Small Cap Value Report (Wed 13 March 2019) - THAL/LSR, BUR, SOM, FRAN

13th Mar '19 by Graham Neary

61 comments 14393 reads

Good morning!

Today, after the introductory comment on Thalassa Holdings (LON:THAL) / Local Shopping REIT (LON:LSR), we have:

Burford Capital (LON:BUR)
Somero Enterprises Inc (LON:SOM)
Franchise Brands (LON:FRAN)

Thalassa Holdings (LON:THAL)

Share price: 81p (unch.)
No. of shares: 17.6 million
Market cap: £14 million

You could be forgiven for not knowing much about Thalassa. It's a small investment vehicle with a chequered history in terms of its track record and corporate governance.

I have written about it quite a bit, both here and elsewhere.

What's interesting about it at the moment is that it owns over 25% of Local Shopping REIT (LON:LSR), and has blocked, at least temporarily, that company's plans to liquidate. Almost all LSR shareholders, except for Thalassa, wanted to liquidate when it was put to a vote.

Instead, Thalassa wants to take over LSR and has offered its fellow LSR shareholders a mixture of cash and THAL shares.

Well, this has led to a war of words. The LSR Board has hit back at Thalassa's offer document, writing up a comprehensive analysis of Thalassa's corporate governance failings and explaining why LSR shareholders should reject the deal.

In my opinion, the LSR directors have done a good job of handling this situation so far. From an ethical point of view, I hope that that they succeed in fighting off Thalassa and finding a way to liquidate.

If you're interested to see what happens when Boards of Directors of small companies go to war, this is a fine case study.

Here are the links to the respective circulars:

Burford Capital (LON:BUR)

Share price: 1914p (+5%)
No. of shares: 219 million
Market cap: £4.2 billion

Full year results 2018

Not a small-cap but a well-followed share among readers. It has been a big winner so far - well done to holders.

It is a litigation finance house, financing lawsuits and owning parts of the claims. It also…

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shanklin100

13th Mar '19

Re Burford Capital (LON:BUR), earlier this afternoon, I sent an email to the CFO contrasting the presentation of EPS in last year's results (front and central) to today's results (not in the RNS and first detailed at p65 of the AR), requesting an explanation for the change in approach.

Rather impressively I received a reply within 40 minutes, The part of the email which relates to EPS reads as follows:

"Your point about EPS is a fair one. We did not include EPS this year because the EPS figures shown in our IFRS statements include non-Burford third party interest noise. Perhaps what we should do going forward is include an EPS line in our reconciliation table (page 51 of our annual report) and then we can have a bullet in the highlights section on EPS. As we have done in our history, we incorporate comments just like yours into our reports going forward to make them more fulsome for our investors so many thanks for your comments here.

An apples to apples comparison of EPS this year to last year (just on Burford only income) would have shown: 2018 at $1.56 EPS vs 2017 at $1.27 EPS, so an increase of 22%."

2018 profit after tax: $327.971 million
Average shares outstanding: 210,776,771 (this figure comes from Note 26)
2018 EPS = $1.56

2017 profit after tax: $264.845 million
Average shares outstanding: 208,237,979
2017 EPS = $1.27"

Hope this is of interest.

Regards, Martin

cig

A tariff does not cause the average price of the thing within the country that raises it to increase by the nominal amount given various substitution effects, so the net effect is (much) less than the headline rate.

mojomogoz

Hi Hawkipa. Is the practitioner you know talking corporate only or personal? If the latter then I can believe that is a saturated market.

The comment seems at odds with the facts from a non-individual sense as the key providers of capital are known (and Burford Capital (LON:BUR) summarise) and their balance sheets are relatively small compared the US and global scale of litigation fees (I don't know exactly the figure but low single digit percentages and not much above 1%).

It also seems highly unlikely that the highly competitive but low available funding capital legal partnerships that access Burford funding nor their clients that have cases that can be profitable (financially, protection of status and image) but hard to fund for a variety of reasons (both dollar size and how it calls on business capital) will pass on by Burford funding given that it has only upside for them compared to doing nothing. Legal partnerships that make the jump are likely to cement their relationship with Burford as partners monetise their expertise.

brucepackard

Hi Hawkipa, when I've asked lawyer friends (partners in city law firms) about Burford they have been similarly dismissive saying things like "well, the hourly fees model doesn't really exist anymore. All law firms are paid on a contingency basis to some extent." By and large they have been rather negative about Burford and litigation finance, which is agrees with the comments you have got back from your inquiries.

These friends made these comments to me several years ago, and despite the negativity Burford results have gone from strength to strength.

fwyburd

Off topic but Mike Ashley just upped his stake from 25.75% to 28.43% of GAME Digital (LON:GMD). I noticed the big trades on Monday and took the opportunity to buy some more but was very surprised to read today that it was him.
https://www.investegate.co.uk/game-digital-plc--gmd-/rns/holding-s--in-company/201903131628467949S/
I cannot fathom why unless he's lining up a bid. Anyone else got any thoughts on this?
cheers
Francis

Quick take on Burford Capital (LON:BUR) -

Understanding the opportunity and why its so potent:

1) IMO the most informative way to think of Burford is as a specialist fundamentally driven event driven hedge fund. I say fundamental to exclude shorter term arbitrage and M&A type event vehicles and compare more to distressed and 'special situations' type investments that often have a heavy legal element to the position taking (and why their is an opportunity for specialist investment vehicles as opposed to ordinary asset managers that run away)

2) But its even better than (1) above as this is the first 'hedge fund' to find the right way to operate in this space by starting with a legal origination, screening and winnowing process. As it is the legal that unlocks the financial event this so much more optimal than the usual approach of starting with financial and newsflow screening and then back ending some legal analysis in to verify the catalyst for financial upside.

3) Effectiveness at exploiting the available opportunity has been demonstrated by past results. There is no reasonable reason to think that these results are not systemic the opportunity set and how Burford exploits it. The only two valid reasons to think that returns could wilt significantly are i) regulatory intervention or ii) economic catastrophe in US and west. Risk (i) is barely plausible as it would be a volte face to our system of government and law...so think political revolution sweeping away current norms....although this could happen in an evolutionary way for a variety of reasons. Risk (ii) is possible but you've got bigger problems to manage than your capital loss on Burford (probably 100% as they wont be able to pay back debt nor roll over). If this risk is your fear probably best stick away from stock market and horde gold etc.

Note, I don't think comparisons to an investment bank are right. They would need to create their own funding capability for that so hedge fund is better. Hedge fund run by old IB traders blow up all the time as they seem unable to realise that they no longer have infinite access to capital to chase down their investment ideas. This is why LTCM went pop and virtually every major hedge fund explosion.

2018 results:

4) The results were ahead of expectations (a tricky concept for Burford as company provides no forecasts and brokers don't know how to forecast it). Nevertheless, its looks like a big beat and multiple comes down to low double digits. This seems remarkably cheap for what is effectively a pool of capital that has proven highly able to make high returns that has a quantum of capital at risk currently that will probably generate very high future returns (that are very hard to imagine disappear any time soon barring political revolution or economic disaster).

But the reaction to results disappointing. Why?:

5) The results and call make it clear that Burford want more capital to go pursue opportunities. They cannot predict timing of cash flows from current cases. From a planning perspective they lack even enough cash at end of 2018 to take up their (very lucrative) share of the SWF partnership announced late last year...its lucrative as for their c.$330m capital commitment they get upside they would get from c.$600m of balance sheet capital!!!

6) So funding is a problem....but in a spectacularly good way.

7) 100% speculation but Invesco have a big inherited position from Woodford and I suspect they are sellers. Perhaps they sold a chunk today into good news and price performance earlier today (when up at £20 area). More generally there's a lot of people who have made a tidy sum from Burford but probably find it hard to appreciate and analyse. In many respects it looks risky as its not a simple widget company or even a bank/lender (its an event driven hedge fund listed on AIM!).

8) The recent high funding needs and significant raises for funds leave some thinking that Burford has growth trouble and an under appreciation of how a significant proportion the cash generation is back ended and comes as a 'surprise' 2-4 years after funds are committed

9) They have committed to a high proportion of single cases after last year trumpeting the relative safety and predictability of portfolio cases. They reported this positively as it indicates growth in new client relationships with legal firms (single cases are the entry level product) but based on last year comment that means their failure rate with cases is a little higher. Note this is balanced by growth in asset recovery business which has protected downside.

My conclusion: Significant upside from both earnings and probability of multiple re-rating. I think they should raise equity again and that shareholders should see that as a good thing as its increases return to them.

David Brightside

First, Full marks and many thanks to Graham for doing the hard graunch of re-writing a lost post. Nothing more frustrating! So, much appreciated.
Burford was a small cap to start with. We are all interested in small caps, particularly when they grow to be mid or large caps.So please keep reporting on them. It's why we invest after all.
Invesco has been a seller for well over a year. Does anyone know why? Perhaps they are just re-balancing. I think they had nearly 30% at one time. So half the holding - roughly £600m - has been seamlessly absorbed by the market.
I love their conservative, lucid, literate annual reports. What else would you expect with an ex-Treasury Chairman?

hawkipa

Hi Mojomogoz. He's a former magic circle operator now solely focused on litigation funding and his current work is a claim funded by a major HF. His firm is also active in the financing of claims and as a result knows and understands the deal flow. A lot of opportunities are out there, butfrom a legal view are deteriorating in quality.
Without the benefit of knowing Burford Capital (LON:BUR) well, I understand from him that the big easy cases ie Repsol are now in the past and the pool of litigation opportunities is smaller than it was (no idea what quantum that is). In addition a lot of major global HFs and bank desks who have had considerable success in the past realise the value of non-correlated asset plays and therefore are keen to see opportunities. So, if say Elliot or Oaktree know of a 'good' opportunity they have the scale, scope and relationships plus the skills to take it on.
I asked him about Litigation Capital Management (LON:LIT) and he talked about the big hitter Nick somebody, who was a Burford founder and he pointed out that his previous endeavour Chancery Capital had clearly failed.
The upshot is that those operating within the field are concerned about the size of excess capital vs the opportunity set.
Like I say, no view of my own, no position in it, just thought it is the kind of thing I would want to hear as a holder. I appreciate your open minded and constructive response, clearly backed up with an informed view. Its exactly why I value this forum so highly, and want to add value to the discussion if I have something I think is of interest to others.
Regards,

willhampson

That's an excellent summary Mojo on Burford Capital (LON:BUR), thank you. There is not much to add, but I think a possible point (10) or an addition to your point (7) is that the founders' lock-up period for disposing shares is up very shortly. They sold a fair chunk just after the full year results last year; the sale was 20/21 March 2018 and they committed not to sell anymore for 360 days (that deadline must be imminent).

It is possible that they are lining up to sell a further tranche (they still hold over 8% of the company) and the City has caught a wiff of this, hence the fall in the afternoon. Pure speculation on my part, but it seems one possibility. Anyway, I guess we will see in due course.

timarr

Like I say, no view of my own, no position in it, just thought it is the kind of thing I would want to hear as a holder. I appreciate your open minded and constructive response, clearly backed up with an informed view. Its exactly why I value this forum so highly, and want to add value to the discussion if I have something I think is of interest to others.

I'd just like to make afew comments about the points that hawkipa is making.

Firstly, given that Burford Capital (LON:BUR) is a board favourite I think it's worth noting that the conversation has been entirely respectful. In my experience anyone posting bearish views on a popular stock is liable to be flamed. Stockopedia is a remarkably civil place to exchange views, long may it remain so.

Secondly, with my psychologist's hat on, it's extremely important to accept and accommodate dissenting views. Confirmation bias, where everyone groups together and refuses to accept contradictory information is one of the most dangerous cognitive biases.

Thirdly, I don't think that using information directly from Burford Capital (LON:BUR) provides a full refutation of the points being made. Even with the best will in the world directors will tend to talk their own book. It's positive information, but we need to look for external points of reference.

Fourthly, the business model here is so successful that it will eventually attract deep pocketed competitors. Whether Burford Capital (LON:BUR) has a real moat or not will be determined then, but hawkipa's comments are entirely consistent with what we ought to expect.

I'm a very very happy holder of Burford Capital (LON:BUR) but I think this type of conversation is incredibly important.

Aislabie

The results from SafeCharge International (LON:SCH) today (I hold) seem to underline a continuing problem in their industry; spectacular growth in mobile payments processing offset almost completely by a decline in margin available.
At various levels SafeCharge International (LON:SCH), Bango (LON:BGO), Boku Inc (LON:BOKU), Mi-Pay (LON:MPAY) seem to all demonstrate the difficulty of getting a return while they all try to get market share. Eventually there will be a winner or two but things could get ugly quickly if payment growth declines

Beginner

Brokers at Barclays (LON:BARC) dropped the GVC Holdings (LON:GVC) target price by 20%.

V4Value

I too hold £SOM and would add that there is strong growth in the use of Autonomous Guided Vehicles or AGVs, basically warehouse robotics. I work in the industry and companies like Amazon, Ocado etc increasingly use this automation as well as auto makers. AGVs also require level surfaces to operate accurately and effectively. I don’t have the numbers but warehouse automation is a growing trend. I’ll be surprised if other companies aren’t competing with Somero in the not too distant future. For now, it looks like they have first mover advantage. Long may it continue.

Garry Hawthron

14th Mar '19

This comment has been moderated

George, this is a fantastic offer! Thank you.

Pencil me in for $95m. If poss I'd like a bullet repayment 20 years from now rather than the pfaff of monthly or annual repayments. This should be possible as your loan will be backed by AAA+++ collateral in the form of a portfolio of the best AIM listed sub £20m market cap cos.

Deal?

smilingmickey

It's good to hear that Burford is in good shape. The interest payments on my 2026 bond look very secure!

However I would draw readers to the excellent results announce by Somero Enterprises reported this morning. Cash generated from this US based business is very high, hence the large and expanding dividend. The final dividend announced (including supplementary) amounts to around 19p/share (approx 5%) which will be paid to shareholders in late April.
Capex is low because the Company is an assembler of bought in parts from third party suppliers, hence very high ROCE figures.
The high margin generated in the business results from their innovative customer led machine designs and great customer service. They have recently embarked on developing machines for use in high rise buildings, where their "flat floor" technology may be exploitable.
I would surmise that the undemanding PE ratio (which belies its financial record) and relates to the fact that Somero is in the construction industry.

jonesj

15th Mar '19

Is this a Somero knock off ?
https://sdfuruide.en.made-in-china.com/product/iKHmVLqhhzro/China-Factory-Supply-Concrete-Laser-Screed-FJZP-200-.html

David Cheong

16th Mar '19

Would you agree that their moat comes from :
-customer service
-Innovative design and methods of assembly?

I am worried these moat features are easily eroded by a competitor in the long run. (some firm which does the same activity of assembling parts from third parties)

cr2263

18th Mar '19

morning Graham,

either yourself or Paul recently mentioned a small cap in the same line as EPO. I had a look at the time, but thought I'd take another look given today's purchase of worldpay by Fidelity National.

I've had a look through the small cap reports, but cannot find any reference...... can you remind me of the company name.

Many thanks and keep up the great work

I believe they have also established patents covering the designs/operating features they have developed. They launch new products with enhanced features on a regular basis.

No moat is a stronghold forever!

SM

Small Cap Value Report (Wed 13 March 2019) - THAL/LSR, BUR, SOM, FRAN

Thalassa Holdings (LON:THAL)

Burford Capital (LON:BUR)

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Graham Neary

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