Small Cap Value Report (Tue 23 July 2019) - IDOX, TUNG, BKS, NXR

Good evening/morning, it's Paul here.

Let's start off with a couple of stragglers left over from Monday's RNS.

Idox (LON:IDOX)

Share price: 29.4p (down c.14% yesterday, at market close)
No. shares: 415.5m
Market cap: £122.2m

Half year report

IDOX plc (AIM: IDOX, "Idox", "the Company" or "the Group"), a leadingsupplier of specialist information management solutions and services, today announces its unaudited half year results for the six months ended 30 April 2019.

This software group seems to be permanently restructuring. The heavily loss-making digital division is now gone.

Forecast reductions - there's not a lot of point in analysing the interim results, as there seems to be an H2-weighting. So we cannot just double the interim profits, to arrive at an estimate for the full year. In this case it's easiest to rely on the house broker's forecast, updated today on Research Tree. This shows EBITDA reduced by 10%, and EPS by 20%, for the full year ending 10/2019.

The company likes to talk about EBITDA, but in my view that number is not reliable for valuation purposes, because the company looks set to capitalise costs of over £4m into intangibles (£2.2m in H1), which note 8 shows is mostly development costs - which in my view is ongoing payroll costs, which is part of running the business, so it cannot be ignored for valuation purposes. This is mitigated by a useful £832k tax credit last year.

Also, as it has material borrowings, we cannot ignore the interest charges either, another reason why EBITDA is not a good measure here.

There are lots of other things I don't like about these figures, so I'll keep this brief & move on;

Balance sheet - is too weak, making this share high risk, in my opinion.

Net debt - looks uncomfortably high to me, at £25.4m - bank facility expires in Feb 2020, so is classified as a current liability - which makes the current ratio look very bad. That won't be a problem if the bank facility is renewed, but it does reinforce the reality that this group is heavily dependent on the confidence of its lenders.

Going concern note - reinforces this point by emphasising that the group is reliant on renewal of its bank facilities, in 7 months' time.

Dividends - not being resumed at this stage, which is wise given the stretched balance sheet.

Accounting irregularities - sounds like some former staff fiddled the figures historically - on a smallish scale, but it doesn't inspire confidence in the financial controls.

Acquisition - currently assessing a bolt-on acquisition. Is that wise? It would need an equity raise to do this safely.

My opinion - as you've probably gathered, I'm steering well clear of this one. There are too many things that have gone wrong, combined with a really weak balance sheet (negative NTAV of £-41.4m), which makes this share uninvestable for me.

Risk:reward looks unfavourable. If problems were to arise with the bank facility, and if combined with weak H2 trading, then the risk is that shareholders could face an emergency fundraising. We've seen recently with Staffline (LON:STAF) (in which I hold a recently opened long position) that the price of an emergency equity fundraising can be ruinous for existing shareholders (and PIs often don't get access to emergency fundraisings, so can get diluted heavily).

Given that I don't know how likely the IDOX business is to turn around, and improve trading, nor the likelihood of it renewing bank facilities in a few months, then why would I want to risk it? Especially when we have so much macro uncertainty around. It strikes me as a complete punt at the moment, unless you know the business inside-out - which would enable you to make a more informed decision perhaps.

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Tungsten (LON:TUNG)

Share price: 52p (up 6% at market close yesterday)
No. shares: 126.1m
Market cap: £65.6m

Final results

From one struggling software company to another. This is an accounting software company, focused on eInvoicing, mainly for large companies. Its shares were a shooting star originally, with wildly exaggerated claims made by former boss, Edi Truell, which subsequently failed to be achieved.

• Results for FY 04/2019 don't look much good to me;
• Revenue growth of only 6.7% to £36.0m
• Operating loss of £5.2m (reduced from loss of £12.1m prior year)
• Cost-cutting has reduced operating expenses by 10% - a saving of £3.3m against last year. The overheads have looked top-heavy here for a long time, so progress has been made.
• Tungsten Network Finance to be divested (as previously announced on 30 April 2019), which said;

The Board has concluded that, whilst Trade Finance is an important service to be able to offer to our clients, its provision is non-core. Accordingly, Tungsten has appointed an M&A corporate finance firm to advise and handle this divestment. An information Memorandum will be finalised shortly and a list of interested parties has been prepared.

Balance sheet - it's no secret that Tungsten needs more cash. In the restructuring RNS of 30 April 2019, Directors even agree to having their remuneration more focused on deferred share, than cash. I like that - it shows decent commitment to turning around the company. But it also shows that the company is pretty near the last chance saloon.

Its balance sheet is dominated by nearly £121m in intangibles (mainly goodwill). Write off all of that, to be prudent, and NTAV goes negative, at £-4.5m - not good, but not a disaster either.

I spot an unusual liability called "contract liabilities" within current liabilities, of £6.8m. What is this? Note 1 explains that this is deferred income - i.e. where cash has been received up-front, but no services yet provided. Therefore the real cash position is actually worse than the net cash of £2.8m suggests.

Tungsten is clearly getting very close to running out of cash. Note 1 contains a going concern comment, saying that Directors believe it can continue trading without needing to draw down any more on bank facilities (which only seems to be £1m drawn at 30 Apr 2019). I don't know what the terms of the bank facility are - anyone considering a purchase of this share would need to find out this, as it could be critical to whether the group can survive or not.

I think another equity fundraising looks almost a certainty. That's not necessarily a disaster though - if the company can get investors excited enough (again) to pay around the current share price, then £6m-ish would only be 10% dilution, and would probably be enough to secure the company's future. The massive cash burning days are over now, so a modest placing should be do-able.

Capitalisation of development spend has been greatly reduced, from £7.2m last year, to £2.9m this year - a good sign, as the company has focused its activities more to reflect the reality that the coffers are nearly empty.

My opinion - the business model has considerably changed, and looks a lot more sensible now. Cash burn has been brought under control, and there's a much clearer focus. The product is used by lots of large companies, so it must be pretty good.

Overall then, despite the lamentable track record, I think there might be a chance of a turnaround working. If sales really start to take off, and it moves into genuine profitability, then the valuation could re-rate higher. How likely is that to happen? I have no idea!

At this stage then, this one is really just for punters. But I'll keep it on my radar, as something that might be potentially interesting in future. Also, I'd want to see a placing successfully completed before investing here, so that solvency is not an issue.

The chart looks a lot like many other companies - the indiscriminate sell-off in Q4 of last year, has now been recovered, now that the USA & other Govts have kept the cheap money taps running, and any idea of normalising interest rates seems to have disappeared again. Equity markets are clearly addicted to cheap money, maybe this is the new normal? It is for now, or at least until the banking system shakes itself to pieces again - which looks inevitable eventually, given the huge gearing that's building up all around us again.

Could TUNG attract interest from a Venture Capital, or Private Equity buyer? Actually, it wouldn't surprise me. The size & quality of its client relationships, and the potential acceleration in growth if more cash is thrown at the new strategy, might be of interest to one of the many well-funded VC/PE companies. I saw some astonishing stats today, and just how much spare cash these VC/PE companies have got, and they're paying some astonishing high, insane valuations, for growth/loss-making companies with a big idea. What could possibly go wrong?! But in this type of bull market, TUNG might attract some interest perhaps?

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Beeks Financial Cloud (LON:BKS)

Share price:  91p (up 17% today, at 12:22)
No. shares: 50.9m
Market cap: £46.3m

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

Tier 1 Client Wins & Trading Update

A cleverly worded RNS title there, by including the phrase "Tier 1" in the title, more people will click on it and read it!

Introduction - Beeks is a Glasgow-based IT company, which provides a connectivity service through the cloud, for financial organisations & traders. It's a very interesting little growth company, in my view. The company came about by accident! An ex-IBM man, the CEO Gordon McArthur had his own automated trading algorithms, but was frustrated by the latency between him, and the exchanges in e.g. America. So he persuaded several exchanges to let him put his server physically in the same room as theirs, thus cutting down the connection distance from thousands of miles, to a few feet. That way the automated algorithms had almost instant execution. Exchanges then passed on queries from other traders to McArthur, so he began allowing others onto his server, thus building a business which has grown into Beeks, and connects to over 100 different exchanges worldwide, allowing customers to pick & choose which ones they want to connect to, and with instant self-setup.

The videos from my friends at PI World are most informative, here.

Client wins - these don't sound particularly game-changing in terms of money (e.g. one is £500k over 2 years), but it does provide further evidence that the company's services appeal to large new clients. It's really all about future upside, at very high gross margins, just 

The other contract win is described as;

The global bank has contracted with Beeks' via a partner for the delivery of an initial proof of concept for a fixed income implementation. This proof of concept is revenue generating and is currently live with the bank. It is anticipated to be a pre-cursor to an extensive deployment with the client.

Trading update - this is for the year recently ended, on 30 June 2019.

The Board is pleased to confirm the Group traded in line with expectations for the year ended 30 June 2019 and looks forward to providing a further update at the time of the Final Results, to be released in late August.

If it's in line, why is the share price up 17% today? I think that's partly due to the contract wins making investor sentiment more bullish. But also because the share price has been drifting down for most of the last year. People inevitably then start to assume that trading must be weak.

Whereas actually, with illiquid micro caps like this, the share price can move all over the place, on very little volume. Hence the share price movements can often be considerably detached from the reality of how a company is trading. This is one aspect of micro cap investing that makes it considerably difficult, and indeed at times very frustrating.

Most of us find it dispiriting to have heavy paper losses. Yet the big multibaggers nearly always involve having to ride out significant losses along the way. This problem obviously doesn't affect the many social media punters who always seem to have miraculously sold at the top, and bought at the bottom, repeatedly!

Valuation - there's an update note on Research Tree today, leaving forecasts unchanged, at 2.9p underlying EPS for FY 06/2019. That puts it on a PER of just over 31 - a punchy rating you might say, but not when you consider that the company is producing strong organic growth.

Forecast EPS for FY 06/2020 is 4.0p, which if achieved would drop the PER to 22.8 - much more palatable. Given that FY 06/2020 is now the current financial year, and the outlook seems positive, then I think it's OK to use this as the valuation measure. Providing nothing goes wrong, then I think that valuation is justified.

Outlook comments sound upbeat:

 "We are pleased to announce a strong second half and successful outcome to the year, in which we delivered continued revenue and profit growth, while expanding our offering. 

"Beeks Financial Cloud is growing the services we can provide and therefore the variety of customers we can serve, as reflected by these exciting Tier 1 client wins.

We are seeing growing interest from financial services organisations in managed cloud computing and connectivity.

The resilience and scalability of our network, combined with our specialist financial services expertise, means we are increasingly well positioned to benefit from the growth of this market and we look to the future with confidence."

OK, the above is mostly generic positive stuff, but I feel there is good reason for management to be confident - e.g. positive results for 06/2019, growing markets, new customers, new services, high recurring revenues, high gross margin, and not much direct competition.

My opinion - it's been a bumpy road in terms of share price, but I'm pleased with the way the company is performing, and the current share price looks reasonable - neither cheap, nor expensive, the way I see it.

As with most of my micro cap investments, it's all about backing strong management. What's most impressive about Beeks, is that it created its own niche, and has historically done very little actually selling - customers sought it out. What does that tell you?! I see that as a remarkably strong position.

There's an argument that Beeks doesn't charge enough - its self-service cloud service seems remarkably cheap, if you look on its website. I see that as an opportunity - once it's bigger, there could be scope to increase charges, and hence dial up a much bigger profit.

In my view this share is too illiquid to try to time the ups & downs. It's more a buy & hold share, for say, the next 5 years. I reckon it could pay off nicely over that sort of timeframe, but only for investors who can tolerate stomach-churning volatility along the way.

I'll crunch the numbers in more detail, when results come out in late August. In particular, I want to check that it doesn't need more cash. The last interim results looked OK in that regard. The CEO has a huge personal shareholding, so we're in his hands. Those of us who met him at Mello were left very impressed. If micro cap investing is all about backing smart entrepreneurs, then this one fits the bill, I reckon.

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Norcros (LON:NXR)

Share price: 218p (up c.2% today, at 14:00)
No. shares: 80.4m
Market cap: £175.3m

Trading statement (AGM)

Norcros plc ("Norcros" or the "Group"), a market leading supplier of high quality and innovative bathroom and kitchen products, issues the following trading update covering the 13 week trading period to 30 June 2019...

The year end is 31 March, so today we're getting a Q1 update.

Graham published an excellent review of the FY 03/2019 results here, which I've just read to get me up to speed. To summarise - the group was trading well, and shares look very cheap on a PER basis. The reasons are: worries about exposure to South Africa, and the large pension scheme.

Today's update - it's in line;

The Group continues to win share in our two main markets with the Board's expectations for the full year remaining unchanged...

You can read the RNS yourself, if you're interested in the additional detail given about revenues.

Outlook comments - this sounds encouraging, given the wobbly macro backdrop;

"We have delivered a resilient first quarter performance against an uncertain economic and political environment, which is a testament to our leading market positions, our portfolio of well-established brands, the strength of our offer and our strong financial position.

The Board remains confident that the Group will continue to win market share and make progress in line with its expectations for the current year."

So, whatever they're doing, it seems to be working!

Valuation - Stockopedia sums it up well, as usual - a high quality business, that's dirt cheap (although I don't know whether the Stockopedia algorithms factor in pension deficits?)

My opinion - Graham mentioned in his last report that he's leaning towards seeing this share as under-priced. I agree. Management seems to be doing a good job in gradually growing the group through decent quality acquisitions, without stretching the bank borrowings too much.

The strategy is to grow the business, so that the pension scheme is diluted as a lesser issue, once the group is bigger. So far, it seems to be working.

I'm not sure what's likely to change here though? Every time the share tries to break out upwards, it seems to be stifled by stale bulls trying to exit.

The best thing might be if someone comes along and bids for Norcros. But who would want to take on that massive pension fund?

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I'm succumbing to the heat, as it's 28oC here inside my flat, so will have to park this until it's a bit cooler.

Regards, Paul.