Small Caps Live Weekly Summary

DX TUNE PMP LOOP SUP

An earlier email this week as there was limited discussion-worthy news amongst the type of companies we follow this week, and pretty much none on Friday. So here you go:

DX Group (DX.L) - Possible Offer

DX becomes the latest UK company to receive a potential offer.

possible all cash offer for the Company at a price of 48.5 pence per DX share

This doesn’t sound overly generous, being a 2024 P/E of just 10. However, the board are minded to recommend it. When a takeover price looks overly cheap, it is tempting for holders to gnash their teeth and waste a lot of energy complaining about a situation they can’t influence. Instead, given current markets, many would be better off by taking the cash and redeploying it into the plethora of equally undervalued stocks.

Gatemore and Lloyd Dunn have provided letters of intent for 29.4% of the shares, so this sounds like a done deal if an offer is made. There is currently an 11% or so arb for those who think this will become a firm offer. In addition, given that the buyer is Private Equity, they clearly see an upside at the potential offer price. So, it is certainly possible that a trade buyer could outbid them due to the synergies available to them. Perhaps it is all to play for now, as it is clear that the board and two larger holders are willing to support a deal at the right price.

Focusrite (TUNE.L) - Trading Statement

Focusrite make their current trading sound quite exciting and like a return to growth, until we get to:

Overall, revenue for the Group in H2 FY23 was slightly ahead of the comparable period in FY22. As a result, Group revenue for FY23 is expected to be not less than £177 million (FY22: £184 million). Supported by improved gross margins, our expectations are for EBITDA1 for the full year to be around the lower end of current market expectations, which currently range between £38.2 million and £39.0 million.

Ok, that’s a pretty tight range to be at the lower end of. It just seems strange to give it all the whoops in the narrative beforehand.

On the positive, cash generation has not been bad in the second half, as net debt has reduced:

As at 31 August 2023 the Group had net debt2 of approximately £1.5 million (FY22: net debt £0.3 million, FY23 H1: net debt £13.2 million).

However, even accounting for the £7.2m acquisition and dividends paid, it is only £9.7m FCF generated over the full year. With a £300m market cap, this is a 3% FCF yield. It's not great, considering this is a period they didn’t grow their top line. The main point is that this level of FCF doesn’t fund major acquisitions that would move the needle on growth so they are stuck in a kind of limbo.

But they are on an EV/EBITDA of around 8, which isn’t crazy if you believe they can grow rapidly organically from recent internal investments. Flat revenue and EPS forecasts for 2024 don’t give a lot of confidence in this, though. And, of course, if they are not able to grow rapidly, they are overvalued.

Portmeirion (PMP.L) - Interim Results

The company starts with a defensive tone:

H1 results reflect previously stated US retailer destocking

And understandably so, we doubt that a swing from 12p EPS last year to losses this year was expected. Also, we did not expect the surge in borrowings. This is due to an increase in receivables yoy and a pronounced decrease in payables both over the period:

higher receivables due to customer mix and lower payables due to reduced inventory purchasing. We expect both of these movements to unwind in H2.

Inventories are flat, so it does seem they have gotten ahead of the downturn, but it is pretty incredible that this kind of balance sheet and profitability dislocation could result from revenues down just 3% yoy.

After previous updates, we commented that we didn't believe the FY 2024 forecasts in the market. This week, broker Singer have trimmed EBITDA but left profitability unchanged. Net cash actually improves. Shore say they leave their forecasts unchanged. So for both 2023 and 2024, cash and profitability, the brokers give some comfort for what looks like a pretty ropey update.

The company are rarely good at meeting consensus forecasts, but after looking at the figures, Leo is happy with Shore's 33p for FY 2024 (versus the consensus of 36p). So that's 25p of real EPS with more sensible adjustments. In current market conditions, and with the history of misses, fair value has to be somewhere around 200p, rising to perhaps 250p in normal market conditions. We’ll be watching H2 restructuring costs and the pension deficit closely. But not that closely, because shareholders appear to be travelling hopefully, as the share price to these poor results was unchanged at 285p, giving little opportunity for a profitable investment.

LoopUp (LOOP.L) - Interim Results

For a while now, the rise and fall of this COVID-darling has made it look like it is on its last legs. In this light, these results are not half as bad as we imagined. They started the six-month period with £1.6m of cash and ended with £0.9m despite paying back £1m of loans and spending £2.5m on development.

The trouble is that the current ratio looks appalling. There's £1.7m of debt repayments (before interest) due within the year, which looks to be a struggle. Payable/receivable movements gave them a boost, which can't continue much longer (if at all). The £3.8m in accruals and deferred income may be customer pre-payments and a problem depending on the profile.

In June 2023, the Group successfully extended its debt facilities with Bank of Ireland by twelve months, such that the facilities will now mature on 30 September 2024.

Reduction of outstanding Bank of Ireland debt to £6.0 million (31 Dec 2022: £6.8m) following scheduled repayment of £0.85 million in June 2023

It is likely that they need to do some more renegotiation with BoI as it isn't clear they can meet their £0.85m payment due (we infer) in December, let alone the next one, let alone the balloon payment next year. This will surely cost them in terms of interest rate margins. The original rate for the BoI loan was 2.5% over LIBOR, increased to 4.5% over SONIA when extended to 30/9/2023, and no change when extended to 30/9/2024. There's a material uncertainty over going concern in the FY 2022 accounts due to the bullet (to the head) payment due on 30/9/2024. That is now only a year away.

Today's results statement is very thin, but from the AR on development expenditure:

The Group has been developing and enhancing its remote meetings platform in recent years and continues to enhance the platform in the prior and current year to integrate the Group’s Cloud Telephony business. The development relates primarily to the payroll costs of the developers who work on the development projects.

Hybridum

The majority of 2022 product development time has been spent materially reworking the platform from its legacy education focus to a next generation version for large scale hybrid corporate training and events. The Group is currently reviewing its go-to-market strategy with a view to the scalable growth potential of this differentiated technology, and will make further market announcements in due course

They don't mention development spending on the Meetings side, but surely there was some to support customers transitioning from PGi Connect? There appears to be considerable scope for development spend to reduce as developments complete or are abandoned, albeit with the risk of restructuring redundancy costs.

Overall, this is far better than we expected. Without doing detailed modelling, it looks like the company could be worth a few million pounds as long as they handle the refinancing and investment in future developments carefully.

The share price responded by rising over 50%. However, we are not sure why, as these figures were broadly known, and we see nothing new today. Perhaps at this stage, it is a bit of a relief rally as they get to live another day or two with BoI’s permission.

With the share price the highest since March, surely equity issuance makes sense here. The thing is, they have a dilemma: Raise enough to take Hybridum to market, which is probably £6-8m, and so would leave existing shareholders with significantly less than half of the company. Or abandon Hybridum, sack most of the development staff and try to extend the loan facilities further. Cost cutting and a raise of £1m should be sufficient to get BoI to extend another 18 months, especially if they persuade them that's all they could get and that's the only available plan.

We have only a limited idea of whether Hybridum is a viable product and what would be best for shareholders, but it seems pretty clear that putting the company into runoff would be by far the lowest risk. Really, it comes down to what story the institutions are willing to buy in to.

Supreme (SUP.L) - Disposable Vaping Ban

Last week, The Times ran a story with the headline:

Tories accept £350,000 donation from vape firm

The Conservative Party has accepted a six-figure donation from a company linked to colourful vapes despite a government crackdown on the products being marketed

Never has £350k been wasted so quickly, as this week The Telegraph ran a story saying:

Ban on disposable vapes to stop children becoming addicted

Health ministers preparing to act after concerns companies are marketing the colourful products at under-18s

It seems many forget that when trying to influence a corrupt regime, they are just as likely to betray you as the people you want to be betrayed.

Rough details are:

A call to evidence was issued last April, with the aim of clamping down on youth vaping. A new consultation, honing in on specific proposals, will put forward the disposable vape ban. The ban would apply in England, with other devolved administrations having to set policy for Scotland, Wales and Northern Ireland. A law change would likely be needed, but it remains to be seen if time could be found in Parliament before the next general election, expected in autumn 2024.

The shares have taken a bath on this news, dropping from a high of around 130p a couple of months ago to around 90p now. We have previously warned that this was a major risk to the company. Particularly as they pivoted away from the more traditional FMCG products to being more vaping-focused.

So, what is the financial impact? In the last Equity Development webinar, they disclosed that disposables were £10-12m from £76m in Vape sales in FY23. They make a 10% gross margin on battery distribution, 27% gross margin on lighting distribution, and 37% across all vaping. So 30% on the mixture of the 88vape contract manufactured and (a small amount in 2023) of pure distribution sounds about right. So, the 2023 operating profit would have been around £3.3m lower without disposables and assuming no substitution (which is more likely on the 88vape side, which offers both).

So, we think you can make a case for FY 2025 profits being similar to 2023's before considering the larger market. Therefore, the forward PE is still around 10x. It's not bonkers, and some may argue good value. However, one has to remember that other regulatory risks remain around vaping, and the management have proven themselves to be of questionable judgment and character. As such, this remains a very risky stock, and the multiples investors are willing to pay should be adjusted lower to reflect that.

That’s it for this week. Have a great weekend!