-of-property-in-singapore-urn:newsml:reuters.com:20150630:nRSd6423Ra/

Interesting brand maybe, but hard to make a case for it as a viable investment under its current dominant single shareholder ownership/management.

Gus.

In reply to post #392354

I agree, it’s either crazy or part of some deal they have struck with retailers to keep visibility of their products in the high streets,but how long for ? Occasionally they have sales that are quite good value, media has advantages for sure, resale, you can lend it or take it to a friends house, how hard would this be to implement ? Reselling games on an online market like amazon sells used stuff? And you take a cut? There are also advantages to no media, like on a phone where if your phone dies you get a new one and it re installs your apps without you doing anything. Many games like mine craft if you bought digitally on ps3 is free on PS4, but the biggest advantage is no clutter and you can just play no need to hunt around for the box amongst piles of boxes only to find the disk isn’t in the box etc

GAME Digital (LON:GMD)

So if that was a profits warning it was indeed quite a mild one; the overall revenue progress was better than I had expected in the context of the poor UK retail environment.

However, the kicker is that too many of the sales have been of lower margin digital and hardware, whereas there has been "continued challenges in the Preowned business that have impacted on the overall gross profit rate."  I would worry that may be in part be related to the successful roll out of Nintendo Switch. If less people than expected are playing the older consoles, then the carrying value of Games' pre-owned games assets may need to be written down.

It seems to me that a significant part of the 12% rise yesterday can possibly be put down to people once again mis-reading the balance sheet.

The idea that there is a negative enterprise value here and that the business is "in for free" has again raised its head across the bulletin boards.

The argument goes that if the company were not investing for growth (BELONG) then the business could distribute the cash-pile to shareholders, leaving them owning the business for free.

 There are two things that point to this not being the case.

1. A couple of years ago, the company did indulge in a significant cash return to shareholders, stating their aim to return surplus cash to shareholders (this was before the potential BELONG investment was fully recognised) - you only need to look back then to how much cash they kept on the balance sheet to understand how much of this cash is NOT surplus.

2. If one looks at the working capital, going back to the latest (end January) figures, we see :

Net Cash : £84.0m

Inventories : £89.8m

Trade receivables :  £4.0m

Trade Payables : -£136.2m

You can see that, more than all of the net cash is committed to paying their suppliers for good already delivered. There is no apparent surplus cash to be returned to shareholders. In fact if the company were to do a return to shareholders, it would seem to me that it would have to be denominated in second hand copies of Super Mario Bros rather than pounds sterling.

Don't get me wrong, been able to run your business on negative working capital (i.e. having your suppliers fund the business) is a great place to be and the net cash gives an impressive buffer also, but I just think people are getting carried away with the size of this net cash.

As Paul rightly says the opportunities here are (I) the short leases providing the opportunity to exit insufficiently profitable stores and/or improve terms and (2) the experiential BELONG concept.

These certainly keep me interested, but the latter is to a degree still blue sky and whilst the update on BELONG is positive, it shares the same characteristics as other blue sky reports - focus on "progress" and nothing material on what profits they generate.

For all of that, I do think GAME Digital (LON:GMD) could be a good investment, but I cannot see through yesterdays reaction being somewhat irrational, so I will sit and wait a while yet.

In reply to post #392354

Re point 2 - I have no real view for or against this argument but I was chatting about it with my personal trainer as we had recently visited the new local VR venue, just to see what it was all about, etc. - And although the novelty wears off quite quickly it was well worth seeing how advanced, but still far behind things are.

Anyway, re: point 2 - We likened it to the gym in some way in that most people (who want to exercise) can do most of what they do at the gym at home, in the spare room, in the garage perhaps, or even outdoors BUT loads of people visit a gym, quite often in some cases. Some cases for this can be the need to be in a specific place dedicated to the purpose, inspiration, the social aspect, the need to be away from the home.

I personally hate outdoor loner stuff like running and cycling but love team sports like 5-a-side. I also enjoy the gym, the surroundings, the get away from things for a couple of hours aspect. I suspect those dedicated to gaming can see the benefits of playing with better players, being with mates instead of being in a spare room on their own or being bothered by those in the house, etc.

As I say I have no real view here but I can see the reasoning and potential - Those who enjoy a certain thing in life have dedicated places just for them, gyms, cinemas, casinos, whatever - So, why not for those who enjoy gaming?

Just my thoughts on it.

In reply to post #392334

Hi Paul,

Interesting write up, thanks for sharing!

Regarding this point:
"Online businesses which are growing strongly tend to be valued at 2-3 times revenues. That would imply a market cap here of £80-150m. Therefore the current market cap of £40m leaves good potential upside."

Are you not being too generous applying this multiple to the entire revenue base, even though only around half is from online? If you took the online part, say 23m, at 2-3x you arrive at 46 - 69m. Then you'd need to add a value for the offline business, presumably at a much lower multiple.

In reply to post #392574

Gromley,

GAME Digital (LON:GMD) - If asked yesterday I would have said I hold mostly due to the negative enterprise value. Therefore your comment led me to double check my assumptions.

Looking at my own notes from when I bought in Feburary I was surprised to find no reference to cash balances / enterprise value and instead a note that it was trading below NTAV. Checking the latest figures (released after that, in March), I find:

Net assets: £117.1m
Intangibles: £31.0m

This means that TNAV (which of course includes trade payables) is £86.1m and so not materially different from net cash of £84.1m and compares with market cap of £58m after today's rise. So, especially given that the cashflow characteristics that seems to support the view that the business is "for free" even taking into account trade payables.

Then I read your comment more carefully to see if I was missing the point and found two things:

Firstly the trade receivables you quote are after 1 year and exclude another £32.7m of current receivables. I can see the argument for excluding non-current receivables when looking at free cash - did you just quote the wrong one?

Secondly and most importantly I thought again about your joke that any cash return would have to be denominated in second hand copies of Super Mario Bros. Inventories account for more than all of the TNAV and so their current value is absolutely critical: How likely are they to be written down? How old is this stock and how current are the valuations? How much can be returned to suppliers? For second hand and other stock that cannot be returned, how much less would it be worth if quickly liquidated?

My particular concern is that some inventory would be worth significantly less without a large chain of shops to sell it through which means GAME Digital (LON:GMD) cannot just liquidate itself without taking a hit. Until the business stabilises or BELONG takes off I can see that this is a cause for uncertainty.

Graham

Stockopedia have been covering Tracsis for a many years, Paul Scott knows our business reasonably well and we have plenty of shareholders who subscribe to your site.  Indeed I am a fan of the site given it's commitment to objective, well reasoned analysis of public companies.

However, I have to confess to being surprised and disappointed by your coverage yesterday. Your opening statement was ‘I'm not overly familiar with this company's operations’ but after a very short summary of a (positive) trading update you go on to conclude by saying ‘Personally, this doesn't feel like a sector where I'd be interested to pay such a high rating for any company’.  Without bothering to give any explanation whatsoever!

I couldn’t help wonder what ‘sector’ you think we operate in, why and how you think our rating is ‘high’ and perhaps give some examples of our performance in relation to other AIM software companies (i.e. those that do interest you).

Regards

John McArthur
CEO, Tracsis Plc.

In reply to post #392714

John,

I'm not Graham, but I happened to see your comment so I'll give my separate opinion. You asked:

...what ‘sector’ you think we operate in...?

Well, from the Profile Summary on Stockopedia:

Tracsis plc is a holding company. The Company is engaged in the business of software development and consultancy for the rail industry.

So Tracsis (LON:TRCS) appear at first sight to be primarily a software consultancy. These fall into the category of "people businesses" where the value is fundamentally created by the individual workers rather than from invested capital. It can be difficult for the company itself to add value in these circumstances because workers can easily move to a competitor and add their value there instead. Some "people businesses" have traditionally been owned by their workers for this reason (e.g. law firms, GP practices). These arguments will be very familiar to regular readers of this column.

Emphasising any ownership of software products that can be sold to multiple customers, preferably with recurring revenue streams and with low maintenance costs would make the business sound a lot better to me.

Secondly the (quasi-)public sector in general and rail industry in particular is a concern to many due to the history of underbidding and problems with contracts. It is very difficult for an investor to judge whether a lack of problems is down to luck or skill.

You also asked:

why and how you think our rating is ‘high’ ..?

Stockopedia today have you on a forward PE of 28.

Compare this to a software company that doesn't do consultancy but rather owns a products sold to many customers with recurring revenues. Dillistone (LON:DSG) - PE 12

And a people business (that admittedly has debt but which is covered by insured receivables): Gattaca (LON:GATC) - PE 5.7.

Of course, valuation isn't everything, but on the face of it Tracsis (LON:TRCS) 's appears to be high for this type of business.

None of this precludes Tracsis (LON:TRCS) from being an excellent business that is fairly priced, it is just that I have to agree it isn't immediately obvious.

Hi John

There seems a small pool for market commentators on Tracsis. I guess not all of them have similar 'love' for the stock or the sector, and that inevitably colours enthusiasm.

Whilst I have always treated Company paid for research with a bit of caution, with MiFid there is less information out there than there used to be, and this increasingly justifies in my view taking this route to promote knowledge and discussion. Edison are reasonably respected, so why not give them a try, and the pool of dessimination may be greater.

In reply to post #392694

You and Gromley are probably correct that a fire sale of assets GAME Digital (LON:GMD) would almost certainly require write downs of inventories below their carrying value, but I think that's a bit of a red herring.

Rather than just shutting up shop in a sudden liquidation or administration-type situation and returning any surplus cash (if any) to shareholders, isn't the game plan (excuse the pun) to wind down the retail business in an orderly fashion in line with the expiry of shop leases, whilst winding up the BELONG franchises? (in the UK at least; Spanish retail seems to be doing OK for the time being).

An orderly wind down of the retail business would surely not require heavy write downs on all £90m of the stock. It's also worth noting that none of the stock is carried at net realisable value, it's all valued at the (lower) cost price, and the £90m of stock is carried net of a £5.9m stock provision, so that provides a cushion to sell some of the stock at a discount without incurring a loss.

Granted there are uncertainties and significant judgements involved in valuing the stock's net realisable value (as the annual report makes clear in several places), but for me the cash and related facilities together with the low price to book are of interest not so much for their liquidation value but for the cushion and liquid resources they provide whilst the group is in transition from a legacy retail business to a new experiential focused business which is promising but as yet unproven at scale.

In reply to post #392729

leoleo73

With respect I'm not sure you understand much about Tracsis or our operations.

We are not a 'software consultancy' business but simply a technology business in its purest sense i.e. we are first and foremost a software company that develops and licenses over a dozen software products which we own all the IP for. We were originally a spin out from the University of Leeds School of Computing and employ over 100 full time professional software developers who generally have very strong maths/physics or engineering backgrounds. Latterly we have also developed our own hardware and now also do a variety of data capture work using all sorts of novel technologies.

I understand the point you are trying to make about consultancy businesses and 'people businesses' but this simply isn't the case with Tracsis. The vast majority of our profit is derived from long term, software licensing contracts with blue chip customers and less than 10% of our income is consultancy. The consultancy we do undertake is highly specialised and is generally derived from doing bespoke projects by using our own products which will be similar to all software companies.

I won't comment on PE other than to say this is meaningless statistic without context. Comparing our PE with Dillistone is fine but surely you need to consider our trajectory - 11 years of consistent double digit growth - whereas Dillistone appear to fairly static.

Best regards
John

In reply to post #392754

Trident

Being candid we have no need for enthusiastic market commentary and are happy to simply let our numbers and results do the talking. The only reason I post on Stockopedia from time to time is that I like the forum and would prefer to correct obvious errors or misunderstandings.

FYI - with regards MiFid we moved from Investec to finnCap partly to ensure our research is more freely available to all parties but I completely agree that company sponsored research will always be prone to potential bias and spin.

For this reason Tracsis will never spend a penny of shareholder money with Edison and we would far sooner openly engage with interested shareholders so that they can find out about our business first hand.

Best regards
John

In reply to post #392694

Good spot Leo - you are quite right I should have quoted the current receivables of £32.7m rather than the non-current figure of £4m.

This though still leaves the current net payables at more than £100m so more than consuming all of the net cash (even allowing for the fact that a portion of the 'payables' are in fact customer prepayments by way of gift cards and loyalty credits then the unencumbered  is still probably slightly negative or at best a single digit figure in millions).

So I'd still stand by the view (as you demonstrate) that the excess value in the balance sheet is really stock rather than cash. Whichever way you look at it, it is a very healthy balance sheet, however with all of it effectively deployed towards running the business, I just don't personally hold by the view that anything is in there 'for free'.

As to the inventory valuation; it was just conjecture (logical conjecture I would argue) that write-downs may be needed on the pre-owned inventory. I cannot now find any indication of what proportion of inventory is pre-owned (I had a view of what it was, but cannot find the evidence) so I cannot really put a value around that risk. We'll have to wait to November to get that view.

I'm happy to wait.

Niche markets (for anything that fits in standard traceable parcels) are the target of Amazon Marketplace, where the stock of slow moving items is kept by mom&pop stores, not Amazon itself. In aggregate it makes an offering that’s hard for a vertical retailer to compete with.

In reply to post #392369

The Little Book That Beats the Market by Joel Greenblatt and his 'magic formula'.

Its very short and concise. Don't make it your gospel. I believe it was written in the 90s and so the successful style probably benefited from tailwinds relating to the period - tendency to rising market with a backdrop of secularly reducing interest rates, increasing credit and liquidity, and the financialisation of the management of companies so as to focus very exclusively on returns to shareholders over all other stakeholders (and longer term investment).

Today I perceive the magic formula to have some headwinds due to changing market. One is a bifurcation in returns and valuation for high margin online and low capital intensity tech businesses versus 'offline' more tradational businesses and high capital intensity tech. I think the new bread of stock throws the magic formula a bit of a wobble as it tends to get stuck in relatively high margin and growth businesses that have just peaked out. Often these are companies that have a relatively small addressable market and so peak out brings radical change and high margins tend to decline anyway.

But, its a reaally good and simple base to think about things from. Used well it will stop you chasing value traps or dream stocks.....now special sits and high growth are great if you can get them but that is a different skill set