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Small Cap Value Report (Mon 23 Nov 2020) - AA., CINE, CER, CDM

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Good morning, it’s Paul amp; Jack here with the SCVR for Monday.

Timing – there’s a fair bit to cover today, so we might over-run the 1pm official finish time. I’ll make a note here once we’re done, as usual.

Agenda -


This part written by Paul Aa (LON:AA.)

Share price: 31.5p (down 6%, at 08:12)
No. shares: 622.8m
Market cap: £196.2m

Update on possible offer

It looks as if things have moved forwards in a positive way for shareholders (anything above 0p is a good outcome, in my view);

The Board of Directors of AA (the “Board”) notes the recent press speculation and confirms that it has received a non-binding proposal from TowerBrook Capital Partners (U.K.) LLP and Warburg Pincus International LLC (together the “Consortium”) regarding a possible cash offer of 35 pence per AA share for the entire issued, and to be issued, ordinary share capital of the Company (the “Proposal”).

On 27 October 2020, AA announced that commercial discussions and due diligence were progressing with the Consortium. The Company confirms that these commercial discussions have advanced and that following a period of due diligence have led to the Consortium submitting the Proposal.

The bidders intend to inject more equity, and help refinance the huge debt mountain.

AA’s Board says it has considered all options, and would be willing to recommend this 35p bid

My opinion – this is a lucky outcome for AA shareholders, who were in such a weak position vs debt holders, that a wipeout for equity was a considerable risk.

Is a higher competing offer likely? It’s always possible, but the greater risk is that the bidders might pull out, and that could easily end up with equity worth little to nothing.

Therefore, in my view, the logical thing to do is to accept the 35p offer, if it becomes formal. Actually, if it were me, I would sell in the market now, just in case the bid falls through.

Gambling on a takeover bid at an effectively insolvent company, is complete madness, in my view.


Cineworld (LON:CINE)

Share price: 54.0p (up 17%, at 08:41)
No. shares: 1,372.8m
Market cap: £741.3m

Significant Additional Liquidity Secured

This is a hugely indebted cinema chain, which follows on nicely from the AA, which is in a similar mess because reckless management took on way too much debt at both companies, thus destroying shareholder value.

Although to be fair, very few people saw covid coming. It turns out that many business models we thought were safe, with repeating revenues that could be relied upon, were not actually safe at all. A lot of thinking needs to be done about what valuation we should put on businesses, and what level of debt is safe to take on, given that another pandemic could occur at any point in the future. Or will everyone forget within a few years, and everything goes back to how it was before? That’s what tends to happen, in my view. Look at the 2008 crisis. It wasn’t long before the excessive gearing that caused the crisis was building up again.

As I mentioned last week, recent press reports were suggesting that CINE could be teetering on the brink of financial collapse. Many of its cinemas have been forced to close, and there’s been a lack of new releases, as film producers have also faced restrictions due to covid.

Personally, I think the bigger threat to cinemas, is that many people now have large televisions at home, and would probably prefer to see films released direct to consumer (a very important investing theme) to stream at home.

Personally I loath going to the cinema, and last time I did, the experience was ruined by people constantly coughing, rustling sweet wrappers, and their mobile phone screens lighting up in the darkness. I thought to myself, this would be so much more pleasant if I could watch at home on my 65” Samsung, sitting right in front of it, which makes for a more immersive experience than being in a cinema with the general public, picking up germs too, even before covid came along.

Anyway, it seems to me that the days of cinemas could be numbered, once the big film makers decide to disintermediate, and sell direct to the end customers with a streaming service. Although a counter-argument to that, is that cinemas charge per person, whereas streaming would be per TV – so a household paying say £6 to download a film would generate much less income that say 4 or 5 people going to the cinema together.

Even without its colossal debts, I wouldn’t be interested in buying CINE shares.

Additional funding – has been secured, as follows, which does have a whiff of scraping the barrel;

· Secured a new debt facility of $450m and issue of equity warrants
· Agreed bank covenant waivers until June 2022
· Extended maturity of the $111m incremental RCF from December 2020 to May 2024
· Accelerated tax year closure to bring forward an expected tax refund of over $200m to early 2021

Cineworld believes that together these steps will provide the Group with financial and operational flexibility until lockdown restrictions in key jurisdictions are eased and studios are able to bring their enhanced pipeline of major releases back to the big screen.

Equity warrants - there’s a separate RNS detailing the terms of the warrants being issued to the lender(s), as follows;

Exercise price 41.49p (10% discount to last closing price before today)

Exercisable at any time in the next 5 years

Dilution of up to 10%, being 153.54m warrants, per the RNS, but the dilution looks to be 11.2% based on the current number of shares in issue, by my calculations

For anyone not familiar with warrants, they’re very similar to call options, giving the holder the option, but not obligation, to buy new shares at a fixed price, over a defined time. Therefore if the company does well, and the share price rises in future, then the warrant holder gets the benefit of buying shares below market price. If the company does badly, then the warrant holder can just do nothing, and after 5 years in this case, the warrants would lapse.

My opinion - the issue here is that the upside for existing shareholders has been trimmed by the dilution from warrants. It would be important to check the last Annual Report, to see if there are other warrants in issue. I’d be worried that a precedent has been set, and in future re-financings, the debt providers might demand a chunk of the upside too, with more warrants.

Total debt is on a massive scale now (and I’ve seen much higher figures in the press, which might have included IFRS 16 leases maybe?);

After accounting for the New Debt Facility, the Group will have aggregate gross debt financing of $4.9bn with a weighted average interest rate of approximately 4.5%.

The problem with debt on that scale, is there’s only one long-term solution – some kind of debt for equity swap, or a huge amp; highly dilutive placing. The big danger is that it might have to be at a deep discount, to raise fresh equity. Therefore, the upside per share could be very limited in future, if there are (say) 5 times as many shares in issue as there are now.

Investing is all about weighing up risk:reward. In this case, CINE shares look extremely risky to me, and with probably quite limited upside, since heavy dilution seems inevitable, sooner or later. The key thing is that re-opening, once vaccinations have happened enough to allow re-openings, doesn’t solve the problem. There would still need to be major repairs needed to its balance sheet.

In the short term, price movements can be violent in this type of situation. Short squeezes are likely, when they panic buy, to cover positions, when news like today (of continued survival) comes out. So it’s dangerous to open short positions where there is already a big short position. I’ve been stung lots of times in the past, even at companies which subsequently went bust, there’s usually a big short squeeze near the end. So personally I don’t touch things like this any more, on the shorting side of things. And I certainly wouldn’t consider going long, in a company that has such high levels of debt, and is clearly struggling for survival at the moment. There are far less risky ways to play the covid recovery, in my view, where you don’t have to worry about insolvency.




Codemasters Group (LON:CDM)

Share price: 489p (down lt;1%, at 11:32)
No. shares: 152.4m
Market cap: £745.2m

Interim Results

Codemasters (AIM: CDM), the award-winning British video game developer and publisher specialising in high quality racing games, announces unaudited results for the six months ended 30 September 2020 (“H1 2021″).

I was hoping not to cover this one, but it’s so popular with readers that my arm has been twisted! Here are my notes. Please remember I don’t know what the future holds, so am just reviewing the historic numbers here;

Revenues doubled to £80.5m in H1 – I couldn’t find a split between organic, and growth from acquisition(s). The text mentions an acquisition called Slightly Mad Studios

Adjusted EPS (my preferred profit measure) also doubled to 13.7p, which looks good in the context of a full year estimate of 18.69p, which now looks too low, depending on seasonality amp; the release schedule for new games

Outlook – H2 has “begun well”, but nothing said about performance vs expectations

Digital delivery now very high, at 72.9%, helped by covid forcing closure of physical games stores for part of the period

Brought forward tax losses are particularly large, at £125m – hence very low tax charge. Should we be normalising the tax, to value the shares? Possibly

Creative sector relief of £5.0m boost to profits in H1, and £9.0m last year, is a major contributor to profitability. This looks like sector-specific tax relief – a risk, in that if it is reduced, or eliminated in future, then that would crash the share price

Balance sheet – looks OK, although note the big non-current liabilities, which would consume a lot of the cash pile. Overall, it looks healthy enough

Cashflow statement – again, looks fine to me. A genuinely cash generative business. Note that amortisation charge for capitalised development spend is roughly in balance with the capex booked. Amortisation policy (65% in first month), then balance over a year, looks prudent, and reflects reality

Recommended offer from Take-Two Interactive – estimated to complete in Q1 2021.

Cash amp; shares. See RNS from 10 Nov 2020.

120p per CDM share in cash, and 0.02834 shares in $TTWO

TTWO shares are currently $170.0 each (volatile price lately), which (including the 120p cash element) values this bid currently at 480p

Are TTWO shares attractive? It’s a big company, valued at £14.7bn, listed in the USA. Stockopedia data on it looks good, with a StockRank of 88, and strong/growing profitability;


TTWO certainly isn’t cheap, on a forward PER of 30, but look at the growth above! If you want good growth, you have to pay up for it at the moment.

It’s worth noting that TTWO has a large, and growing cash pile, most recently $2.4bn. So it’s not clear to me why it is mainly using its shares are currency for the CDM deal? It can, and should pay cash! I don’t like takeover deals using the acquirers shares, as it creates an overhang of sellers who don’t really want their new shares.

Is the takeover price attractive? Probably not I would say, but I don’t have any up-to-date forecasts for CDM. Based on these interim figures, then the full year results could be 20-30p maybe? If so, then that would make the takeover price somewhere between PERs of 16-24 – hardly a knockout price, for a rapidly growing group.

I’d be inclined to reject the takeover approach. It needs to be higher priced, and all in cash. 600p+ strikes me as the right starting point.

Why on earth has CDM management recommended this seemingly ungenerous bid? The commentary says it’s a good deal for the company’s progression, but is it a good deal for shareholders? Do management have enough skin in the game to make the right decision for shareholders? Have they got the backing of the biggest shareholders? I don’t know.

My opinion – it looks an interesting company, but remember that a fair chunk of the profits come from favourable tax arrangements. Profits in this sector come from churning out new games, with a rapid payback, then a long, slim tail of revenues once the novelty has passed. This makes me nervous of the sector. That said, it’s clearly a growth area, and the graphics on some of these new games are almost lifelike.

Covid lockdowns may have boosted demand, from people on furlough, which could recede as we go into (hopefully) more normal conditions in 2021. I like digital delivery, as that can disintermediate the retailers, resulting in higher margins for the games makers, maybe?

As regards the takeover bid, it just doesn’t seem credible to me. Why would shareholders want to exit at this stage, when the company is doing well, for a modest premium, and receiving unwanted shares for three-quarters of the price? Sure, TTWO is a liquid share and you could lock in the selling price by opening up a short position via a CFD or spread bet. Then sell your physical shares, and close the spread bet simultaneously, when they are issued.

In the meantime, I’d be asking management some searching questions about why they have recommended this deal? Maybe they know something we don’t, and the price achieved is fair after all? Who knows?



This part written by Jack Cerillion (LON:CER)

Share price: 329.9p (+4.73%)

Shares in issue: 29,513,474

Market cap: £97.4m

Cerillion (LON:CER) has a 20-year track record in providing software for billing, charging and customer relationship management (“CRM”), mainly to the telecommunications sector. It has around 90 customer installations across 45 countries.

The business was originally part of Logica before its management buyout, led by CEO and major shareholder Louis Hall in 1999.

Business has been good for the group and it recently announced its largest ever contract win in September 2020 (£11.2m) – but you could argue that its premium tech valuation (with a forecast PE ratio of 26.8 and a forecast PEG of 2.3) has so far muted the reaction.


Final Results

The final results look solid, with ‘all key financial performance measures reached record highs’. Running through a bit of the detail, we have:

  • Revenue up 11% to £20.8m and recurring revenue up from 27% to 29% of total,
  • At the year end, on an annualised basis, recurring revenue was up 57% year-on-year to £7.9m – so this looks to be accelerating,
  • New orders matched last year’s record of £23.3m, which appears to represent a step change in activity,
  • The Back-order book is up 41% to £31m
  • Adjusted PBT up 7% to £3.7m and reported PBT up 8% to £2.6m
  • Adjusted EPS up 10% to 12.4p and reported EPS up 13% to 8.8p
  • Net cash up 54% to £7.7m
  • Total dividend up 12% to 5.5p

Brokers were forecasting EPS of 10.4p. Cerillion’s adjusted EPS figure is calculated by taking profit after tax and adding back amortisation of acquired intangible assets, share-based payment charge and exceptional items.

I would add back the share-based payment charge of £68,727 but this is not a material sum and so the adjusted figures seem reasonable. On that basis, it’s a forecast beat and puts the group’s shares on an FY20 PE ratio of 25.4.

The Group’s revenue streams are categorised in three segments: software revenue (comprising software licences and related support and maintenance sales); services revenue (generated by software implementations and ongoing account development work); and revenue from other activities (mainly from the reselling of third-party products).

  • Software revenue fell by 16% to £7.6m (2019: £9.1m) and accounted for 37% of revenue. This was due to the reduction in licence sales during the year to £1.6m (2019: £3.9m).
  • Services revenue increased by 44% to £11.3m (2019: £7.9m) and comprised 54% of total revenue (2019: 42%). This was due to a significant increase in new customer implementation work.
  • Third-party income remained constant at £1.8m (2019: £1.8m) and comprised 9% of total revenue (2019: 10%).


The trend is encouraging here and Cerillion’s CEO does say:

Revenue, pre-tax profits and the back-order book are at record levels, and we closed our largest ever contract win in the final quarter of the financial year, continuing a trend of larger wins.

So perhaps it can push on, continue to win bigger contracts, and grow into its valuation. That must be what holders are anticipating, and Cerillion has a decent chance of achieving this.

Founder and CEO Louis Hall owns 30% and institutions have been increasing their stakes, so they must see potential.

Demand for billing, charging and CRM solutions in its core telecommunications market is forecast to rise, with 5G rollouts driving a wave of investment in both telecoms infrastructure and ancillary systems. Cerillion also has that healthy order book.

It’s looks like a high quality operator too, with strong cash conversion, prudent finances, and double-digit returns on capital and operating margins. Of its c£25m of assets, only around £7m are goodwill and intangibles (while cash and accounts receivable come to nearly £15m). It has paid down £1.2m of debt this year and expects to pay off its remaining outstanding debt in FY21.

Furthermore, with gross margin coming in at 74%, perhaps there is scope for decent operating and profit margin expansion here as well.


The main concern here is probably generating that earnings growth in a timely manner in order to justify the premium valuation. But given the recent large customer wins and existing positive market trends, it looks like Cerillion has a fair chance of achieving this in my opinion.




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