Small Cap Value Report (Wed 18 July 2018) - MPAC, CALL, HEAD, RDL

18th Jul '18 by Graham Neary

31 comments 10867 reads

Good morning!

Today we have in line with expectations updates from Hotel Chocolat (LON:HOTC), Premier Foods (LON:PFD), DX (Group) (LON:DX.), Strix (LON:KETL), Bloomsbury Publishing (LON:BMY) and Team17 (LON:TM17).

So I intend to focus on MPAC (LON:MPAC), which issued a profit warning, and on Headlam (LON:HEAD). Paul has also written a section on Cloudcall (LON:CALL).

MPAC (LON:MPAC)

Share price: 145p (-34%)
No. of shares: 20 million
Market cap: £29 million

Half-Year Trading Update

I have previously described this as "a pension fund with a small operating business attached".

It traded under the name "Molins" and was traditionally associated with the tobacco industry, but sold its tobacco division in August last year.

What is left is a packaging machinery business focused on the pharma, healthcare and food & beverage markets.

Today's news

"...the business climate has softened considerably as the year progressed, attributable in part to general economic as well as Brexit related uncertainty, leading to customers deferring machinery investment decisions. The Board believes these contracts will be delivered in future financial years."

Many small-cap investors will be familiar with this type of profit warning. Decisions on contracts get delayed sometimes, it goes with the territory.

It's still a disappointment of course. A longer sales cycle ultimately means lower earnings for MPAC and makes it a less valuable company.

Blaming economic and Brexit-related uncertainty is a bit harder to stomach. Given how many companies have reported that H1 was in line with expectations, it suggests that most companies are not finding conditions as difficult as MPAC is.

The UK manufacturing PMI has been softer than it was last year, but it remains north of 50. This means that most manufacturing companies are continuing to report an improvement in conditions.

Source: TradingEconomics.com

The final point I would make is that only 14% of MPAC's sales are to UK-based customers (according to the 2017 annual report), while 24%…

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Graham Neary

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31 comments

Graham Neary

18th Jul '18

Hi IG - sure! MPAC (LON:MPAC) news is fairly interesting. G

Graham Neary

18th Jul '18

Hi everyone - MPAC (LON:MPAC) and Headlam (LON:HEAD) are the most requested and I agree they are the most interesting ones today. So I'll be writing about them first, and then seeing what I have time for after that. Thanks. G

LeoInvestorUK

18th Jul '18

SRT Marine Systems (LON:SRT) - call me cynical and probably ignorant, but I read their announcement as follows:
The customer didn't meet the financial or governance requirements for an EU development loan. They don't have they money to pay themselves, but hopefully the UK government's export guarantee programme will be more relaxed.
We recognise revenue upon the signing of contracts that amount to little more than letters of intent, rather than when payment is guaranteed or as services are delivered. Our forecast results are therefore subject to large adjustments at any time, including many months after the period close. While this is one of the reasons we are slow at producing our accounts, prior year adjustments cannot be ruled out.
We were relying on this single contract for most of our revenue and to make a profit last year, and if it doesn't come through this year then we can't really say whether we'll make money this year. We are a very small company with very big customers and therefore easily bullied on contract terms.

This is not a share I follow, but I can't understand why such a business would have been valued at 16x forward earnings before this news or why it has fallen by only 15% today. Very happy to be corrected as always.

HornBlower

18th Jul '18

Hi Graham

I know you focus on actual news not price movements but given you own it I wondered if you had any thoughts on H&T recent price weakness

Paul Scott

18th Jul '18

Good morning!

I posted my thoughts on Cloudcall (LON:CALL) (in which I hold a long position) on yesterday's report's comments section. However, as most people probably wouldn't notice it there, here is a copy;

Hi,

Somewhat belatedly, here are my comments, in response to reader requests above, on the Cloudcall(LON:CALL) trading update yesterday. I hold a long position in CALL shares.

Firstly, it was clearly a profit warning, but a fairly mild one. The 2 brokers which report on CALL (both make their research available to subscribers of Research Tree) both put out updates, reducing 2018 revenue forecasts from c.£9.5m to c.£9.0m.

One broker reduces its 2018 EBITDA loss from £2.4m to £3.1m, and the other reduces from a £1.9m EBITDA loss, to a £2.9m loss, so quite a significant drop in forecasts at the EBITDA level.

What's gone wrong? The company says it's all down to timing of recruiting & training new sales people, which has taken longer than expected. It says there's not a problem with customer demand, they just didn't have the internal resource to bolt on new customers at the pace required.

The brokers clearly believe that explanation, as they have not reduced revenues forecasts for 2019. The company also talks about expecting a strong H2 in 2018, as the new recruits kick in.

If it all pans out as the company suggests, then the current share price weakness should prove negative. The trouble is that the company has proven somewhat accident-prone in the past (repeatedly missing targets, especially on cash burn), so investors are wise to take the company's outlook comments with a degree of scepticism. That doesn't make it a bad company, but I'm just pointing out that it tends to be overly optimistic, and then disappoints a bit. But that's within an overall picture of strongly growing revenues (which have risen organically from £3.3m just 3 years ago, to forecast c.£9m this year - that's very impressive growth).

Organic growth - is still very impressive, as noted above. The market tends to put a significant premium on the price of any company delivering over, say 20% organic growth at the top line. CALL is still well above that, at +31% Y-on-Y revenues growth in H1 of 2018. That's still a very impressive growth rate, albeit below the previous forecast of c.39%. I don't think the company should be punished too hard for this.

I like to look at not just year-on-year growth, but also sequential half year growth. This has been;

H1 2017 £3.2m

H2 2017 £3.7m (up 15.6% on previous half year)

H1 2018 £4.1m (up 10.8% on previous half year)

So there's been a slowing there, but still good growth.

Note also that the company has sticky, recurring revenues - because its product is excellent (I use it myself). Cashflow is hence highly predictable, with customer receipts coming in regular as clockwork each month. Customer retention levels are high, because people find the product so useful. That's key for building a SaaS business. Gross margins are also very high - again a key point.

Will it need more cash? Almost certainly, yes in my view. Does that matter? Not at all, in my view. There is no reason for shareholders to worry about another fundraising, because the company is well beyond the blue sky stage, when fundraisings are uncertain & can be done at deep discounts if investors are nervous. CloudCall's business model is now proven, and if it needs say another £3m to push it over the line into profitability, then that would only be about 10% dilution, and I reckon Instis would be queuing up to participate.

Evidence for this is that the last placing raised £5.7m in late 2017, and was priced at 143.5p, only a 5.3% discount to the then share price of 151.5p.

The only circumstances in which CALL would struggle to raise more equity, would be if the whole market turns bearish, and/or if CALL's revenue growth grinds to a halt. If that happens, then we'd be looking at a much lower share price, for sure. But that hasn't happened, hence why I think worries about another placing are wide of the mark. It's not a worry to me at all, for the reasons given.

Note that the company has a track record of repeatedly stating that it will not need to raise more cash, and then going on to raise more cash! So the reassurances given in the latest update that it has adequate cash resources, and worthless in my view, given the history. But it doesn't actually matter either way.

Is this a buying opportunity? That's obviously up to each individual to decide for themselves. I see this as a "good" profit warning - i.e. temporary, fixable problems, with the business model & growth story intact, just slightly blunted in H1.

The share price recently peaked at 193p. So being able to buy at 135p today, seems an attractive proposition to me. I can understand emotions kicking in, and some investors' patience wearing thin, but taking a longer term view, this share could be worth substantially more, once you factor in a few more years' strong growth, and the eventual move into profit.

Tech shares like this are not really valued on profits at the moment. The market is instead placing more emphasis on growth, with strong organic growth (combined with lots of operational gearing here, from high gross margin) should attract a premium rating.

There are plenty of private equity buyers around, willing to pay eye-watering valuations for growth tech companies. I would welcome a takeover bid for CloudCall, providing the premium is sufficiently large. It doesn't sit well in the stock market, where people are too focused on short term performance. Whereas, the better option for a growth company is to set aside short term profitability, and instead "go for it" in terms of growth, which might mean incurring heavy losses in the short term.

For stock market investors, CloudCall has been frustrating, in that the runway to profitability seems to be extended each year, by a year! The company is increasing its costs to take advantage of growth potential (and extending the features of its product), but with the time-lag inherent with that type of spending, it results in administrative costs relentlessly increasing, and absorbing the benefits of increased sales/gross margin. Hence why I don't think CALL should be listed on the stock market - it would be better off as a private company, and able to press on with faster, but more cash-consuming growth in the short term.

Overall, I think that for investors who are prepared to be patient, then we should do well out of this one in the long-term. The current market cap is extremely low for a SaaS business that's not far off profitability. Just look at the valuation of LoopUp (LON:LOOP) to see what can be achieved in this sector.

Regards, Paul.

rpmeurope

18th Jul '18

If you have time, I think Carr's (LON:CARR) is a company that is worth covering. Nice business with a long track record.

Gromley

18th Jul '18

Interesting comments on the MPAC (LON:MPAC) pension scheme Graham.

There is an interesting compare and contrast with yesterday's announcement from 600 (LON:SIXH)

At the last report (November 17) their comparable pension figures were

Accounts.

Assets : £232.4m

Liabilities : £188.7m

Surplus : £44.7m

Actuarial view - Surplus £12.2m

Yesterdays announcement was that they have agreed (as have the trustees) to sell the pension schemes to Pension Insurance Corporation Plc and expect to get a net £3-4m (I presume this to be the figure net of 35% tax).

Personally I'm not so sure that is such a great deal, but 600 (LON:SIXH) look to be very short on cash and were certainly burning it in the previous financial year, I also think the company on a stand-alone basis looks too highly valued.

This does though demonstrate what can be done.

I would expect the actuarial valuation of the MPAC (LON:MPAC) fund to have improved since the 2015 number, but not I would expect by nearly enough to bring it in to surplus.

The next actuarial valuation will be as at June-2018, but as it took them two years to complete the last one, we may not see this until 2020.

So no cause whatsoever for immediate excitement, but it is worth remembering that separating the company from the pension scheme could happen at a later date if and as the overall health of the scheme improves.

Brian Hamilton

18th Jul '18

MPAC: I think the two recent departures of very senior people was significant and could have been mentioned. Simon in IC recommended the share the previous day and still believes it is a good buy at today's reduced price.

Not for me: falling knife?

davidjhill

18th Jul '18

That's pretty much spot on Paul, ice write up. Mirrors my view as well.

TamzinPiworld

18th Jul '18

K3 Business Technology (LON:KBT) just posted the presentation from ShareSoc July 18, last week, following their H1 results.

https://www.piworld.co.uk/2018/07/18/k3-business-technology-kbt-presentation-at-sharesoc-july-2018/

The new management who joined in October 16 are making their presence felt, with margins up and opex down. Could be interesting if they can maintain the momentum.

davidjhill

18th Jul '18

I think people are missing the point really on MPAC (LON:MPAC)

The profits warning relates to 2 legacy (non repeated) contracts that will impact profitability by £1m but the business is still profitable and should be around 5p EPS for this year and 10-12p next.
Although order book has shrunk next year revenues are well covered and its markets are growing at 5% p/a, not shrinking. That does admittedly raise questions as to why the order book shrunk at all which, is the core negative for me.

Cash is 165p and if you only value the business at 8* this years reduced forecasts you still get something worth 205p.

I also don't think you can treat pension schemes effectively as debt and just add to EV. It's too volatile, depending on many actuarial calculations, performance and long term interest rates. Rather, in my view attention should be paid to (1) agreed contributions / relationship with trustee (2) affordability of those contributions even in a tough market and (3) actual likely deficit/surplus rather than an out of date triennial review. On all these accounts I think MPAC (LON:MPAC) are appropriately placed.

Structurally the market they are in is also positive - so whilst I have downgraded my personal target from 275p to 225p to reflect the short term order book I was very happy to add at 122p this morning.

Gromley

18th Jul '18

I also don't think you can treat pension schemes effectively as debt and just add to EV. It's too volatile, depending on many actuarial calculations, performance and long term interest rates. Rather, in my view attention should be paid to (1) agreed contributions / relationship with trustee (2) affordability of those contributions even in a tough market and (3) actual likely deficit/surplus rather than an out of date triennial review. On all these accounts I think MPAC (LON:MPAC) are appropriately placed.

I agree, because of the volatility of these deficits (or surpluses) it is difficult to know how to treat them.

But, if you don't take it into account the EV then aren't in practise taking it off the balance sheet? (As used to be the case). And if you do that, then pension deficit payments cease to become "internal transfers" but becomes a real cost.

The £1,8m pa they are paying deficit payments amounts to 5.7p per share which wipes out the earnings you are predicting.

Which suggests the company is only making sufficient profits to service its pensioners with nothing left to add value for the shareholders.

That's an overly harsh description perhaps, but unless you make the assumption that the IAS19 figure is correct and there is no "real" deficit (which actually I don't consider a too unreasonable assumption) or you need to account for it either by looking at EV or by expensing the top ups through the P&L imho.

dgold

18th Jul '18

BIt of a late comment - re Ranger Direct Lending Fund (LON:RDL) which Graham has previously elaborated on further by pointing out the high dividends previously paid plus the discount to NAV. I believe the discount to NAV of about 9% is probably not sufficient reason to buy the assets, given that it will take a few years to realise the loans. But Graham's point is that there also large dividends of 90-100p per year on the way, which is what helps to make it into a good deal.

I just wanted to question this assessment. Could it be that the NAV already takes it into account the high expected income due to be converted into dividend payments, and that therefore as the income is received and paid out the NAV will therefore decrease to offset this? If this is true then the case for buying is much weaker. Would be happy to hear Graham's opinion (or anyone else's).

dgold

18th Jul '18

Further to Gromley's comment, I would also point out that cash is not 165p per share as you state, Equity Development helpfully show this figure for past years and expected figures for future years. For end 2017 it was 146p, for 2018 they expect 118p and 105p for 2019. Part of the reason for the reducing cash is the pension fund payments - I haven't delved into it deeply enough to work out the reason for the rest.

rmillaree

18th Jul '18

Ranger Direct Lending Fund (LON:RDL)

Dgold

Could it be that the NAV already takes it into account the high expected income due to be converted into dividend payments, and that therefore as the income is received and paid out the NAV will therefore decrease to offset this?

That's a pretty decent question that did pique my interest, as i like a decent value play.

Graham did say the following in the 11th June article which suggests the company does indeed earn some sort of crust while waiting for its chips to be cashed in. probably a bit akin to the boring bit when its down to the last 2 at the WSOP of poker, and they keep playing for another 11 hours when everyone has gone just because the refreshments are on the house.

Per Graham

So I do think I will get a nice interest yield on the existing debt portfolio and then get a capital return as the portfolio is liquidated.

Ok does this tally with the 2017 annual accounts ? lets have a look

http://www.rangerdirectlending...

Aside (Ooooh top marks for sensible directors fees)

ok (all dollars)

Investment income 26 mill - 8 mill other income - fees (hmm is that where directors have their snouts?) + expenses 14 mill

profit 20 mill (Dollars)

now swap to GBP???*^*???

Market cap 125 mill (StockyP hope its the right page this time)

that looks like some kind of decent yield with similar profit previous year (18 mill) to the previous year.

So without knowing didly squat (are the yielding assets going, going , gone?) it looks like there is some sort of income that will presumably reduce as stuff is liquidated. However at that time one would probably expect some sort of payout or similar so the excess cash ain't just sat there doing nowt.

SundayTrader

18th Jul '18

Re SRT Marine Systems (LON:SRT), harsh, but not unreasonably so. It is not unheard of for small software companies whose business is with a few large customers, such as governments, to start work on projects on "little more than letters of intent". Usually it works out OK in the end. But how on earth is the outside investor in a plc to make any assessment of whether or not the directors' judgement is sensible? They can't. The market cap here is little more than a blind punt on the quality of the software offering.

I think this will probably come good in time. But in the meantime the equity investors are completely at risk. (I have held earlier, but sold out about a year ago, partly because of a feeling that contracts like this tend to end up being spread out over more years than originally intended.)

Andrew L

19th Jul '18

Paul, Thanks for that. I met Cloudcall (LON:CALL) at the Shares investor show in January. CEO seemed very good and confident. I remember questioning about the competitive position and it was all about focusing on the recruitment sector. The edge was recording calls within their platform to allow easy play back. I couldn't get too excited due to the Market cap to sales valuation. Secondly, the difficulty in understanding the competitive environment and thirdly the unclear timeline to profitability. Fourthly, the lack of clarity over what kind of margins this company will have when it is profitable. I didn't do any follow-up research to assess these points.

A few follow-up points if you have time. Thanks,

1) As you use the product it would be great to have some feedback on why it is better than the competition and how it can sustain its edge. Surprised that you are using it as I thought it was only for small companies?
2) The valuation argument you put forward is all relative. We could argue that LoopUp (LON:LOOP) is overvalued. But a difficult comparison as LoopUp (LON:LOOP) is profitable. In other words, if we are comparing Cloudcall (LON:CALL) to an overvalued sector and a stock that is overvalued then it will seem cheap (not sure if either is the case). So I guess I would ask looking just at Cloudcall (LON:CALL) what do you think about its valuation relative to its potential and the risks? This is I guess what matters most for a growth company. What is its current valuation relative to its potential.

TangoDoc

19th Jul '18

I have assumed that was the usual function of the weakness of the gold price but would also like to know if Graham thinks there could be other issues. https://www.gold.co.uk/gold-price/

Graham Neary

19th Jul '18

Hi guys, I'm not aware of any other reason. G

Boon

20th Jul '18

I disagree that this is the wrong time for Headlam (LON:HEAD) to be looking for acquisitions. Now that the whole industry is struggling, it is the smaller ones that do the worst, and so Headlam (LON:HEAD) should be able to pick up lots of small acquisitions at really good prices, and then also realise a lot of synergies.

Granted, this will stretch their balance sheet and also management attention, but if they get it right they could end up really building a business that throws off lots of value in the next few years.

Small Cap Value Report (Wed 18 July 2018) - MPAC, CALL, HEAD, RDL

MPAC (LON:MPAC)

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Graham Neary

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