Small Cap Value Report (Wed 6 Nov 2019) - MKS, CMA, PARK/APP, IDP, SEE, FDEV, CNCT

6th Nov '19 by Graham Neary

58 comments 7875 reads

Good morning!

There's a comment below, "Should we consider shorting MKS?"

My answer (subject to the usual disclaimer: no advice) is a resounding yes!

It has many of the features of an attractive short:

legacy, disrupted (not disruptive) business model
shrinking revenues
not much evidence of any economic/competitive moat
low margin
capital intensive
financially geared (financial net debt £1.6 billion, plus lease liabilities)

Bar skimming the headlines, I haven't studied its results in detail today. But if I was looking for another short candidate, this stock would be my immediate focus. For now, my shorting energies are dedicated elsewhere.

Competition & Markets Authority

An update on a minor matter.

On September 17th, I wrote to the CMA and asked them to put more information in their RNS headlines, to help speed up my work and the work of everyone else who checks the RNS feed every day.

I was informed that the team responsible for scheduling RNS updates had been forwarded my message.

It turns out that they implemented my suggestion from September 19th:

Thank you, CMA!

So which small-caps am I going to look at today?

Provisional list:

Park (LON:PARK)
Innovaderma (LON:IDP)
Seeing Machines (LON:SEE)
Frontier Developments (LON:FDEV)
Connect (LON:CNCT)

Park (LON:PARK)

Share price: 52.18p (+2%)
No. of shares: 186 million
Market cap: £97 million

Appreciate Group PLC - Change of Company Name and TIDM

Please note that I have a long position in PARK (or "APP").

This might win the award for "silly RNS of the day".

I've not yet heard anybody on the message boards or elsewhere say anything positive about this name change. Therefore, the contrarian in me wants to defend it. But "Appreciate Group" is a bit of a strange one, isn't it?

Imagine if Berkshire Hathaway ($BRK) (disclosure: long) had changed its name to "Compounding PlC". Would it make me want to own it more - not at all! The name of the PLC doesn't matter to me at all.

This has been a difficult holding, and I have been tempted to give up on it, but the value and…

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JohnEustace

6th Nov '19

Michael C - You'll need to open a spread betting account. The odds are strong that you will lose money. I would say at least to read the Robbie Burns book first.

https://www.amazon.co.uk/Naked-Traders-Guide-Spread-Betting/dp/0857197053

davidjhill

Graham - re Innovaderma (LON:IDP)

The final report addresses that point directly and says the following......

We also highlighted a change in our approach which was rewarded with very strong DTC revenues in the second half, a combination of better strategic spend and new product offerings setting the pace. Our DTC customer database grew significantly, both in the UK and the US, with the business having just over 625,000 customers, up from 422,500 a year ago. As highlighted previously, we see this as a critical asset for the generation of future revenue for the business. The Company has taken a conservative approach to valuing the customer list intangible assets carried on the balance sheet.

I don't see this as particularly suspect given the modest amount involved. That customer list has significant value and is growing so wouldn't be impaired.

Note the report also talks about the fact that most product R&D cannot be capitalised since the outcome is uncertain. Thus a good chunk of what they do is expensed.

Feels a bit like a spurious short attack from bulletin boards that gathers a life-force of its own. Clearly put you off.

What am I missing ?

Gromley

Thanks David,

Those Innovaderma (LON:IDP) numbers were what I had looked at before. So in crude terms they value each customer on the database at around £3.50. I did some rough calculations that led me to believe they make around £15 gross margin on even their cheapest Skinny Tan bottle sold via DTC.

So my reasoning was that if they get one repeat order per 4 customers (and bear in mind that a loyal customer will probably make several purchase a year, and they would hope into the future) then they have covered the "asset".

Those are not meant to be scientific numbers, just to put a bit of 'scale' around the value.

As for today's price movement and trades - very curious - if the figure of 3.5m shares traded is correct (*) then that would be 25% of the shares in issue.

(*) I recall some discussion about inaccurate figures and trades being cancelled/reversed still being in the count - I think this was in relation to Burford,but I cannot recall where that post would be, nor who made the observation.

Incidentally the AGM slides are on the website https://www.innovaderma.com/company-publications/

and Finncap put out a note - with an unchanged view.

Neither of which look at all disturbing.

rmillaree

Innovaderma (LON:IDP)

Are the amounts involved not material though?

company makes profit 1,3 mill profit

company capitalises its cost of acquiring customer to the tune of 900k

profit with no capitalisation 0.4 mill thats 2/3rd's lower

If these expenses are paid out as commission type payments to affiliate types - i would guess they don't pays these bods til sales have been generated and i can see the viewpoint that wahtever the accounting standards say this is nothing other than a direct cost of generating the income they have done.

Whatever way you look at it the recipient of the 900k cash spent has more out of the 1.3 mill kitty than the company which has basically nothing left when you factor in the the "presumed" (by me) lack of tax deduction for the capitalised item. 1.3 mill pre tax profit less 900k spent less tax = nowt !

One simple question is to ask what % of listed companies have similar capitalised costs ? - i guess the % is pretty small.

GrahamF

I would not presume to argue with anyone qualified in finance as to whether customer lists can be capitalised or not. If they say they can then so be it.

However, to me this sounds like a desperate attempt to make the profit look better than it is. The profit is I am told an imaginary number invented by the company accountant. However, if the accountants all play fast and loose to this extent with how they invent that number then comparing companies’ finances with one another becomes highly problematic and Ed’s number crunching ranking system less reliable.

The only reason I can think of to deviate so far from how other companies present their numbers is because all is not as it seems and the true picture is being deliberately obfuscated.

Next time I see a salesman I’ll be sure to tell him that as the cost of him is a cost incurred to acquire customers I’m going to capitalise him!

No I don't see it like that at all with Innovaderma (LON:IDP)

They spent 900k of cash generated on acquiring 200,000 customers for future sales. Those customers are not one off customers but many are repeat orderers. Therefore those repeat customers have a value so the capital cost of acquiring them (but not any direct marketing spend) should be included on the b/s as an intangible asset.

These customers are valued as expected to spend an average of £30-40 during their lifetime in order for the asset not to be impaired, so I'd say that is indeed pretty conservative per the financial report.

It would certainly be more helpful to have some metrics around this - ie average customer order, proportion of repeat business etc. as that would validate or otherwise the assumptions made.

I for one am happy for them to invest cash generated on acquiring future customer lists to drive profits higher and I don't expect that cost to be shown as an expense unless they are one off purchasers. I do expect marketing spend to be shown as an expense.
Interestingly the R&D on product development that they do is generally expensed even though you could argue it should be capitalised. They take the view that the result is "uncertain" and therefore don't capitalise. This doesn't strike me as the behaviour of a company trying to mortgage the bottom line as I have seen with many others when the "result is equally uncertain".

Then there is the bizarre suggestion of a profits warning around the new product being weighted to 2021. That has always been the case. The 2021 financial year starts mid way through 2020 and this product was not slated to be launched until next year.

Hi Graham - it is not the same thing at all. A salesman is a direct cost and has no certainty that they will make any sales at all, nor that any sale is more than a one off. The purchase of a customer list is an asset (similar to buying a machine if you were a manufacturer). This has a reasonable certainty of pay off, albeit in an uncertain range of outcomes. They don't capitalise the marketing/sales to that list of customers they capitalise the purchase of the asset, which are the customers themselves. Then they give them an asset value.

What I would say is look at cashflow. Last year they were -£2m and this year they are +£200k so despite the purchase the cash generation trend is good. Assuming results are in line it will be even better this coming year and that is what we need to see.

Next time I see a salesman I’ll be sure to tell him that as the cost of him is a cost incurred to acquire customers I’m going to capitalise him!

You cannot capitalise the salesman, because you pay for his cost on an ongoing monthly basis anyway.

However, you could (under the right circumstances) capitalise the 'value' he brings in to the business - I.E. the customer or their contract. If he brings in no customers, there is nothing to capitalise,

I was going to expand on that, but I have hit a total mental block on describing it in quite the right way.

Anyway I do agree that it is quite aggressive accounting, but I can personally see the justification, other opinions are (obviously) available.

Edit - Whilst I was wrestling with words David's response much better captures the nub of what I was struggling to say!!

They spent 900k of cash generated on acquiring 200,000 customers for future sales. Those customers are not one off customers but many are repeat orderers. Therefore those repeat customers have a value so the capital cost of acquiring them (but not any direct marketing spend) should be included on the b/s as an intangible asset.

Fair enough but this sounds like the golf club offers.

Pay £1000 to sponsor the tee box and we give you £1000 of free golf rounds - advertising being tax and vat allowable and entertaining not. It's not obvious what the proper price is for either and it presumably allows an aggressive amount of tax claim that would take a real switched on tax inspector to knock back and too boot the business owner has a boatload of golf rounds to use up.

I think everyone here does understand the logic of paying up front to have future benefit and i don't think anyone is saying anything is wrong its just us cautious bods here won't always give a business the benefit of the doubt here - practicably speaking buying a list of names will nomally have the highest future sales advantage very soon after day one it is made available - as the list gets older its of less advantage as it will end up perhaps being out of date or having customers "opt out" - that being the case it makes no practical sense to book the great immediate sales hit from that spend and totally ignore the cost till sometime never in the future. It would be interesting to see when they acquired the database and started generating sales from said spend.

Valid scepticism rmillaree.

Assuming they have got nothing to hide, it would be useful for the company to expand on some of their policies (I can't see there are any commercial barriers to doing so).

I will see if I can follow this up with them.

rmillaree and Gromley - I'd say scepticism is more than factored in to the share price. The EV of this business is now £7m and they are on track for forecast EDITDA of £2m so they are now on 3.5* which for a fast growing company is laughable.

even if you assume they do another £800k on client list acquisition or the like and being cynical we subtract from profits as an expense we are still talking about an EV to Ebitda of 5.8!!

And those forecasts exclude any revenue from this new product launch.

Anything around this price early next week and I shall be buying a chunk

mojomogoz

Enjoyed the Innovaderma (LON:IDP) discussion above. I'm on the sceptical side as I would like to see them produce a bit more cash regardless of accounting jiggery pokery and provide a more accessible and stable product development and sales outlook...always feels a bit duck and dive...why does it need to be so?

On product testing I can report:-

Skinny Tan does what it says on the tin, but....

Prolong doesn't...but welcome other people reporting on experience...

Michael C

7th Nov '19

Thanks for the helpful replies.

And now on the subject of Innovaderma (LON:IDP) we now know the reason for the massive volume and share-price movements yesterday.

Executive Chairman Haris Chaudhry has left the company and at the same time sold his entire shareholding - comprising c. 30% of the total.

It all sounds fairly amicable and my reading is that he isn't that interesting in running an ongoing business, but rather wants to bring new ideas to market.

Although I already had a "full" position here from a few weeks ago, I have bought a few more as I think the current share-price still represents an overhang opportunity.

Interesting interview with the new Innovaderma (LON:IDP) Chairman and the CEO by proactive today.

Interview Video

@ 6:25 Joe Bayer (Exec Chair)

The business spends a lot of money on online marketing costs to acquire customers. We do put a part of our efforts into acquiring customers as a comparison to acquiring sales and hence we treat that appropriately.

Good evening Mr Bayer if you are reading in!

Vsihv

To capitalise an asset, the costs involved in that asset need to be separately identifiable.
If I work in sales, and I identify the key decision maker at a customer, and put that person on a list, there is no way of separately identifying the time I spent identifying the customer contact versus my day to day activities.

It would be the equivalent of a football club capitalising an element of their costs associated with acquiring season tickets over multiple years, because a customer is likely to buy season tickets for many years (not to mention that customers children and grand children).

On acquisition, the treatment is slightly different - because Mgt are basically saying a separately identifiable element of the purchase price related to customer lists (which were not separately identifiable, and therefore not recognised).

Personally, I would suggest in general that costs being capitalised as intangible tend towards the aggressive end of the spectrum, because they flatter operating cash flow in current year and flatter cash conversion.

No opinion on Innovaderma (LON:IDP) itself.

Thanks Gromley - I didn't see this news until later but also bought some down at 60p earlier.

note that the non exec picked up circa 45,000 at 47p so clearly felt there was good value there too.

Doesn't surprise me that Chaudry went but not sure the sale was particularly orderly. That's a lot to offload in one swoop !!

Anyway, I like existing management and I consider the business now very cheap so happy to hold.

You've never had to book every single hour of your work-time to individual customer projects then sharmvr? (It's no fund whatsoever I can tell you).

In this case I think they are just talking about digital marketing cost. FB,Instagram and the like.

So I am guessing the line of logic goes like this : all (?) of the money spent on click through ads is spent on customer acquisition. Once they have acquired the customer (onto their DTC database) all future interactions with the customer are direct and therefore do not require digital marketing spend.

In theory once they get "enough" customers they could stop (or at least reduce) digital marketing spend and live off the repeat business and some word of mouth sign-ups.

I do though agree that it is aggressive, but I'm personally comfortable that we've got the visibility to see what the numbers would look like if they expensed the spend.

Surely this doesn't flatter cash conversion though? You ensuring that in the short term you book profits are less than your cash income.

Re cash conversion, I am specifically referring to op cash as % of op profit - basically you have more non cash items in future P&L (amortisation).
Overall total cash flow should not be impacted aside from some tax impacts I expect.

Re timesheets - agree no fun ! I spent many years doing exactly that (at an accounting firm no less) - don't recall any of my time being capitalised!
Certainly don't miss the timesheets!

Not sure I accept that digital marketing is different to regular marketing - not sure I see Coca-Cola or McDonald's or Gregg's vegan sausage rolls having digital costs capitalised doing this, although I expect their customer life is longer than a year.

But as I say, don't know the company and if investors are comfortable with the treatment and disclosure is clear/transparent and most importantly in my view consistent year in year, then who am I to judge!

8th Nov '19

I see my earlier Innovaderma (LON:IDP) humour didn’t jive :( ...so playing it straight...

Innovaderma just became interesting...however....seems that the company has effectively signaled that we should await a serious revision (outlook, relationships, accounted valued, etc) to hit the RNS some time soon given weirdness of Choudrygate. Expect bounce followed by some pain?

It seems improbable that the miraculous Choudry turn to events makes an immediate clean slate!

Did anyone go to AGM and if yes what was the vibe?

Small Cap Value Report (Wed 6 Nov 2019) - MKS, CMA, PARK/APP, IDP, SEE, FDEV, CNCT

Competition & Markets Authority

Park (LON:PARK)

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Graham Neary

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