Small Cap Value Report (Tue 27 March 2018) - GMD, DPP, BILN, SUS, OPM, APH, SSY

27th Mar '18 by Graham Neary

47 comments 16080 reads

Good morning!

Once again, there is no shortage of news today.

I will choose some of these to write about (editing this list as the day goes along):

Alliance Pharma (LON:APH)
Billington Holdings (LON:BILN)
DP Poland (LON:DPP)
GAME Digital (LON:GMD)
1pm (LON:OPM)
SCISYS (LON:SSY)
S&U (LON:SUS)

GAME Digital (LON:GMD)

Share price: 24.5p (+2%)
No. of shares: 173 million
Market cap: £42 million

Interim Results

Disclosure: I own shares in Game Digital.

Many of you will be familiar with this high street games and video console retailer, operating in the UK and Spain. It has appeared regularly in this report over the last year.

And what a volatile period it has been for shareholders. The share price bottomed out at 19p last year, rallied to over 60p in December, and is now 24p.

It's Cheap!

When I covered it last, I rather pessimistically said that the shares might represent "value" if they were priced at a discount to tangible book value. My rationale was that resources would be needed to pay for the next wave of store closures, and that future profitability was highly uncertain. So to compensate for this, a discount to tangible book value is what I'd be looking for.

We are there now. According to today's results, tangible book was sitting at £86 million at the end of January, i.e. more than double the current market cap.

Within this, the balance sheet is dominated by £85 million of cash.

On top of the cash pile, the company has undrawn banking facilities of up to £75 million, which can be extended by £25 million during peak season.

It also has a Spanish working capital facility and a £55 million borrowing facility from its major shareholder and partner, Sports Direct (LON:SPD).

In other words, this is now a company with very deep pockets. I reckon that its total spending power in cash and undrawn borrowing is in the order of a quarter of a billion pounds, more than 6x its current market cap.…

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Gromley

27th Mar '18

GAME Digital (LON:GMD) has been on my watch-list since the summer when I sold, for a tidy profit, realising that I had bought to soon in terms of my personal view of the retail landscape.

The price ‘got away from me’ once back in December when the price rose from 40p to 60p (on the back of an SCSW tip I believe). With a 25% rise today, yet still above the 40p where I thought it might have been settling, maybe it is getting away from me again. Am I a tempted buyer now?

Not really, I thought the near term outlook was more negative than I had expected; irrespective of retail spending headwinds (which may be on the verge of abating) they threw in some industry specific headwinds too. (Although I read elsewhere recently that the ‘gaming’ sector is actually doing well.) So if I wasn’t a buyer yesterday, I’m not today when I consider the value potentially reduced but the price increased.
Nevertheless, there is every chance I will be a buyer sometime in the next year or so, maybe at a higher price, maybe lower, but hopefully with a clearer view of the “outer”.

Graham makes some very good points and there has been a good review by Paul in the past, but here FWIW is my quick pen picture.

GAME Digital (LON:GMD) is a loss making retailer operating at a difficult time for retail as a whole, but it has three key attractions to me (other than the general reversion to mean value enjoyed by those that manage to survive).

1. Very short store leases, providing the potential to significantly reduce the cost base and exit loss making stores (of which I’m sure a read a while back there are not many). This also supports attraction 2.
2. A potentially transformative, experiential, business addon in the form of BELONG gaming arenas. Much of £GMD’s existing estate is probably not suitable for conversion, but those short leases together with a partnership deal recently signed with Sports Direct gives the opportunity to move target venues to better suited premises.
3. A significant discount to TNAV, with almost all of that represented by cash on the balance sheet.

I have however a healthy degree of scepticism about the value of these attractions.

1. Certainly there is scope to transform the cost base during lease renewals, as Graham points out they told us today of “the delivery of further operational efficiencies and cost savings of c.£5 million” . Indeed, but at the same time PBT fell by £4.2m. These are “staying alive” cost savings rather than drivers of improvement at the moment. This is reinforced in the outlook where after explaining reasons not to be cheerful they told us “even greater priority has been placed on efficiency and cost saving actions that the directors believe will largely offset this impact.”
To be clear, I actually think for a retailer at this stage to have a clear staying alive plan is no bad thing, but there is not transformational profit growth yet.

2. BELONG certainly seems to be very big plus (there was much more detail in previous discussions on GAME). However, they recently signed an odd partnership with Sports Direct giving SD 50% of the BELONG profits and 50% of the BELONG IP (but reading between the lines not 50% of the risk). All this for the princely sum of £3m, plus loans (at commercial rates) and the opportunity to host BELONG/Game stores in mutually agreed SPD premises. It is hard (and I cannot do it) to avoid the view that Game shareholders have been significantly diluted in terms of this opportunity. However, I take the view that BELONG is potentially big enough in impact that even an ‘unfairly small’ share is a big plus. I also suspect that the management may have concluded that they couldn’t actually deliver the BELONG project without a deal like this.

3. NTAV of £86m of which cash £85m. Fantastic – or is it?

I’ve argued in the past that the H1 cash position is very seasonally flattered, but even the position at the end of H2 is not too shabby at £47m. There was still circumstantial evidence that even that figure was unrepresentatively high. Now though the company have given the missing piece of evidence (it may have been there before, but I missed it). Discussing the available debt facilities the company refers to :

>>> Long-term asset-backed revolving loan facility in the UK of up to £50 million, increasing to up to £75 million over the peak season

>>> New two-year facilities signed in Spain on 19 January 2018 for €28 million and increasing to €44 million over the peak season

Aha, so even if we assume the “core” debt facilities are to invest in growth or some such, this still suggests that despite the massive cash surplus, in the “peak season” there is a need to borrow up to nearly £40m.

We can get an alternative demonstration of the same thing by looking at an alternative presentation of the balance sheet (hopefully the formatting works) :

£m
“Non-cash related”
Property, Plant, Equip 15.8
Def & Cur tax assets    1.1
Def & Cur tax liabilities    -2.4
Leasehold incentives -1.9
Inventories 89.8
Net Non cash related 103.4

“Cash related”
Non-Curr receivables    4.0
Curr receivables    32.7
Cash    84.9
Payables -136.2
Borrowings    -2.7
Net Cash Related -17.3

Total TNAV 86.1
Intangibles 31.0
Total NAV 117.1

So it seems to me that if you dissolve the business, rather than ending up with a pot of cash to distribute to shareholders, you end up with £90m of new and used consoles and games & £16m of shop-fittings (neither realisable for par) to satisfy £17m of creditors.

Nobody Is talking about liquidating the business of course, but that is the logical conclusion of too much balance sheet analysis.

So whilst I do agree with Graham that GAME Digital (LON:GMD) has comparatively deep pockets, they need to be very careful on how they spend, given that they would be increasingly their peak requirements for debt, just for “staying alive”.

Anyway, despite question some of the ‘gloss’ here, I do actually think there is significant potential value here from all three of the attractions, I just think it is easy to overstate.
I also don’t understand what caused the big upside today – all of the ‘good points’ mentioned were already know, whereas, to me at least, the outlook was disappointing.

This time the price might permanently “get away from me” but I’ll no longer beat myself up over such things, I’ve been practising my gallic shrug (il y a d'autres poissons dans la mer). Just as likely though imho is a return to the gloom and boredom.

I’ve been doing pretty well at not buying things recently, it can’t possibly last!

Edward John Canham

Broker issued a positive buy note on Plus500 (LON:PLUS) . Also expected downgrades on IG Group (LON:IGG) of 10%.

Decided to go back into Plus500 (LON:PLUS) due to its metrics/SR and the removal of one item of uncertainty.

Phil

peterthegreat

Re: matylda's comments on DP Poland.
I think most markets, including the US, where Dominos Pizza companies/franchises operate are full of competitors and have good quality frozen pizzas but the company is still able to operate reasonably successfully in these markets and I hope Poland will be no different. As for the low quality of the pizzas, I would conclude that those you have bought in Poland must be made differently to those in other markets so I would hope that DP Poland can bring up the quality to match DP franchises in other territories. With sales of the inferior pizzas in Poland continuing to increase, I would hope this would have significant impact. I think my main hope is that the company will soon be able to demonstrate that selling its pizzas in Poland is a fundamentally profitable business model.

woodlandantics

davidjhill and matylda

I am another holder of SCISYS (LON:SSY) and very pleased with todays results. Currently undervalued, probably as its such a small company but good long term growth prospects IMHO,

cheers

rmillaree

SCISYS (LON:SSY)

"Feels like this should trade at 160p+ to me."

I am guessing there is the dangerous lumpy contracts issue here that deserves some discount perhaps? - it's less than 3 years ago when this same company last came out with a profit warning over a problem contract and soon after they were in the position where they technically looked like failing their banking covenants.

Do holders feel this is a less risky company now in this regard than it was?

Graham Neary

Hi Andrew, re: Alliance Pharma (LON:APH). I've looked into this for you. G

davidjhill

Massively so in my opinion.

They are far more diversified both divisionally and client wise. They should be more or less debt free end of this financial year with plenty of headroom and have an order book visibility of almost 2 years.

Howard Marx

JMLDutch

I would also be concerned about digital disruption if the company had long leases on it's retail stores. But as Graham mentioned, they are all short leases:

Basically the company can liquidate it's retail footprint if demand for it's products falls off.

In the meantime the Net Current Asset Value (Current Assets less Total Liabilities) is 38p/share.

Basically there appears to be asymmetrical upside risk.

Hi Aislabie, I'm afraid I don't have the time to cover Orchard today. I thought it was a nice little company but probably fully priced the last time I looked at it in this report. I don't know what the minimum requirement is for a banking license but doesn't it seem a little bit ambitious to go for it, with just £13.5 million in equity? PCF had £25 million in equity around the time it received its banking license, and had to raise an extra £10 million with the following rationale:

The net proceeds for the Placing will allow the Group to maintain the level of regulatory capital and liquidity the Group is required to hold as agreed with the PRA and FCA pursuant to the Group's authorisation on 6 December 2016 for a banking licence.

Orchard's new Chairman is the former CEO of Secure Trust Bank (LON:STB), so presumably they have a plan. For now, their balance sheet looks too small to me.

Hi clarea, bit of a busy day today so I'm not going to get around to Moss Bros (LON:MOSB), sorry.

Paul did cover it in a lot of detail last week, so in case you or anybody else missed it, here is the link:

https://www.stockopedia.com/content/small-cap-value-report-wed-21-mar-2018-mosb-aiea-lpa-cpr-mtc-342638/

JonBirdy

Hi Graham

Many thanks for your insightful coverage of GAME Digital (LON:GMD) and Alliance Pharma (LON:APH) I hold both. I thought it a happy conincidence you covered them both almost exactly a year ago ;)

As a new investor, short explanations about things like the Earning Manipulation Risk are really helpful.

Jon

Richard Goodwin

Re Director non-buying at GAME Digital (LON:GMD)

If I was a director I don't know whether I would invest whatever the investment merits.
Many years ago, when it was a quoted company I worked for British Steel. The share price collapsed down to 4p. I bought a very few at 6p and felt myself clever when the share price rose massively. The reasons I didn't buy more were: 1. my salary was already tied up in the business 2. my wife's salary was tied to the business 3. We both had DB pension tied to the business.
So although it appeared to me the shares might be a bargain I had very limited diversification and too much too lose to want to invest further funds.
Market falls of this scale shake everyone's confidence including the Board ("maybe someone knows something that I don't, look at Accrol").
I presume the same applies to many directors of quoted companies. I'm sure however that if the share price does well then directors will find other, lower risk ways to capture some of the upside...

herbie47

GAME Digital (LON:GMD), the last directors share buys were in 2015 when they bought around 200p, 2 months before a profit warning, maybe they don't want to risk any more money.

Andrew Brien

Alliance Pharma (LON:APH)

Many thanks Graham.

DJCP

Re GAME Digital (LON:GMD) expiring leases.

There's approx. 200 weekdays until 31/12/18, so they're working on sorting out more than 1 lease per day (although the 233 figure might have already reduced since being published).

I've no idea on the work/costs involved in renewing/ceasing each of these existing leases, but if the landlords also know of the number expiring this calendar year, they may assume GAME Digital (LON:GMD) could be pressured into signing quickly, as opposed to discussing a better deal. How much longer would it take them to find alternative premises in a particular area, with all the extra relocation costs and delays too? Maybe the landlords will do the opposite if there are local Sports Direct shops, knowing GAME Digital (LON:GMD) could move into those, and offer better terms.

Perhaps all the above is total irrelevant to those in the know on retailery stuff ;^) but it's been playing on my mind, and with the share overhang, is why I've not re-invested here, ... so far.

p.s. I did purchase an Xbox game for a friend a few weeks ago, and the very helpful Game staff member, noting my blank/confused expression when answering my questions, also didn't laugh when I pointed out the last console games I played for any length were Space Invaders and Pac Man (the original ones !)

Steves cups

Thanks Graham for the note on SCISYS (LON:SSY).
First thoughts were positive until I noted the slim margin and the exceptional profit of £1.6m due to reassessing the Annova earnout which puts a different complexion on the results. There seems also to be a seemingly easy way of confusing operating profit and profit before tax.
Not for me

Steve

clarea

No worries Graham just appreciate the pearls you and the other half of the dynamic duo Paul share with the rest of us long may it continue.

Cisk

Surprised no-one has mentioned the elephant in the room with GAME Digital (LON:GMD) - Mike Ashely (and Sports Direct). For me, it makes it uninvestable, not doubting the man's abilities but his corporate governance. I remember the deal being announced with Sports Direct a while back - if GAME Digital (LON:GMD) are so flush with cash, why do this deal anyway?

Suspect the market is moving towards e-sports and downloading everything, less and less will buy from bricks and mortar, so I guess if GAME Digital (LON:GMD) can get rock-bottom leases then it might be worth it, but still remember the Ashley factor.

28th Mar '18

You are missing that in the revenue numbers there is £8.8m of non-margin pass through numbers (these mainly fall away under IFRS15). So 15% of reported revenue at 0% margin as a pass through. This underestimates the actual margin the company makes so you need to add that back.

Given the acquisition there are indeed a number of amortisation/depreciation items and adjustments to the Annova earnout but what is more important as a measure of SCISYS (LON:SSY) for me is FCF. This years number is artificially high for various reasons so I discount that, but on any given normal year they are circa the 95% of ebitda number and 80% of Op Profit excluding tax (ie including Capex & interest).

Therefore my expected EPS of 14p in 2019 should also be backed by an equiv. FCF number less tax.
I also think there is material upside to those numbers as the business is in growth mode.

john652

Hi Richard,

I can understand why you only bought a limited amount of shares as you had 2 salaries and your pension in British steel, but.... you still did buy, and you were not running the company. One director not buying, sure, personal reasons, not a single purchase from the whole board is very odd if you ask me.

Small Cap Value Report (Tue 27 March 2018) - GMD, DPP, BILN, SUS, OPM, APH, SSY

GAME Digital (LON:GMD)

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Graham Neary

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