Small Caps Live wekly Summary

BIDS BOTB CNC LOOK G4M HSS SDY SOM TGP

Another quieter week for small cap share discussions. Nice weather meant that investors’ priorities have been elsewhere. In addition, rising interest rates, including a 50bps rise in UK base rates, have dampened sentiment. While the drip drip of outflows and cautious trading updates can be hard to take, it is difficult to be depressed when quality businesses are available at all-time low valuations. However, in these markets, investors need to be especially good at avoiding promotional dross.

These are the companies that were discussed this week:

Bidstack (BIDS.L) - Annual Report & Accounts

With so many companies failing to have uploaded their annual report when they say they have or putting it in a hard-to-find corner of the website, whoever was responsible for this statement deserves the credit for linking directly to the download page of an extant report. Perhaps less credit is due for the state of the company finances as the auditor’s report says:

We draw attention to note 2 in the financial statements which indicates that the group is dependent on further equity funding to sustain itself over the following year and that there is no guarantee that such fundraising will be available. As stated in note 2 this condition indicates that a material uncertainty exists that may cast significant doubt on the group’s ability to continue as a going concern.

Shareholders presumably knew they wouldn’t survive without another equity raise. However, there is also an Emphasis of Matter:

We draw your attention to note 18 in the financial statements which describe the conditions on which management have assessed the recoverability of the amount owed by Azerion.

Note 18 says:

the extent of Azerion debtor recoverability is uncertain and therefore management feels that it is prudent, due to the inherent risk involved in any litigation, to take a bad debt provision against the amounts owed by Azerion at year-end 2022. Bidstack's external counsel cannot provide the company with a percentage likelihood of a successful outcome. Consequently, Bidstack management has arrived at 30% as a reasonable % to provide.

It seems the auditors perhaps don't agree this provision is conservative. We would suggest potential investors use a figure of 90-100%. Until this is resolved then investors would seem unwise to support the required equity raise. Here is the breakdown of customers:

They are clearly massively overdependent on one customer whom they have now fallen out with. Revenue from their other customers has pretty much halved, at least when inflation is considered. But the biggest problem with the company is and always has been the level of administrative expenses. Staff on-costs alone have climbed from £4.3m to £5.9m in a year. This is why the company as it operates is worthless and likely to fail, probably this year.

Best of The Best (BOTB.L) - Recommended Cash Offer

Normally, shareholders would be pleased with a takeover. However, in this case, the 535p offered is lower than the shares have been trading since February. Unsurprisingly, the offer is from Globe, controlled by Teddy Sagi, who are almost 30% holders. Here's how they sell it:

an approximate 33.75 per cent. premium to the price of 400 pence per BOTB Share paid by GIL to acquire the 29.9 per cent. shareholding in BOTB on 8 September 2022 (the "GIL September 2022 Purchase");

With management also supporting the deal, they have over 50%, and it is a technicality to complete. And we have some sympathy for the view that thus is actually a good deal for shareholders. The following chart shows where popular commentator Paul Scott revealed this to be his largest holding:

Best of the Best can’t help it if smaller shareholders get carried away on a tenuous basis and bid the value of the stock too high. Management here has always had a better understanding of the underlying value of the company than smaller shareholders, or even exuberant institutions. So if they are selling at 535p, it is probably a fair deal.

As always, getting a decent takeover premium is a matter of shareholder structure and valuation, not just desirability to an acquirer.

Concurrent Technologies (CNC.L) - Update on Audited Results

This is another company that looks like they are going to be suspended for not producing audited results on time (although they simply note the deadline rather than saying explicitly they will miss it).

The issue is having to restate prior accounts for too aggressive capitalisation of R&D:

Whilst still ongoing, the audit process is expected to result in a change in the capitalisation of historical research and development ("R&D") costs over the period 2016 to 2020 that requires a prior year adjustment being booked in the closing accounts for the financial year to 31 December 2020 ("FY20") of approximately £1.1m, reducing both capitalised R&D and retained earnings by this amount, which will reverse through a lower amortisation charge going forward.

The current year seems to be going well, though:

Looking forward to the current financial year ("FY23"), the Board is growing increasingly confident of delivering a significant increase in revenue over FY22 and of its ability to meet and, potentially, exceed current market expectations for FY23. This confidence is underpinned by continued growth in new orders and increasing visibility on physical delivery of key components required to fulfil backlog orders.

The market has taken the risk of suspension as a negative, so it could be an opportunity for true believers who don't need access to their money. We are sceptical, though. If we understand correctly, it also looks like a loss of £0.5m is being forecast for the year, so a £1.1m loss in H2. Not great, even if they exceed these figures, when the market cap is £47m.

Properly accounting for capitalised R&D, it looks like EPS has been broadly static at around 3.8p for several years. Apply a reasonable multiple (6-8x) for a static company, and you get a fair value share price significantly lower than the current pre-suspension level. There is also around 12p of net cash per share to add in, but little history of returning any of this to shareholders apart from a fairly paltry dividend. On top of this, in our opinion, new management appears to have a history of allowing a false market by failing to announce a previous dip in trading in a timely fashion. So an investment here pre-suspension would appear to tip over into foolhardy rather than simply brave.

Lookers (LOOK.L) - Takeover

The car dealership sector has been ripe for consolidation, and Lookers are the latest to be bought at 120p cash:

The Offer values Lookers' entire issued and to be issued share capital at approximately £465.4 million.

This works out to be just 5.5x historical PBT, but then 2022 was an exceptional year, which isn’t forecasted to be repeated.

For the year ended 31 December 2022, Lookers delivered an impressive trading performance that was ahead of the Lookers Directors' expectations, with Lookers recording revenue of £4.3 billion and profit before tax of £84.4 million.

The deal is at a decent premium to Tangible Book Value, though, and a decent premium to the share price:

The Cash Consideration represents a premium of approximately:

·    42.2 per cent. to the volume weighted average price per Lookers Share of 84.4 pence for the one-month period ended on the Latest Practicable Date;

This looks like a done deal, with Cinch supporting the offer rather than making a counteroffer:

In addition to the irrevocable undertakings given by the Lookers Directors as set out above Bidco has also received letters of intent to vote in favour of the Scheme at the Court Meeting and the resolutions relating to the Offer at the General Meeting from Cinch Holdco UK Limited...

As a reminder, Cinch is part of Constellation, which bought its stake from Tony Bramall in February 2022. They are also a rival PE consolidator, having bought Marshalls. They also own BCA and WeBuyAndCar, as well as Cinch. Therefore it is unclear whether they decided to take a quick profit and will bid for somebody else or this is an indication that they have rowed back on their aspirations.

Their stake in Lookers is worth around £90m at the bid price versus approx. £250m market cap for each of Vertu and Pendragon. Hedin may return to bid for Pendragon once their legal issue is sorted out (and in the meantime, their business has only been improving). Car Dealer Magazine reports that:

Swedish car dealer group Hedin has said it is considering issuing bonds to help raise around £110m to fund ‘potential acquisitions’.

Which might imply Constellation will bid for Vertu once they have the Lookers cash, perhaps in four to six months’ time?

Gear4Mmusic (G4M.L) - Final Results

These are poor, with them reporting a loss:

Not only that, but the outlook is pretty negative:

Market conditions have continued to be challenging since our last update in April, and we are taking the appropriate and necessary actions to ensure our business is correctly configured, resourced and positioned strategically for long term success.

Looks like they hit revenue but missed on profit if Stockopedia figures are up to date. Their net debt is down from last year but still up on the half-year and represents a significant part of their capital structure.

Cashflow looks weak after adjusting out the inventory change. The total capitalised for their software platform looks too high for the size/complexity of the business. The amortisation period given is 3-8 years. We’re not sure what parts could justify 8 years so perhaps it is being under-amortised. We think it would be prudent to use cash values here.

At current trading levels, it would seem likely that net cash will deteriorate from now until when Christmas receipts start coming in. The cost of debt (interest rate margin) is not given. Unless things start improving, they could start having a problem during the calendar year 2024 at current levels of capex. Some guidance here would therefore be useful.

H2 EBITDA was much weaker than H1, suggesting an uphill battle to hit 2024 estimates. However, broker Progressive say:

Outlook−forecasts unchanged. The softer trading conditions seen in the last two months of FY23 have continued into the current financial year. At this early stage of the year and given the importance of the Q3 peak trading period (October to December) to the full year outturn, we are leaving our forecasts unchanged at this pointfrom the revisions made in the wake of the April FY23 full year trading update.

The risk of a miss remains, though. And even if they hit the figures, they don’t look cheap on a 21xP/E (not even debt-adjusted). The market appears to have been bonkers bidding this up after the April trading update.

HSS Hire (HSS.L) - AGM Trading Statement

This is in line, but with positive momentum:

The Group has continued to see positive trading momentum in the first five months of FY23 and remains on track to deliver full year Adjusted EBITA1 in line with market expectations.

"We are very pleased with the Group's progress in 2023, both in terms of financial performance and the implementation of our strategy.

(Our emphasis)

This still seems too cheap, given the trading momentum. Although we can see why the market is waiting to see the numbers before any re-rating. Presumably, people are worried about the prospects for housebuilding customers.

Speedy Hire (SDY.L) - Final Results

This is obviously small-cap hire company week, as Speedy Hire also reported:

These appear to be a beat on EPS, at least on an adjusted basis. The statutory results include the write-off of missing equipment. At least it should be a genuine one-off.

The outlook is very similar to HSS:

· Recent key contract wins and extensions, as well as strong pipeline, gives confidence in meeting our expectations for the coming year

· We remain vigilant to the continuing challenges of the macro-economic climate

They note:

In view of the new growth strategy which has been implemented there is presently no plan to engage in a further share buyback programme, but the Board will continue to keep this under review.

This is another company that has spent a considerable amount of cash buying back shares well above the current share price. Their return on capital is well below the industry leader, and their valuation relative to tangible assets reflects this. So perhaps the money is indeed better targeted at sorting things out.

However, with share price weakness going into the results, apparent "inline" guidance and a strategy to improve performance, we see this as a positive update, and, like HSS, the shares look good value.

Somero (SOM.L) - Trading Update

Starting the update with “while” gave the game away here:

Having considered these current factors, the Company expects H1 2023 revenue will range between 15% and 20% below the record US$ 68.5m revenue reported in H1 2022. The Company now expects 2023 revenue will approximate US$ 120.0m, approximately 10% below 2022 revenue of US$ 133.6m. The Company anticipates an improvement in H2 2023 revenues over H1 2023 driven primarily by increased availability of the S-22EZ during the second half of the year.

So this is a profits warning. Having been this big growth driver in the last few years, the US is the problem, particularly due to concrete supply issues. They say:

We continue to anticipate strong contributions to 2023 revenue from Europe, Australia, and the Rest of World territories, with Europe and Australia each expected to report H1 2023 revenue that meets or exceeds the comparable H1 2022 total.

Broker finnCap say:

We are reducing our FY23 revenue forecast by 10% to $120m, with a 16% reduction in adj EBITDA to $36.0m, resulting in adj PBT of $32.5m and EPS down 17.3% to 44.0ȼ. Our yearend net cash expectation increases from $31.0m to $32.0m due to working capital actions. Our total dividend for the year reduces from 31.0ȼ to 27.0ȼ.

Here are their figures:

The rating certainly suggests that some of this warning was already in the price:

However, shareholders rarely shrug these sorts of things off. And indeed, the share price opened down 14%. This was a little bit less than the EPS reduction, putting them back on the 7x cash-adjusted forward P/E that seems to be the norm at the moment.

The basic truth here is that Somero are a capital goods supplier, and their customers are feeling less confident. So with an H2-weighting, there could be more pain to come.

This suggests that they don't see this as a short-term blip:

Somero's operating model enables it to adjust quickly to changing circumstances. Due to the anticipated 10% reduction in 2023 sales compared to previous expectations, the Company has reduced its operational workforce by 10%, a restructuring that takes effect alongside this trading update. The workforce reduction combined with strict cost controls for the remainder of 2023 partly offset the profitability impact of the revised 2023 revenue expectations. The Company has also taken additional steps to minimize inventory levels.

However, they have added significant capacity in their Houghton facility, which suggests that long-term management still expects to see growth. It would be easier to argue for this if we saw more traction on their innovative products and less reliance on US boomed screeds.

Tekmar (TGP.L) - Interim Results

At first glance, it looks like this may have finally turned the corner:

Revenue of £17.7m (HY22: £13.0m) with strong growth across both Offshore Energy (37%) and Marine Civils (35%) divisions, compared with prior year comparator

·      Gross profit margin for the Period increased to 28% (HY22: 22%), driven by strong variation and commercial management…

·      Expect business to break even at an Adjusted EBITDA level for the current financial year, with revenue in the region of £40m, of which over 90% is already secured

However, this old chestnut is back:

Accrued income has increased to £6.0m (HY22: £1.9m). The majority of the HY23 balance is expected to be invoiced by Jun-23. As an offset, deferred income balance is £5.5m which reflects the improved commercial terms and project milestone payments the business has been able to secure.

So £4.1m of the £17.7m for the period is uninvoiced for 3 months.

They are now billing some money on signing contracts:

These contracts had sizable upfront milestones which were billed at the half year and represented around £3.8m of the £5.5m deferred income balance, however, as at end of March had not yet crystallised into cash.

Elsewhere, we’d say these were good commercial terms. However, given the history, this is another red flag, given the non-delivery risk. And until we see positive consistently positive cash flow then this remains very risky.

That’s it for this week, have a great weekend!