Small Cap Value Report (Tue 22 Jan 2019) - CALL, ZOO, RIC

Good evening/morning, it's Paul here.

I'll start off doing a write-up of the Capital Markets Day which I attended last week, held by Cloudcall (LON:CALL)  (in which I hold a long position), hosted by its PR company.

Then we can move on to the usual review of Tuesday's results/trading updates on the RNS.

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~This section written on Monday evening ~

Cloudcall (LON:CALL)

Share price: 99p
No. shares: 24.2m
Market cap: £24.0m

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

Capital Markets Day & Trading update

I reported on the recent (15 Jan 2019) positive trading update here.

I'm a long-standing CALL shareholder (4-5 years, maybe? I can't remember exactly, as I invest in so many companies, and my interest can wax & wane during that sort of timescale, depending on the newsflow & financial results).

After years of decent top line growth, but rather disappointing overall performance (missed profit forecasts, and repeated fundraisings), I think there is now clear evidence that the company is coming good.

What does CloudCall do?

It's a SaaS software company, whose product is an add-on for CRM software. The add-on provides integrated cloud telephony (recorded phone calls, and SMS messages). The best example is for the recruitment sector, where every telephone call to & from candidates & clients is automatically recorded, with the audio then filed within the CRM system, for easy review & recall, and emailing audio to clients.

CALL's largest CRM partner is Bullhorn, a global recruitment sector CRM software provider. About a third of CALL's business comes from Bullhorn, and there is growing penetration of Bullhorn's customer base, internationally.

The service is relatively cheap (typically about £30-40 p.m., per user) and also provides cheap telephone call charges. There's no doubt the product is great (I have used it myself), and demand is strong. It's also fair to say that CALL has been learning how to sell its service, as it goes along. Its initial scatter gun approach to customer acquisition a few years ago, has since developed into a much more effective, structured process, through partner software companies.

Capital Markets Day

It started at 12:30 on 17 Jan 2019.  I was predictably 15 mins late, so stood at the back initially, which gave me a good opportunity to count human heads. There were 50 people in the audience, which was close to full capacity - an excellent turn-out. I would guess from their appearance, and that many dashed off early, that most were City fund managers, or analysts. There were also a handful of familiar, friendly faces - high net worth private investors that I often bump into at this type of event. So it was very well attended - there's clearly considerable interest in the company, given that it's only a £24m market cap.

Simon Cleaver, CEO

I like Simon a lot - he is always very enthusiastic, genuine, and clearly extremely passionate about the business. In the past though (and I've told him this directly, so it's not a snide remark), I've found some of his presentations to be almost incomprehensible - with complicated presentation slides, and the narrative flying off at tangents, leaving the audience somewhat confused as to what conclusion to take away.

This time however, it was a model of clarity. The new, simpler presentation slides made complete sense to a layman like me, and he explained them all very clearly.

The event was filmed, so will be available online shortly. A hyperlink to the video recording, when available, will be here. For this reason, I won't replicate everything here, but will just focus on what, to me, seemed the key points, as follows;

• Revenue growth is now accelerating, as promised previously, after overheads increased in H1 of 2018 (more sales & marketing, more product development)
• Product is getting better & better, they have added messaging and will shortly be able to automate a lot of menial functions - e.g. sending a reminder text to recruitment candidates before interviews (with a map), and a follow-up text thanking them for attending, etc. - clients love the product, and makes them more sticky for the partner CRM companies
• Monthly growth in user numbers - H1 2018: +580 users,  Q3 2018: +673 users, Q4: +775 users. The company needs to hit +1,000 new monthly users in 2019, to hit sales targets, then cash position will be fine. Very confident they can achieve this in 2019

Four pillars of growth

1. Bullhorn - which is CloudCall's largest CRM partner. Average customer has 27 users, so CALL needs 10 new customers per month, to achieve overall growth targets, "100% confident we can do this". Currently in negotiations with a number of potential new customers with >1,000 potential users each. Bigger deals could be transformational

2. Microsoft Dynamics - "This is a monster, this is huge". "Surprisingly little competition". "We could get 4,000 new users from this channel in 2019".

3. Additional CRM integrations - a particular opportunity in USA - where CALL is already doing well - new business wins in USA have already overtaken UK. CRMs are 5* size of UK companies.

4. Increased focus on USA - confident on 2019 forecasts.

Overall - any 1 of the above 4 pillars could achieve target numbers. So clearly the company sees scope to out-perform, if several pillars deliver what they hope to achieve.

A word of caution though! Simon is always very enthusiastic. Although I've been to lots of meetings with him over the years, and this is the first time that he's drilled down to specific sales opportunities. For that reason, I am minded to place more reliance on his bullishness this time.

Fireside chats & Q&A

This was quite innovative, and it worked very well, giving us third party evidence & opinions outside of CloudCall, with their partners. The tone was convincing too - these people came across as yes, friends of CloudCall, but talking about the relationship in their own words; 

Robert Pope, from Microsoft - spoke highly of CloudCall. Asked why Microsoft is happy to re-sell a third party product, he said it "helps fill in the gaps", thus improving Microsoft's overall CRM offerings.

Carlene Jackson, from Cloud 9 Insights (a partner reseller);

• CloudCall is an added value service to her clients, so she is happy to sell it - "CloudCall helps us close deals"
• CloudCall is a leading edge solution - speaks very highly of the product
• GDPR compliance is an important sales driver
• CloudCall has recently hired an "exceptional team, we have an exceptionally good relationship"

Peter Linas, from Bullhorn (CALL's biggest partner, they do 38% of business with Bullhorn) - this was a more broad-ranging talk, with Q&A. Key points I jotted down;

• In USA investors are happier for tech businesses to run at a loss, and expand fast. Less so in the UK, so UK companies like CloudCall are growth-restricted, which is a pity
• CloudCall hasn't got enough funding to expand as fast as it could/should
• Very high customer retention rates for Bullhorn customers who upgrade to using CloudCall - "We sell CloudCall because it makes our customers happy, which makes us money. It helps us retain our customers"
• "We think there's a lot more to come"
• Neat, simple, intergrated well, CloudCall is a great product

Clearly then, as we heard from the horse's head, these are 3 very credible, and very happy partners/resellers.

CFO presentation

A lot of this was fleshing out the trading update.

Key points;

"We are now exiting the phase of rapid opex growth.  This will now reduce to 6-8% p.a., whilst gross profit will be rising c.35% or more" - therefore, operating losses & cash burn should rapidly reduce

We have enough cash to reach breakeven - very good, but we've heard that before, and they did more placings!

SaaS statistics are very impressive. To summarise;

• User acquisition cost is £270, up-front
• Low rate of churn means each user has expected 8 year lifetime
• Lifetime customer support cost is £310
• Net lifetime income is £2,000
• Payback on CAC is just 8 months (very good!)
• Lifetime value divided by acquisition cost, is 7.4 - reckoned to be very good

Therefore the conclusion is that CALL should be maximising this opportunity, and increasing its sales & marketing functions considerably more. Therein lies the problem though - stock market investors want to see breakeven & profits, not interminable increases in S&M costs.

My opinion - this is by far the most bullish presentation I've ever attended from CloudCall. There is no doubt at all in my mind that the company is on the brink of considerable success.

However, management is clearly frustrated at having to restrict the growth in S&M spend, which would deliver outstanding longer term returns, due to pressure from investors to reach breakeven.

Why have a CMD day? We touched on this in the Q&A. It's pretty obvious that another equity fundraising is one of the options management is considering, but they don't want to issue new equity at the current bombed-out share price. The share price has fallen a lot, which does not reflect the great progress being made - it's just a wider stock market problem - practically all growth/tech stocks had a big correction in 2018.

Bank facility - I asked how secure the bank facility is (with Barclays), and that banks don't generally like lending to loss-making companies). Simon responded that the bank facility (currently unused) is secure, and that Barclays have a policy of targeting SaaS, recurring revenue businesses, if growing strongly. Their attitude is that, in extremis, CloudCall could switch off its heavy S&M spend, and run the recurring revenue for cash, thus paying off the bank debt at any time of its choosing.

I followed up with a question that, presumably the bank facility depends on revenue growth targets being achieved? The CFO replied yes that is true, but there is plenty of headroom on the target growth rates. They seem genuinely comfortable with the bank facility. Although I note that, in the past, the company actually did another placing, rather than dip into its bank facility.

My view overall, is that a top-up placing of maybe £2m-ish is a likelihood. However, I don't see that as being problematic, as it would be raised from a position of strength, with the share price now rising, on the back of an excellent recent trading update. Also, a top-up £2m placing is only 8% dilution, so what's the problem?

My opinion - these are the most important factors for me, and make this share look very cheap, in my opinion. So this is the bull case, as I see it;

• Excellent organic growth of 34% Y-on-Y
• High levels of recurring revenue - so almost complete visibility of future revenues
• Low churn - so revenues are very sticky (indicating happy customers)
• Very high gross margin of c.80% - amazing operational gearing, once it moves into profit
• Product which delivers proven benefits for customers, at a reasonable price (are CloudCall setting their pricing too low, one attendee asked? SMS messaging is now being sold as an extra service, for £20 pm, so should deliver good incremental revenues)
• Potentially accelerating growth rate, given the big pipeline opportunities outlined at this CMD
• Astonishing sale price of $350m achieved for sort-of-competitor, NewVoiceMedia - it's a UK company, so check out its accounts at Companies House, which I've done - it's massively loss-making. This valuation implies a ballpark valuation of maybe $100m for CloudCall, or something like 3-4 times CALL's current market cap

For the sake of balance, what is the bear case on CloudCall?

• Investor fatigue - the company has raised a lot more cash, and increased overheads more & earlier than planned. So people are understandably sceptical about the latest promises of a move towards breakeven in late 2019
• Chicken & egg on expansion - the company has a big opportunity, to raise S&M overheads, to drive faster growth. However, that would be seen negatively by the stock market. So management has a real quandary here. My preference would be for them to consider taking on a new, strategic investor, at a higher valuation - to inject fresh cash, whilst remaining stock market listed
• Some customers (especially bigger sales prospects) want a global offering - Asia, ANZ, and Brazil were mentioned as new territories that bigger customers are keen for CloudCall to expand into
• Fundraising - investors may be lukewarm about putting in additional equity. So the risk is that another placing might require a deep discount on price, in the worst case scenario
• I would be very disappointed if an opportunistic takeover bid happens, at a low premium, just at the point the CloudCall is about to take off. So my worry is that, having funded the losses for 5 years, shareholders like me could have the upside snatched away from us, on the cheap. We have to rely on management to reward our loyalty, with their loyalty.

Overall - make of it what you will. I reckon there's probably another equity fundraising in the pipeline, but a top-up of c.10% or less, is not a problem from my point of view. Indeed, I'd be happy to put in some cash myself again, if there's a discount to the current market price.

The CMD was a very useful update, and showed that CloudCall is clearly on the cusp of good things, in my opinion. Obviously, that's the reason for holding a CMD - but everything stacks up here in my view, on the balance of probabilities.

I would like to see a move towards breakeven. That may be the old-fashioned way of doing things, but it's a pretty good discipline - i.e. move into positive cashflow, then use that cashflow to drive further growth. That's a lot better than never-ending losses.

I particularly liked the glowing references from important third-party partners - you can't get a more credible reference than from Microsoft.

I'll keep an eye on things, and will probably be increasing my personal shareholding in this company as 2019 develops, depending on newsflow.

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Zoo Digital (LON:ZOO)

Share price: 62.7p (down 45% today, at 12:27)
No. shares: 74.4m
Market cap: £46.6m

Trading update - profit warning

ZOO Digital Group plc, the provider of cloud-based localisation and digital distribution services for the global entertainment industry, provides an update on current trading for the year ending 31 March 2019.

Zoo's services include subtitles, and foreign language dubbing for TV/films.

A nightmare day for holders of this high-flying growth stock - they're dropping like flies at the moment, aren't they?

This share had an amazing run in 2017/17, rising from its slumber in early 2017 when it was around 9-10p. I remember that well, as I sold mine at 11p, thinking it wasn't going anywhere. Then it soared to a peak of a staggering 172p in July 2018. Here we are today, with the price 64% down from the peak. I wonder if it's worth revisiting?

The market does seem to be over-reacting to bad news at the moment, creating some interesting buying opportunities - e.g. in my sector, both Superdry (LON:SDRY) and QUIZ (LON:QUIZ) (in which I hold a long position) have recently bounced around 50% from the lows - very lucrative, if you timed your entry well.

As you can see from the usual 2-year chart above, Zoo had a big correction in Sep/Oct 2018, but largely recovered from that. Unfortunately, it's turned out to be a precursor to a bigger plunge today.

Graham reported on Zoo's wobbly AGM statement here in late Sep 2018. He (correctly as it turns out) felt that the company's shares were way too expensive, at 134p back then. With hindsight, the disruption from a big customer, would have been a good trigger to sell up and move on.

What's gone wrong today?

Although trading in the second half began encouragingly with the previously-reported disruption to localisation revenues having normalised, together with the Group continuing to secure a number of appointments as a preferred vendor with major media companies, the second half performance has been affected by the loss of a single, material localisation project that was scheduled to begin and be completed during the period. This was due to reasons wholly unrelated to the Company.

Furthermore, revenues associated with processing legacy DVD and Blu-ray titles in the second half will be significantly lower than anticipated as the overall market decline in this area has accelerated more quickly than envisaged.

What's the financial impact? This is the revised guidance;

Accordingly, the Company now expects revenues for the second half to be comparable to those in the first half, and therefore to be approximately 10% below full year expectations.

The Group expects to be profitable and cash generative in the second half, but in view of the largely fixed cost base of the Group and the higher margin associated with DVD and Blu-ray processing, Adjusted EBITDA* for the full year will be significantly below expectations.

The Group expects to end the financial year with a cash balance broadly in line with that at the year ended 31 March 2018.

That's obviously disappointing, but it doesn't strike me as a disaster.

As the CEO comments, the profit warning is primarily down to one-off occurrences. So this could potentially fall within the fixable category of profit warnings?

Outlook comments sound upbeat;

We remain confident that the Company's strategy is correct and will enable us to capitalise on the long-term opportunity. We are now enjoying a growth in orders from our largest clients and expect to add significant new accounts during the remainder of the second half.

"With several major media companies recently announcing their intention to launch OTT services, there is no doubt that the market will continue to expand significantly and with it the growing demand for the premium services offered by ZOO. Our excitement for the future remains undiminished."

Revised forecasts - FinnCap has published an update note today. Its profit forecasts for FY 03/2019 have taken a huge hit;

Adj EBITDA down from $3.4m to only $1.0m

Adj diluted EPS forecast is down from 2.1p to -0.4p - it's not clear from the note whether these are in sterling, or in US cents. So I've assumed in sterling, which could be right or wrong, so best to check the figures yourselves.

FY2020 forecasts are left unchanged.

Last interim results - looking back, these were really not very good at all. The balance sheet is quite weak too, with some debt, and a strange creditor of $4.7m named "separable embedded derivative", so that would need looking into.

Cash generation has been poor historically too.

My opinion - I'm not seeing anything particularly appealing about this share, but as always, that's based on a fairly superficial review of the numbers.

Clearly, the share price got wildly ahead of reality last year, and today looks a painful correction. It's whether you see the glass half full, or half empty? This is a big earnings miss, so the growth rating applied to the share is now questionable. The company seems heavily dependent on key customers, and key projects, so visibility is not as good as I would like.

Looking at it glass half full, the problems seem one-off in nature, and the company is upbeat about the outlook. It seems to operate in an interesting & growing niche. I wonder what competitive moat there is for subtitles & dubbing services? It sounds quite low-tech to me. There must be numerous companies active in this space. Doing a google search does indeed throw up lots of competitors. Zoo appears on the first page, the 8th item down, and has an attention-grabbing strap line saying "Netflix preferred fulfillment partners" - which sounds great, but could make Zoo vulnerable if Netflix were to change its supplier.

If I already owned this share, I'd probably be inclined to sit tight, and maybe buy some more if it carries on falling. As an outside observer, I'm not inclined to get involved. My commiserations to shareholders - I think quite a lot of my friends hold this one, sadly.

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Richoux

Shares in this tiddler are in freefall at the moment, because it has decided to de-list.

It's worth reviewing our portfolios for tiny, loss-making, cash-strapped companies. The end game for that type of company is usually a de-listing. That tends to instantly wipe at least 50% off the share price, and often it can be nigh-on impossible to sell in any size.