Mello London
Less than two weeks to go to the Mello London investing conference at the end of the month. A lot of UK small cap investors, including many SCL contributors, will be attending. There is no talk from Mark this time, but he will be on the BASH panel to discuss some interesting share ideas. Do join us for what is the UK’s best investing conference for individual investors. Use code ML40X for 40% off tickets.
Takeovers
There have been so many takeovers of UK stocks recently that we rarely comment on them. However, Hotel Chocolat got a bid this week at a 170% premium. Bearing in mind that the company looked like it had become permanently loss-making following recent results, we wonder what the acquirer Mars is actually buying. We are thinking it is really the brand name that has value. Mars will sell off the hotel in St Lucia, in-house all the manufacturing and push the chocolates through their existing distribution channels.
It goes to show the value that a founder controlling stake has in determining the price paid:
In contrast, DX Group got their long-anticipated bid from Private Equity. Here, the board hold minimal stakes, so they seem quite happy to recommend a bid at 48.5p, of which 1p is the already ex-dividend payment from the company’s own cash resources. They will no doubt argue that the share price has done well recently, and there was a 30% premium to when the deal was mooted. However, since then, the company has beaten expectations and was at the start of a multi-year tailwind from competitor Tuffnells going under.
We usually chastise corporate management for being massively overconfident. However, here, the board seems to doubt their own ability so much they gave in on a cash-adjusted forward P/E of just 10! It certainly suggests that they believe that recent strong trading is down to chance rather than the strength of their decision-making. This is a done deal, so it does shareholders no good worrying about these things, especially as there are so many opportunities to deploy cash into bargain UK stocks at the moment.
Fintel (FNTL.L) - Acquisitions & Trading Update
Despite the name, this is not a Finnish Telcoms company but the owner of the DeFaqto rating business for insurance policies, amongst other things.
Trading is inline:
The Core business continues to deliver resilient earnings in line with board and market expectations for FY23, with the ongoing pressures in the UK housing market being largely offset by continued progress in software license sales and acquisitions.
Which on a forward P/E of around 18 makes them a little toppy for a business with long-term single-digit revenue and EPS CAGR. However, they are still scaling their business as the bigger news is two acquisitions. The first is:
Acquisition of VouchedFor via Fintel IQ, a technology and knowledge platform
o VouchedFor is a leading review site for Financial Advisers, Mortgage Advisers, Solicitors and Accountants, serving over 5,000 intermediary customers…
o Completed in November 2023, the transaction was part debt funded with a net upfront cash consideration of £7.5m, of which £6.5m was drawn from the Group's £80m revolving credit facility
o A contingent earnout, based on a multiple of recurring revenue generated over the next two years, is capped at £10m
The second:
Acquisition of AKG by Defaqto, the leading provider of financial information, ratings and fintech
o AKG is a leading provider of independent assessments and ratings of financial strength for a range of organisations including life companies, investment platforms and discretionary fund managers…
o Completed in November 2023, the transaction was funded entirely from cash reserves with a net upfront cash consideration of £1.6m. In addition, up to £0.4m contingent earnout is based on certain trading criteria being delivered in the first three years of ownership
The latter looks fairly immaterial, but at up to £17.5m, VouchedFor is material. However, Fintel doesn’t seem willing to share any financial details of what they have bought. A companies house search doesn’t help either. VouchedFor is too small to be required to file an income statement. Our instinct tells us they would have told us some figures if they made it look like a good deal. This is backed up by house broker Zeus, who say:
These acquisitions will add to revenue, but be dilutive to EBITDA margin while they build scale.
Gear4Music (G4M.L) - Half-Year Results
Another weak half from this former stock-market darling:
But do we get the downgrade we have been predicting? Kind of:
Whilst profit expectations remain the same, we are moderating our revenue expectation for the year to £144m, to reflect sales run rates and the actions taken to prioritise profits over growth. This has been offset by an increase in gross margins and lower costs contributing to higher overall profit margins. As such, full-year adjusted/underlying profit outlook remains in-line with current consensus market expectations.
So, instead of revenue rising from FY2023's £152m to £162m for FY3/2024 (+6.3%), it is now expected to fall to £144m (-5.2%). What a remarkable turnaround in less than four weeks! The good news is that the new revenue guidance is a lot more sane. We’re not so sure about the margins, though.
One positive is that inventories have fallen 10.1% versus forecast falls in revenue of -5.2% and a further seasonal reduction is expected for the full year. There is some concrete evidence of reductions in future admin costs:
Exceptional costs of £0.5m relate to redundancy costs incurred during the restructure of various Head Office teams, principally Software Development. These costs were paid in full in FY24 H1.
Also:
Headcount at 30 September 2023 (including Software Development team) of 434 was 20% lower than as at 30 September 2022 (541).
There remains some mystery about these figures, though. Running some basic maths: The average employee they let go cost them £37k to employ, so they probably earned £25-30k when you adjust for Employer NI, pension etc. They paid them £4.7k redundancy, on average. That’s two months’ pay. So it seems the majority of those being let go are low-paid warehouse workers on insecure contracts or IT contractors on zero notice. Of course, what may have happened is that the most employable IT staff saw the way things were going and left on their own without needing a payout.
The market appears to have given them the benefit of the doubt, as has house broker Singer, who say:
We have downgraded sales by 11% both this and next year, which is offset by better gross margin assumptions (+75-80bps) and cost efficiency (50-60bps). On these revised assumptions, our EBITDA margin forecast expands by 30bps this year, and by 40bps next year to 6.0% (on a pre-IFRS16 basis). Adj PBT/EPS forecasts therefore remain unchanged.
We wonder how long that will last, though.
Jadestone Energy (JSE.L) - Operational Update & Acquisition
We always read these with some trepidation, given recent history. However, this time, it is good news as Jadestone report production guidance at the upper end of the guidance range due to higher-than-expected performance from new wells in Malaysia:
Since 1 April 2023, Group production has averaged c.14,400 boe/d and has averaged c.13,100 boe/d year-to-date. Based on current expectations for the remainder of 2023, production is now expected to be towards the upper end of the April to December guidance range of 13,500 - 15,000 boe/d
Capex is slightly higher due to the need to re-enter one well, but these wells pay back in less than six months, given higher-than-expected production.
There are a few minor issues with Montara, but nothing out of the ordinary, and this is a lot less important to the company than it was earlier in the year:
Montara has averaged c.5,700 bbls/d in recent months, with good well performance offset by occasional brief interruptions associated with offtake arrangements, including the replacement of a short section of offload hose at the shuttle tanker;
Atkara is on schedule for commissioning in 24Q1, and the first gas in H1.
Later in the week, we get the announcement that they are acquiring a further interest:
[Jadestone has] executed a sale and purchase agreement with Japan Australia LNG, to acquire the Seller's non-operated 16.67% working interest in the Cossack, Wanaea, Lambert, and Hermes ("CWLH") oil fields development, offshore Western Australia, for a total initial cash consideration of US$9 million, and certain subsequent Abandonment Trust Payments.
So, the company are back to its core rationale of acquiring mature fields that are immaterial to others, where there is scope to add production. This deal looks like a great price:
As such, we are pleased to be increasing our interest in a very high-quality, long-life asset with low decline rates at an attractive 2P acquisition cost of US$1.7/bbl, or less than US$1/bbl on a 2P + 2C basis. This acquisition also provides us with greater influence over investment decisions on an asset which is expected to be an important part of the Jadestone investment case for years to come.
Given that operations are now largely back to where they were at the beginning of the year, with some dilution but also a better outlook for many assets, it would seem strange that the share price is still in the doldrums. One theory appears to be that Baillie Gifford is being pressured to sell Oil & Gas positions for “ESG” reasons. If this is the case, then this could be a great bargain. We love it when funds are sellers for reasons unrelated to the underlying value of the business. Whoever is feeding the market could go on selling for quite some time, though. So patience will be needed.
That’s it for this week. Have a great weekend!