Small Cap Value Report (Fri 19 Feb 2021) - Roubini on Bitcoin, TUNE

Good morning!

It’s Friday, time to ponder things.

In my view, we are now in the final, manic, euphoric phase of a bull market. It feels *exactly* like 1999 to me. That means there’s lots of money to be made, on mad speculations, and it’s going to end really badly. Maybe not for a while though, nobody knows. In this type of market, my thoughts on company fundamentals just become irrelevant, as the hot money chases the increasingly silly speculations. Facts amp; figures go out of the window, as people chase stories.

There are two key things to remember in this type of market – (1) don’t believe in the speculative stories, just sell them on for a profit to the greater fool, and (2) cash out of all the speculative junk before the crash happens, then walk away amp; don’t look back.

When things are going well, it’s worth pondering, how much money do you actually need? A word of warning here. I was sitting on about £x millions in 2007. Here I am 14 years later, and I’m still not quite back to flat. Why didn’t I just cash out in 2007? Greed, and hubris. Simple as that. A big run of luck amp; success, in a bull market, led to me risking money I needed, to make more money I didn’t need. A very harsh lesson. Let’s not do that again. It’s so difficult, and time consuming, to rebuild from a disastrous downturn.

Bitcoin is the mania of the moment. It’s an absolutely classic financial bubble, hiding in plain sight. It ticks all the boxes that previous manias over centuries have done. Here is a brilliant demolition of it by Nouriel Roubini -

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I do sometimes wonder why people who are so clever, and fluent in English, don’t think to improve their accent to make it more intelligible?

What he says is just brilliant though, and it’s quite obvious to me that sooner or later, Bitcoin amp; all the rest of these things, are likely to collapse. The danger is what damage that inevitable collapse does to the financial system, which is likely to end up containing a lot of leverage that fed the boom.

Or does it all just end up being picked up by the taxpayer, via QE? Who knows. This could all run amp; run, for many years. Nobody knows, the rules have all changed.

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Share price: 1,065p (+8.8%)

Shares in issue: 58,661,639

Market cap: £624.7m

Are we looking at one of the highest quality companies on AIM here? Focusrite (LON:TUNE) is a global music and audio products group that develops and markets proprietary hardware and software products. It trades under six established and rapidly growing brands: Focusrite, Focusrite Pro, Martin Audio, ADAM Audio, Novation and Ampify Music.

Its products are well regarded and are used by audio professionals and amateur musicians alike to enable the high-quality production of recorded and live sound.

Focusrite and Focusrite Pro offer audio interfaces and other products for recording. ADAM Audio are ‘precision innovators’ in professional monitoring and loudspeaker technology. Martin Audio design and manufacture sound systems, while Novation and Ampify products are used in the creation of electronic music.

The stock is superficially expensive, with a forecast PE ratio of 32.6x and a forecast dividend yield of 0.48%. But you might say Focusrite always looks expensive.

We looked at both Focusrite alongside Gear4music Holdings (LON:G4M) back in May last year in this post.

While G4M has rerated very strongly, TUNE has also handily beaten the market (and it looked expensive back then, too). What’s more, I can’t see any reason why these two companies wouldn’t continue to grow at above-average rates.

Trading update

The company says that revenue, profits and cash are currently ahead and it is therefore likely that current market expectations for FY21 will be exceeded.

Demand has remained strong so far this financial year and revenue for the six months to 28 February 2021 is expected to be in excess of some £90m (H1 FY20: £49.9m). Healthy cash generation also means Focusrite has cleared all bank debt.

Very positive, but there are a couple of notes of caution thrown in as well.

Alongside the strong demand for TUNE products, there are supply chain issues due to an ongoing global shortage of semi-conductors and other components. A more detailed announcement will be made in late April 2021, alongside the half-year results.

Tim Carroll, Chief Executive commented:

We are delighted that consumer demand for Focusrite and ADAM products has remained very high. This has resulted in increased demand from the distributors and dealers, which has translated into strong sales momentum producing higher revenues, profits and cash generation in the first half of the financial year.

Conclusion

This is a sparkling update and many might be wondering why they do not own this share.

Valuation is a concern. Against a market of thousands of opportunities there could well be greater upside elsewhere. TUNE is not quite QARP (quality at a reasonable price), but it is certainly quality.

FY20’s revenue was £130m, with HY20 revenue of £49.9m. We have FY21 forecast revenue of £135m and TUNE has just confirmed HY 21 revenue of £90m so it could be set to blow those forecasts out of the water.

Assuming a simple doubling of HY revenue for the full-year, that gives revenue of £180m. Running with a 10% net profit margin, that would make for net profit of £18m and earnings per share of 30.7p. Against a share price of 1,065p, that makes for a forecast PE ratio of 34.7x.

But brokers are already anticipating better margins and higher EPS than this (at 31.8p), and it appears to be those expectations TUNE is confident of beating. Applying the forecast net profit margin of 14.8% to the higher revenue figure posited above, and you would end up with forecast EPS of 45.5p per share and a forecast PE ratio of 23.4x. That would be some beat, mind. If we just add 10% to the broker EPS forecast, that would give EPS of c35p and a forecast PE ratio of 30.4x.

The above is obviously a very broad spread of earnings estimates and I’m just playing around with some numbers at this stage. And, again, there is that question: is this just a temporary lockdown boost to trading? Maybe we’re all locked down and dusting off our neglected electric guitars, but secretly just waiting until we can rush back to the pub.

Either way, Focusrite is worth a look for its quality and trading momentum. It’s not a bargain though. The market is bad at appropriately valuing true quality and long term growth, and I understand why existing holders are very happy, but still I wonder if there are better opportunities out there in terms of valuation. The really great returns happen when you combine earnings growth with multiple expansion.

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