Small Cap Value Report (Wed 31 Oct 2018) - VCP, CRAW, FJET, NXT, CCC

31st Oct '18 by Graham Neary

40 comments 11774 reads

Good morning! There are lots of comment-worthy news stories today.

To get us started, we have an updated comment from Paul Scott on Victoria (LON:VCP).

I'd also like to mention:

Crawshaw (LON:CRAW) - intention to appoint administrators
Fastjet (LON:FJET) - funding update
Next (LON:NXT) - trading update
Computacenter (LON:CCC) - Q3 2018 trading update

This section written by Paul Scott.

Victoria (LON:VCP)

Share price: 375p (-4%)
No. of shares: 125 million
Market cap: £470 million

Victoria (LON:VCP) has issued an update regarding its possible bond issue, here;

Credit rating and response to speculation

This carpet maker has given more details about its proposed bond issue, to replace the exiting bank borrowings. Summarising it, with my comments:

Credit rating - Fitch has given the rating BB(stable) for the intended bond issue. Using a table shown on Wikipedia, this doesn't look very good - it's in the bracket described as non-investment grade, and speculative. "Higher degree of default risk, speculative" are the description provided by Google for BB credit rating bonds. So not something to brag about, I would suggest. The interest rate would therefore tend to be higher than better quality bonds.

"Misleading rumour & speculation" - what does the company expect, if it drops a bombshell on the market, with no explanation? At the same time as issuing a profit warning, which is what happened here.

Banking relationships (with HSBC and Barclays) - Victoria says;

Firstly, the Company continues to have a close and positive relationship with its lending banks, HSBC and Barclays, and continues to operate with significant headroom with respect to its covenants under the existing 2-year facilities put in place in August 2018.

Our lending banks are acting as joint global coordinators and bookrunners on the potential Bond issue and have been working with us on the project since April of this year.

That's reassuring on the banking covenants.

What I don't understand is this. If the banks are happy with their existing lending to Victoria, then why have they been working with the company to get their lending repaid through a bond issue? That just doesn't make…

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nicobos

31st Oct '18

Paul - I have some expertise in this area so some comments below:

More detail is given about why the company thinks a bond issue makes sense for Victoria;

Long term (5 year) funding of a bond - but this could also be done via a term loan from the banks. Maybe the banks don't have the appetite for long term lending to Victoria?

It could do but banks are reluctant to hold large amounts of leveraged debt on their balance sheets with 5 year + tenors. It would require a larger club of bank lenders to raise c.£250m of debt. The debt package would come with controls in place which may not offer Victoria the flexibility they require.

Banks love issuing bonds as it is capital light financing - i.e. no need to use the balance sheet (unless providing a Bridge) but still make a c.2% fee on the issue which drops straight to their bottom line. The risk is mainly reputational - i.e. that they promise to get an issue away at x% price and it fails or prices higher than expected.

Fixed rate funding - again, this could also be achieved through conventional bank borrowings, adding an interest rate swap or cap if needed.

Yes, but a swap comes at a cost which needs to be factored in to the overall cost of capital calculation. There's also a cost to breaking a swap if refinancing.

BB financings are not as 'junk' as you'd imagine. Current average European new-issue yields for BB fixed rate notes are priced at 3.56% and have been as low as 3% earlier this year. Pretty competitive pricing vs the risk !

Flexibility - but not specified why a bond is seen as more flexible than bank borrowings. I would have thought the opposite is the case. Bank borrowings can be easily amended, whereas bonds are usually set in stone.

The main benefit of issuing Bonds vs Bank debt is flexibility. They are repayable on redemption with no amortisation and no maintenance covenants (net debt / EBITDA for example). There is little bondholders can do before a payment default whereas banks would step in a lot earlier due to more onerous conditions / triggers in the loan document.

Shareholders will be able to sleep easier at night with 5 year committed financing in place ahead of Brexit / elections / trade wars etc.

Depth of the bond market - suggests perhaps that the banks are at or near the limit that they want, in terms of exposure to Victoria.

Yes, they are at the limit of what is probably achievable with bank financing. Bond market offers extra liquidity (when it's open!) to 'tap' bondholders for further cash if required in the future.

Hope that helps!

EDIT: Sorry Graham, just seen your comments which I wholeheartedly agree with!

Graham Neary

Nicobos, thanks for the contribution. It seems like you echo many of the points made in my own response to Paul. G

Tortoise investor

I was reflecting this lunchtime at how many profit warnings I feel I've seen recently so wanted to check the stats. Looking at EY's profit warnings monitor, 2018 isn't actually higher than recent years: https://www.ey.com/uk/en/issues/capital-and-transactions/restructuring

However, they note that the standout exception are 'general retailers' who are at a seven-year high for profit warnings. General financials, electronics, support services, travel/leisure, and media companies also seem to be issuing a lot of profit warnings at the moment. I am of the view that travel/leisure companies have been particularly affected by the unusually warm weather and the World Cup this year so there might be some opportunities in that sector. On The Beach (LON:OTB) has had a lot of share price weakness for example.

Also interesting to note the median share price fall for profit warnings is 21% - this is the highest median ever recorded by EY suggesting investors are reacting particularly badly to profit warnings at the moment.

oscar247

GYG (LON:GYG) - are taking a hard hammering after issuing a second profit warning in as many months.

The company came to Aim less than eighteen months ago at a placing price of £1.00. Heavily backed by Woodford Investments, who hold of 22% of the equity. I would suggest that todays news from the company has done nothing in reviving Mr Woodford's flagging reputation as ' the best fund manager of his generation'.

Hi andrea - I managed to cover Computacenter (LON:CCC) by the finish, thanks for the suggestions! G

Yes, I think valuation of 16x-17x might have been just a bit too racy for Computacenter (LON:CCC).

rmillaree

Computacenter (LON:CCC)

I havent looked at this one in quite a while
Share price 1100p
Market cap £1.4 Billion
EPS 2017 65p - 2018 forecast 73p - 2019 81p

So potentially pe of 15 - seems reasonable for growth rates expected- how in the bag are these projections? they seem quite optimistic but we are close to end of 2018 year now.

dividend 2%
Decent EPS growth - not sure how much of this is organic?
Debt seems minimal

Notes
share count decreasing - i like that
High debtors and creditors figure - high debtors is always somewhat risky from pimping up the numbers perspective. Note high debtors figure is partly explained by high turnover.

Seems interesting if you believe there will still be reasonable organic growth into the future.

does anyone have any thoughts as to how futureproof their income sources are likely to be going forward. They have growth at present but could they be eaten away by smaller or nimbler competition?

Paul Scott

Graham & others,

Thanks for your comments on Victoria (LON:VCP) , interesting. Maybe I'm being too paranoid.

If VCP can get a bond issue away on reasonable terms, then great, it will certainly de-risk things.

I'd rather sit on the sidelines unless it's sorted out though. In any case, the balance sheet is too weak to consider an investment for me.

Regards, Paul.

barnetpeter

Anyone interested in dfx? Software company was over 440 pence last year. Closed as highest gainer of day today at 10.5p. Obviously small cap now although it was not so last year! Has good support from much larger company. Punting money only but worth a look as a special situation.

Wimbledonsprinter

Trident, I would not hold any faith in the bonds being in”friendly” hands. The bond holders will be different from the shareholders, and each side will look out for themsleves (as they should).

While being BB, the buyers (if any) of the bonds are likely to be institutional. But if the company were to run into difficulty, and say the bonds become distressed (yielding>10%), it is likely that these institutions will sell and the bonds will get bought by specialist distressed funds, who will be legal experts in how to maximise their bargaining position in any restructuring.

None of this is to say that Victoria (LON:VCP) might not prosper. But be aware that in nearly every situation where there is a restructuring and there are a significant numbers of bonds outstanding, these bonds at the time will be held by legally savvy distressed funds (not the original purchasers). In such a scenario, these distressed funds are much more likely to play hard-ball than the banks.

thanks for the reminder dfx.
Not now listed Touchstone Group PLC (probably just me and Mr Birch left holding shares here)
Any holders should have received their 7.5p per share dividend this month - accounts were released July but i only just noticed them now
Stewth is it really 9 years since this company delisted.

AnonymousUser252054

If you're very interested in platinum.

andrewjames

I am much less convinced by the view that as a basic principle, a bond issue is a better idea than bank debt to finance a business - and I have seen both work and fail multiple times. Bond issues tend to be very inflexible, because if there is a covenant or similar breach then it is extremely difficult to achieve consensus on waiver terms and the trustee is in no position to exercise any discretion. It ultimately comes down to the specific terms negotiated on each deal but, in genera,l if I was a relatively small or medium sized business, I would steer well clear of a bond deal - and as an investor I avoid companies that go this route. I am not invested in Victoria (LON:VCP), but if I was then I would be highly alarmed by this switch in financing strategy and I would really struggle to see it as other than bad news.,

Vsihv

This might be complete horsecr4p but banking regulations and specifically capital requirements are changing.
Interestingly (very fast and loose with the word), this would reduce the return on regulatory capital for loans to business.
European banks are big financiers of agriculture (think credit agricole) and that is hideously unprofitable. DB has asked lower credit grade customers to find alternative lenders on expiry, because they cannot generate return on capital (given current interest rates I assume) and I expect a lot of banks are thinking along similar lines.
RBS during their announcement mentioned reducing exposure to the industry and I imagine they are not alone in this mindset.
This transaction allowed bank to cut capital requirement and earn fees (infinite return on regulatory capital) while cutting industry exposure.
For the banker it makes sense.
For the issuer, in line with comments it only makes sense if the cost is manageable given other benefits like market depth, covenants etc.
Vulture funds that try to take control well below the BB level - have a lot of respect for these guys - they genuinely are the smartest guys in the cloud since they take a lot of risk #howardmarks.

All of that said - I'm not investing in a balance sheet like that - having learned a lesson (more than once) that I should already have learned a long long time ago

TQ12

Since GW took over VCP has paid around 3% for debt capital. If the current loans are replaced with BB rated bonds then hard to imagine a coupon under 5%, more likely starts with a 6 or 7. Never met GW, but he appears an usually feisty CEO, imagine he is playing hardball from a weak position. Maybe this turns into an equity funding at a deeply discounted rights issue from SP levels. Interesting situation.

1st Nov '18

I agree with the statement that a bond is not necessarily preferable to taking out bank debt. It all depends on the size and requirements of the business at the time. As you say, small and medium-sized businesses don't need to issue bonds.

But Victoria doesn't qualify as an SME. It is a large business with over 2,000 employees and over £300 million in bank borrowings (March 2018). At this sort of size, I think it's normal that a company would ask the question as to whether the bond markets could play a role. All the best, G.

xxx

Enjoyed today's report due to the discussion on Victoria plc...2 honest views which is rare to see and learned something from Nicobus !

Trident

Wimbledonsprinter

Fair point.

DVB99

re Crawshaw - being a cynic even there is any cash in the business, most will get eaten up in the administrator's fees!!

gus 1065

6th Nov '18

News released this morning that Victoria (LON:VCP) have pulled their proposed high yield bond issue ...... on the grounds that the proposed yield was too high. Full text of the release pasted below. Wonder if history might show this to have been something of a “Ratners” moment for an emperor with no clothes?

Gus.

————-

Victoria PLC

('Victoria' or the 'Group')

Update on Bond

The board of Victoria ("the Board"), the international designers, manufacturers, and distributors of innovative flooring, confirms that it has resolved to continue with the Company's existing bank facilities, rather than refinance them with a senior secured note ("the Bond") as proposed last week. Whilst we continue to believe that, in terms of structure, the Bond would have been suitable for the Group to meet its long-term financing objectives, the indicative pricing for the Bond, which was higher than had been anticipated, was such that it did not warrant changing the Group's debt financing arrangements at this time.

Geoff Wilding, Chairman of Victoria PLC, commented:

"We embarked on the Bond process in good faith and with the intention of delivering benefits for all shareholders in the form of long-term funding at an attractive, fixed interest rate.

It is very disappointing that despite the positive, stable credit ratings, the indicative pricing for the Bond moved unfavourably over the course of last week, particularly when there have been no fundamental changes to the Group or its business.

I want to reassure shareholders that, as with our strategy of only paying the right price for acquisitions, the Board applies a high degree of rigour to our long-term financing arrangements. Therefore, as we continue to have a close and positive relationships with our lending banks and operate with significant headroom with respect to covenants under our existing 2-year facilities put in place in August 2018, we will continue with these facilities. The banks have been, and continue to be, very supportive of our strategy and performance. Any suggestion to the contrary is untrue.

Nevertheless, last week was not the Board's finest hour in terms of the clarity of our communication. For the last six years, the Board has endeavoured to maintain an open dialogue, fully appreciating that it is the shareholders who own the company. Unfortunately, we placed too much emphasis on technical guidance and market convention and not enough common sense was applied in terms of communication with shareholders. By failing to communicate clearly last week and in the run-up to the Bond launch, the Company needlessly left shareholders feeling uncertain about the future. Critically, this also left an open goal for those with less than pure motives to spread outrageous untruths. This has damaged the value of the shares, although, of course, there has been no impact on the underlying business, which is high quality and continues to successfully design, manufacture, and distribute flooring products around the world as it always has done.

Victoria's operational management are firmly focused on delivery of our organic strategy. Separately, the Board continues to identify and very selectively pursue attractive acquisition opportunities. We have adapted our usual acquisition structure in such a way that remains attractive to potential vendors but ensures that future acquisitions remain value-enhancing for shareholders by reducing requirements for new equity whilst staying within our internal debt limits. As such we continue to see opportunity to pursue our acquisition strategy to meaningfully enhance the Group alongside organic growth.

The Board continues to believe that Victoria is well placed to deliver growth in shareholder value.

Small Cap Value Report (Wed 31 Oct 2018) - VCP, CRAW, FJET, NXT, CCC

Victoria (LON:VCP)

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Graham Neary

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